Deloitte has been helping a growing number of startups go public through initial public offerings and special purpose acquisition companies in the past two years, but a recent poll suggests the appetite may be growing more cautious.
“We’ve seen a tremendous amount of activity this year in companies going public, companies getting ready to go public either through a traditional IPO or a SPAC primarily,” said Mark Davis, national managing partner of Deloitte Private Enterprises, who leads the firm’s Greater Tri-state IPO Readiness Practice. “The stats are overwhelming. In 2020 there were 480 IPOs, and in 2021 there were over 1,000 IPOs. How often does that happen? The last time was 1999, 2000, with the same type of result. It was about 480 in 1999 and over 420 in 2000. We haven’t seen this type of activity in the IPO space probably for about 20 years.”
While there have been other years when the IPO rate has been high, in 2007, 2008 and 2014, they didn’t reach the levels of the past two years, he noted. Many companies have been going the SPAC route in recent years by doing a reverse merger with a shell company, also known as a “blank check company,” as a way to go public more quickly than the traditional IPO route. There too Davis has seen an uptick in activity, pointing out that over 600 SPACs went public in 2021, compared to 250 in 2020. “Basically for 10 years before that, there were 200 in total,” he said. “The last time we had SPAC activity over 200 was in 1999 and 2000. The markets that are very big for IPOs tend to be hot markets for SPACs.”
Nevertheless, an online poll conducted by Deloitte during a December webcast and released Tuesday found some signs of caution, with 47% of the private equity professionals surveyed and 21.8% corporate development professionals indicating they are rethinking how they will access the public markets in 2022. Some 37.6% of the survey respondents in private equity, and 41.8% of the corporate development respondents, indicated their organizations are not prepared to pursue an IPO. But despite those concerns, 21.3% of private equity respondents and 19.6% of corporate development respondents expect their organizations will pursue an IPO or SPAC transaction in 2022.
When asked what was most likely to deter IPO and SPAC transactions for their organizations in 2022, 26% of private equity respondents indicated a global economic downturn, while 25.9% of corporate development professionals pointed to undesirable valuations. Other deterrents include continued regulatory scrutiny of transactional structures, according to 15.6% of the private equity respondents, along with post-transaction regulatory compliance, cited by 11.7% of private equity respondents and 11% of corporate development respondents.
Companies preparing to go through either an IPO or SPAC typically need help from accounting firms with their financial statements. “During the recent hot deal market, some leaders have taken their companies public three or four times faster than the typical 18 to 24 months usually needed to complete required financial, accounting, regulatory compliance work,” said Nicole Swenson, a Deloitte Risk & Financial Advisory managing director focused on transaction execution, accounting, reporting and integration at Deloitte & Touche LLP, in a statement. “But a tougher test of mettle for public companies and their leaders might be in maintaining strong financial reporting and regulatory compliance after transaction close and despite ongoing challenges.”
Of the 600 companies that set up a SPAC in 2021, estimates are about 75% still have not deployed that capital. “There could be somewhere around 400-plus companies that are looking to do a transaction,” said Davis. “When you talk about our emerging growth practice, we have hundreds of companies in our practice nationwide, and I would say more than 50% of them are talking to us today about being ready to go public, either through a SPAC or an IPO. In all the years I’ve been doing this, that’s the highest rate that we’ve seen in our firm.”
Despite growing inflation and the threat of the war in Ukraine spreading beyond its borders, along with the uncertainty of the lingering pandemic, the hot market for SPACs and IPOs could well continue this year.
“The market softens just because of events in the world that are sometimes out of the control of people getting a company ready, but at the end of the day, the opportunities are there,” said Davis. “I really think no matter what happens in the market, a company has to get ready to be public. That’s the focus today. Regardless of what’s happened in the market in the last few weeks, the companies are still getting ready. There’s always a moment when the market improves or the market drops. What does that really mean to a company going public? It’s just a moment in time. If you’re a great company and you have a great business and you have an enthusiastic employee base, the idea that you have to wait for the market to turn around is not necessarily the case. We haven’t seen a slowdown in companies that are preparing to be public. It takes 12 to 24 months to get yourself prepared to be a successful public company with governance and internal controls and accounting and converting your financial statements to SEC-level PCAOB standards. Those things take a while. We have not seen companies walk away from the market.”
That’s different from what he saw during the dotcom bust of the early 2000s. “When the bubble burst in April 2001, I would say probably 95% of the people that we dealt with in the companies in the Greater Tri-State said they were pulling out of the idea of doing an IPO, and I’m not seeing that today,” said Davis. “I think that many companies look at these events in the market as temporary and ultimately want to position themselves. There could be 400 SPACs that would look to deploy capital, and if that alone happens, that would be a record year, except for last year. It would be a phenomenal year if all of those SPACs completed their transactions. I think 2022 will still be a positive year in comparison to other years for IPOs and SPAC transactions that get completed.”
SEC warning on warrants
The SEC issued a
“We went through that in spring to summer of last year, when the SEC focused on the accounting for warrants in the initial SPACs,” he said. “They were asking questions about warrant accounting and generally, in the past, those warrants have been recorded as equity. After a lot of back and forth with the major accounting firms and the two firms that do most of the SPAC audits, Withum and Marcum, ultimately it was decided that many of those warrants should be accounted for as liabilities. What ended up happening is it took a month or two for most of the transactions that were in process. I had a few of our clients that were the operating companies that were being acquired by the SPAC. They were working through with the SPAC to get those filings updated and working with the accounting firms that audit the SPAC. But really, all it did was delay the process. We didn’t see any one of our clients here in the Greater Tri-state that actually stopped pursuing the SPAC transaction because of that. That did not get in the way of SPACs getting completed.”
The decision to go with a SPAC as opposed to an IPO may depend more on timing than on how the SEC views the accounting treatment. “When people are looking at the difference between doing an IPO and a SPAC, sometimes it’s timing,” said Davis. “The view is that a SPAC transaction can be done quicker than a traditional IPO. The other part is that you’re not subject to what the market might value your company in an IPO, whereas in a SPAC transaction, you can negotiate that with the investors. There are differences in the transactions, but I don’t see the accounting issues that were raised by the SEC as something that got in the way of the success of those deals. As they do with a lot of things, they raised good questions. The firms evaluated them with their clients, and adjustments were made. In this case, it just delayed the transaction, but in most cases, it didn’t stop the transaction.”
Tax considerations
Tax is another issue that comes up when deciding whether to do a SPAC or an IPO. “When we’re assisting our clients, we always pair up and bring our tax folks to the table because getting the company set up correctly at the time of an IPO will be studied by law firms and underwriters that you bring in, so making sure the ownership structure works is a key part,” said Davis. “Tax becomes a key element of an IPO or a SPAC transaction. Some of the SPAC transactions are very complicated tax-wise. Another element besides corporate tax is sales tax. We often find, depending on the industry that the company is in, that sales tax is something that a company needs to make sure they understand. Are they responsible for collecting sales tax? Have they collected it? Have they remitted it, and if not, what type of estimate needs to be recorded in the financial statements? That is a significant area.”
Another important tax issue involves Section 382 of the Tax Code and whether the change in ownership could affect the deductibility of net operating losses. “You have to go through a calculation to see if any of your NOLs have been limited because of the ownership change that occurs at the time of an IPO or SPAC transaction,” said Davis. “Those things are key focuses of all the clients that we service.”
The overall M&A market also plays a role in IPO and SPAC transactions and whether a potential merger could be happening after the transaction between the shell company and the operating company.
“I would say that all of these companies that are looking at a potential IPO or SPAC are also at the same time looking at acquisitions,” said Davis. “They’re looking at potentially selling the company. They’re looking at private equity investment. There’s always a multipath track on these transactions. It’s never just one track. We’re also seeing as a firm nationally a significant amount of M&A activity within the pre-IPO space. Valuations are very strong for companies looking to sell. Depending on the industry, when you look at some of the technology transactions that have occurred in the SaaS space particularly, they can be at very sizable premiums compared to what their recent valuation was. Companies need to look at that. They can’t just go in one path. I’ve had clients for 20 years that are looking at a potential sale of the company as well as finishing an IPO. I would say a significant percentage at the last moment would potentially sell the company rather than complete the IPO. They get a higher value and we don’t have to wait for the company to grow. They’re getting the value that they think they're going to be worth in two or three years today. You see a lot of companies get purchased right before they complete the IPO. We haven’t seen that as much in the last year or two. More of the companies are completing the IPO or the SPAC transaction.”
Companies need to keep an eye on several important areas as they prepare to go public, whether it’s through a SPAC or an IPO.
“Ringing a stock market bell and seeing a ticker trade publicly are both exciting inflection points as organizations go public,” said Christine Murphy, a Deloitte Risk & Financial Advisory managing director at Deloitte & Touche LLP, in a statement. “However, we always urge leaders to stay focused on their organizations’ long-term, transformative needs as a future or newly public company. By measuring their companies’ efforts against requirements for publicly traded institutions, those leaders can help identify financial reporting, talent and skill sets, processes and systems gaps that — once addressed — improve overall company performance.”
IPO and SPAC questions to ask
Questions leaders can ask to ascertain the strength of financial reporting teams, practices and protocols for organizations pursuing or newly trading in public markets include, according to Deloitte:
- What does our organization’s filing calendar look like? Establishing a clear timeline of when various filings are due can help organizations navigate the change to public company requirements. Building and honing processes — and sometimes additional resources — to support deadline achievement can often serve as a bit of a resource gap analysis spanning areas inclusive of accounting, financial reporting, financial planning and analysis, tax, internal controls and IT systems.
- Are our internal controls ready to support Sarbanes-Oxley Act (SOX) Section 404 compliance? While SOX will enter its third decade later in 2022, compliance with it can be complex for newly listed companies. Requirements for management to implement internal controls designed to provide investors with reliable financial information or — if the public company is large — to assess and report on the effectiveness of internal controls can be a marked change for previously privately held organizations.
- Have we tested our organization’s ability to meet regulatory requirements? If accounting and reporting processes as well as internal controls are established or poised to launch, organizations can consider working to find ways to improve efficiency and effectiveness as part of an ongoing process to help provide regulators, investors and other stakeholders with accurate information.
- What new talent do we need to bring on board? Just as private entities don’t always have professionals with experience in public company financial reporting or SOX, they also don’t typically have treasury or investor relations functions. Often prior to initial filing or shortly after filing, organizations need to scale talent in these areas.
- How formalized is our organization’s corporate governance structure? Depending on the exchange they’re listed on, publicly traded companies have varying requirements for their boards. Typically, organizations shifting to public status need to transform their boards to include more members who are independent, experienced in advising other publicly traded organizations on finance, accounting and other regulatory requirements, experienced in the industry and who demonstrate the organization’s commitment to environmental, social and governance (ESG) and diversity, equity and inclusion (DEI) advancement.
