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Blank Checks: The Cost To Startups
Published on October 4, 2023
Blank Checks: The Cost To Startups

The financial ecosystem has been abuzz with the advent and rise of Special Purpose Acquisition Companies (SPACs). SPACs was started in 1993 by David Nussbaum, when “blank check” entities were actually illegal in the US. Now, however SPACs are a major player as startups explore avenues to go public. But, the nuances of SPACs, especially their implications on financial transparency, has demanded closer examination.

Special Purpose Acquisition Companies (SPACs) have emerged as a popular alternative to traditional Initial Public Offerings (IPOs). However, Accounting Today reports that Glass Lewis, a proxy advisory services company, stated last month that after several years of companies going public through IPOs or SPAC mergers, it observed a more than 2.5-fold increase in companies with concerning material weaknesses or restatements, partly because many of the companies are only in the early stages of developing strong internal controls. (Cohn, 2023)

For startups considering this avenue, understanding these challenges and equipping themselves is vital.

Exactly what are SPACs?

SPACs, or 'blank check companies', are shell corporations; termed as 'blank check companies', SPACs function as shell corporations. They are designed to raise capital with the singular aim of acquiring a private company, thus making it public. Post-acquisition, the private company is thrust into the public domain, sidestepping the intricate dance of a traditional IPO. Here lies the appeal, in their promise of reduced bureaucracy and faster access to public markets compared to traditional IPOs.

There are advantages to SPAC, as Dr. David Panton (Navigational Capital Partners) points out in a talk with Excelsior Capital:

  • Valuation: Public companies trade at higher multiples than private companies, so SPACs offer an opportunity for higher valuation.
  • Control: While business owners lose some control when taking on private equity, SPACs allow you to maintain a significant stake in the company.
  • Liquidity: SPACs offer security in liquidity through the cash raised in the IPO.
  • Time: Traditional IPOs can take up to 2-3 years to finalize, but SPACs are typically completed in 2-3 months.
  • Cost: Unlike traditional IPOs that are very expensive to execute, SPACs typically pay for most of the costs, saving a significant amount of money for the company.
  • Certainty: SPAC deals are identified ahead of time, and the valuation is agreed upon by both parties. Rather than “hoping the window is open,” you can be certain that the transaction will occur and that it’ll be for a value you are on board with (verbatim et literatim).

The Emerging Problem?

One of the cardinal challenges is the nascent stage of many SPAC-associated firms. Startups, in their embryonic phases, often lack the fortified internal controls that more matured companies possess. Transitioning from a private to a public entity demands meticulous financial scrutiny. Without a robust internal mechanism, these entities become vulnerable to inadvertent financial missteps and discrepancies.

Many startups opting for SPACs are in their early stages and lack comprehensive internal controls.

This can lead to accounting errors. Young companies may not have mature accounting procedures, increasing the risk of errors when reporting financial results. Furthermore companies may face deeper and more stringent regulatory scrutiny, which can expose any inadequacies in a startup's financial systems post-SPAC merger.

As a startup leader, you should always be as upfront, as transparent, and as organized as possible before entering any financial deal that will affect the future of your company, and your reputation.

What Are 5 Action Steps Startups Can Take To Be Better Prepared?:

  1. Internal Control Development: Before considering a SPAC merger, establish a robust internal financial control system. This includes checks and balances, routine audits, and risk management procedures.

  2. Due Diligence on SPACs: Investigate the track record of the SPAC and its management team. A history of successful mergers can indicate experience and reliability.

  3. Engage Financial Experts: Hire or consult with financial experts familiar with the SPAC process. Their insights can help navigate the merger and ensure compliance with all financial regulations.

  4. Regular Training: Ensure your team is knowledgeable about the regulatory environment for public companies. Regular training can keep them updated on best practices and changes in the landscape.

  5. Use Financial Software: Modern accounting and financial software can automate many processes, reducing the risk of errors and ensuring accurate reporting.

There is no arguing that SPACs offer a compelling avenue for startups to enter the arena of the public market, but this route comes with its unique set of challenges, and the journey is riddled with intricacies. It's imperative for startups to not only comprehend these challenges but to arm themselves adequately; taking a proactive approach, focusing on robust financial controls and informed decision-making. In the amazing race to go public, preparation and understanding can make all the difference between being thrusted into the public spotlight, or being thrown under the SEC bus.

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