Raising capital is a critical challenge for many growth companies. With the market for smaller initial public offerings relatively quiet in recent years, some companies are turning to alternatives such as Specified Purpose Acquisition Corporations (SPACs) and reverse mergers.

A SPAC is actually a form of an IPO, explains Charles Weinstein, CPA, managing partner with Eisner LLP in New York City. The primary difference is that a SPAC has no operating business at the time of the offering. SPACs are “acquisition vehicles” formed by dedicated management teams, usually consisting of some combination of individuals with relevant industry experience, successful entrepreneurs, managers and/or investment bankers. The team works with an underwriter to raise money in an IPO that will be used to acquire an existing business in its target sector.

Acquisition of an Operating Company Whether a SPAC or a conventional IPO is preferable depends on the nature and objectives of the parties involved, points out Joseph Tiano, Jr., a partner with Thelen Reid & Priest LLP in Washington, D.C. A viable operating company seeking additional working capital and wishing to retain control of its operations would likely favor an IPO. A SPAC is generally formed for the specific purpose of acquiring an operating company, with control passing to the principals and stockholders of the SPAC.

SPACs are "acquisition vehicles" formed by dedicated management teams, usually consisting of some combination of individuals with relevant industry experience, successful entrepreneurs, managers and/or investment bankers. The team works with an underwriter to raise money in an IPO that will be used to acquire an existing business in its target sector.

Typically, 85–95% of the proceeds raised in a SPAC IPO are held in trust. The SPAC must generally sign a letter of intent to form a business combination within 12 or 18 months of the IPO, or it will be forced to liquidate and distribute the trust holdings to the public stockholders. The acquisition target must have a fair market value equal to at least 80% of the SPAC’s assets at the time of the acquisition. If a letter of intent has been signed within the specified time period, the SPAC can close the transaction within six months of the end of such period.

Regulators Show Increased Interest in SPACs However, the increasing popularity of SPACs is also bringing closer scrutiny by the SEC, warns Steven Skolnick, a partner with Lowenstein Sandler PC in Roseland, N.J. “SPACs offer a simplified alternative to a traditional IPO for raising cash and can be useful for an entity that does not currently have an operating business and is looking for an acquisition candidate” he says. “Prior to the summer of 2005, it was an easier transaction to complete. But once the number of deals started increasing, the SEC started looking at them more closely, and the regulatory climate has grown more stringent.”

In particular, the SEC has begun looking closely at the fair value of unit purchase options going to underwriters in SPAC deals. The agency is also asking more pointed questions about capitalization levels of SPAC entities and how that figure was determined.

A potential pitfall associated with SPACs is a requirement for shareholder approval of an acquisition, a process that may be cumbersome and time-consuming for the seller, notes Weinstein. Skolnick points out that the increased use of SPACs could make it more difficult for entities to find appropriate acquisition targets because of increased competition.

New Rules May Help Climate for Reverse Mergers In essence, a reverse merger is a transaction in which a private company becomes public through a combination with an existing public company, with the private company ending up in control of the combined entity. “More often than not, the public entity in a reverse merger is a ‘shell’ company, with no operating business and insignificant assets,” Weinstein explains.

• Ability to complete the transaction without engaging an underwriter, thus reducing overall costs.
• Avoiding the rigors of the IPO process, including a long road show.
• Less vulnerable than an IPO to the vicissitudes of public markets and risk of being unsuccessful.
• Ability to complete the transaction in a shorter time if the private company has audited financial statements and other required information available at the time of transaction, preparations that can be easily completed with a CPA firm.

In the past, there has been a potential stigma attached to companies taken public through a reverse merger because there was very little information about the operating company available immediately after the transaction, Weinstein points out. However, he believes that elements of a new SEC final rule related to filings by shell companies (17 CFR Parts 230, 239, 240 and 249) that became effective on August 22 and November 7, 2005, may help to “legitimize” the marketplace for reverse merger transactions. The new rules require more timely and extensive disclosure for the operating business in a reverse merger, such as the filing of Form 8-K within four days rather than the previously required 71 calendar days after the date that the initial report on Form 8-K must have been filed.

For more information, please contact Mike Bernstein at mbernstein@gellerco.com.