Reverse Recapitalizations

Introduction

Business combinations come in a variety of shapes and sizes. As such, knowing when and how to apply the guidance in ASC 805, Business Combinations to acquisition transactions can be challenging. Accounting for acquisitions involving Special Purpose Acquisition Companies (SPACs) is no exception. When SPACs acquire other companies, they must consider SEC guidance, including situations in which these transactions are accounted for as reverse recapitalizations rather than as business combinations. 

This article explains SPAC business combinations and reverse recapitalizations by providing context on what SPACs are and when SPAC-related acquisitions are treated as reverse recapitalizations instead of business combinations.

What is a SPAC?

A SPAC is a type of shell company that has no business operations but raises capital through an IPO to acquire a private operating company (known as the “target”). SPACs are commonly called “blank check” companies because generally the only material assets on their balance sheets are cash and marketable securities. 

SPACs usually have a time limit to acquire a target company before they must wind down and return capital to investors. When a SPAC successfully acquires a target, the combination transaction is called a “de-SPAC” transaction. For more information about SPACs and de-SPAC transactions, see this article.

Like other companies, SPACs must consider business combination accounting when completing a de-SPAC transaction, including identifying the accounting acquirer. This determination affects how the SPAC applies ASC 805 and/or specific SEC guidance when accounting for the acquisition of the target.

How Are De-SPAC Transactions Treated Under ASC 805?

De-SPAC transactions can occur in a variety of ways, but this article focuses on two common methods:

1. A SPAC pays cash to acquire the stock of a target
2. A SPAC uses its own stock to acquire the stock of a target

In either scenario, the accounting acquirer (the entity that gains control of the other) must be identified. When a SPAC acquires a target using cash, the SPAC will generally be the accounting acquirer.¹ Even in scenarios where observing a controlling financial interest (greater than 50% voting stock ownership) is not enough to clearly determine the acquirer, ASC 805-10-55-11 states that when one entity purchases another for cash, the entity transferring the cash is usually the acquirer.²

If a SPAC uses its own stock to acquire the target, the SPAC is the legal acquirer (the company purchasing the other) but may be either the accounting acquirer or the accounting acquiree. In these cases, the SPAC may need to apply the guidance in ASC 805-10-55-12 through 55-15 to determine the accounting acquirer. This involves evaluating which entity:

• has the most relative voting rights or a larger minority stake in the combined entity
• has owners with the most power to control the combined entity’s board
• provides the management who will run the combined entity
• paid a premium over the fair value of the other entity in the acquisition, if any
• is larger based on assets, revenues, or net income
• initiated the acquisition process

This analysis will result in one of two scenarios:

1. A forward merger, where the SPAC is both the legal acquirer and the accounting acquirer.
2. A reverse merger, where the SPAC is the legal acquirer but the accounting acquiree (the private target company is seen as effectively acquiring the SPAC from an accounting perspective)

Ultimately, if a SPAC acquires a target using cash or is identified as the accounting acquirer in a stock acquisition, the transaction is accounted for as a business combination under ASC 805.

However, in most de-SPAC transactions involving an equity exchange, the private target company is identified as the accounting acquirer. This is because the target’s management usually runs the merged business going forward and the target often meets other factors from ASC 805-10-55-12 through 55-15. As a result, most de-SPAC transactions are reverse mergers, where the legal acquiree (the private operating company) is the accounting acquirer.

While any business combination could result in a reverse merger based on facts and circumstances, additional considerations are needed for reverse mergers involving SPACs. Although the SPAC is the accounting acquiree in these scenarios, it is usually not considered a business under the FASB’s definition in ASC 805-10-55-3A through 55-9. This is because its only material assets are cash and other liquid assets and it lacks substantive revenue-generating inputs and processes.³ Instead, SPACs are generally considered nonoperating public shell companies.⁴

Since the SPAC is not a business, the de-SPAC transaction cannot be accounted for as a business combination under ASC 805. Instead, such a transaction is treated as a reverse recapitalization, which is not directly codified in US GAAP.⁵

Reverse Recapitalizations

According to the SEC, “the staff considers a public shell reverse acquisition to be a capital transaction in substance, rather than a business combination…equivalent to the issuance of stock by the private company for the net monetary assets of the shell company accompanied by recapitalization.”⁶

In other words, the SEC views a reverse merger between a SPAC and a private operating company as a financing event where the private company issues its stock for the SPAC’s cash. Because the transaction is economically like issuing stock to raise capital, the future financial statements of the combined entity represent a continuation of the target’s financial statements, adjusted to match the SPAC’s capital structure. This is what the SEC refers to as a reverse recapitalization.

Reverse recapitalization accounting is unique but, in most respects, similar to business combination accounting used in reverse mergers, with or without a SPAC. The following table outlines the primary differences between how SPAC forward mergers and reverse recapitalizations are accounted for:

Why Reverse Recapitalizations Matter to Investors

Unlike business combinations, reverse recapitalizations do not result in remeasured assets and liabilities, and no goodwill is recorded. As a result, net income in future years will not be affected by the amortization of newly recognized intangibles or fair value step-ups. This improves comparability with historical data. 

Additionally, earnings per share are retroactively restated using the merger’s equity exchange ratio (how many SPAC shares were used to acquire each share of the target)⁹. This allows shareholders to more easily compare the operating company's pre- and post-merger performance under the same new capital structure. 

Finally, because transaction costs in reverse recapitalizations often show up as a reduction of equity rather than an expense, reported net income for the period of the merger is not negatively impacted by these one-time costs. Taken together, these accounting results show investors that a new public entity formed in a de-SPAC transaction is essentially the same as the former private operating entity, but with an increase in cash and a change in capital structure.

Investors should be aware, however, that de-SPAC transactions can also burn a significant amount of cash and are often more expensive than traditional IPOs because two companies are hiring auditors, lawyers, and preparing for a merger. SPAC shareholders can also decide to redeem shares, which may cause the target to receive less cash, require concurrent financing, or stall the deal if the target does not receive at least a minimum cash amount.¹⁰

Investors should also understand other financial reporting and disclosure requirements for de-SPAC transactions, including substantial changes the SEC released in 2024. To learn about these changes and the SEC’s efforts to inform and protect investors in de-SPAC transactions, read this article.

Conclusion

Because most de‑SPAC transactions result in the private operating company being identified as the accounting acquirer, they are often accounted for as reverse recapitalizations rather than business combinations. In these cases, the private company’s historical financial results carry forward, no fair value step‑ups or goodwill are recognized, and the transaction is treated as the private operating company receiving capital and adjusting its capital structure to reflect the SPAC’s. 

Understanding this distinctive accounting treatment helps preparers apply the appropriate guidance, comply with SEC expectations, and faithfully reflect the substance of de‑SPAC transactions in the financial statements.

References

10. Torres & Zheng Business Law, Minimum Cash Conditions in U.S. De-SPAC Transactions: From Boilerplate to Deal-critical Term

Other Resources Consulted

ASC 805, Business Combinations

ASC 810, Consolidation

Deloitte Roadmap: Business Combinations

Domestic SPAC mergers–accounting and financial reporting

SEC Division of Corporation Finance Financial Reporting Manual, Topic 12: Reverse Acquisitions, Reverse Recapitalization, and De-SPAC Transactions

Mayer Brown, SPACs: A Market Update and Securities and Regulatory Overview

SEC 2024 Final Rules on SPACs, Shell Companies, and Projections