Markets continue to experience volatility across the globe and throughout most industry sectors. Although monetary policy and government stimulus have provided dramatic assistance that is helping to propel the major stock indices, certain underlying economic metrics show that the economic recovery from the COVID-19 pandemic continues to be slow and is filled with significant uncertainty.
With high stock prices, growing debt on balance sheets of both governmental and private entities, and uncertainty related to when, and if, a full recovery will occur, investors continue to search for a place to invest their capital to manage these risks. Precious metals continue to be looked to as a hedge against inflation and currency risk during periods of economic uncertainty. Some investors may look to holding precious metals directly, such as gold, silver, or platinum to name a few. Companies in the business of extraction and production of precious metals also have benefited from the attention of investors through significant share appreciation and strong yields. Demand for precious metals, rare earth elements, and other strategic metals have increased as the digital age and the “green economy” expands as these metals are often a key component in the manufacturing of electronics, solar panels, wind turbines, and electronic vehicles. These factors have led to gold prices doubling over the past five years and nearly 25% to date in 2020, which has only increased the focus on metals overall.
Companies mining for precious, rare earths, or other strategic metals typically require unique financial structures due to their operating model and asset characteristics. There are long-term investment time horizons given the life cycle of a mine, from prospecting, exploration, and defining reserves, to development and construction, to extraction and production, and finally to reclamation. The long development times, the sheer size of the projects, and the lengthy list of execution risks leads to a very capital-intensive business model. Additionally, significant pre-revenue time frames can make conventional debt sources impractical.
In addition to general exploration and extraction risk, there are often other complicating factors. The locations of these minerals are often in difficult to access settings or in locations governed by challenging governmental regulations or strong local opposition. These risk factors provide a profile that certain capital providers are unwilling to accept. The COVID-19 pandemic creates additional risks related to health and safety of workers given the close proximity of working conditions of an operating mine, although these additional risks are not only impacting mining companies. Given these unique characteristics of mining companies, typical options for raising capital include large equity financings and complex convertible debt instruments. Joint ventures are also common to bring different parties together to help address these capital constraints.
Equity raises as a financing venue
Initial public offerings (IPOs) have historically been a common option to address these financing challenges for mining companies. However, market volatility provides a disincentive for an IPO as the wider market sentiment can directly, and negatively, impact the company’s ability to raise capital. Additionally, a traditional IPO is a complicated, time-intensive, and costly process. An alternative increasingly viewed as a more advantageous financing route is the special purpose acquisition company (SPAC).
SPACs are not new but have been increasing in popularity recently due to their advantages and are often referred to as a “blank check company.” As of September, throughout all industries, approximately 40% of this year’s initial public offering volume has come from SPACs, according to Bloomberg, which resulted in raises totaling $41.2 billion through the same period, according to the Wall Street Journal, up from last year’s total of $13.5 billion.
A SPAC is a new company that’s formed for the purpose of raising capital, and thus has no initial operations. The capital is raised through an IPO process and that capital is then utilized to acquire future target companies, which are often unknown at the time of the SPAC’s creation. Since the SPAC doesn’t have any current operations and is effectively a shell company at the time of its IPO, the process of raising capital in a SPAC is simplified as compared to a traditional IPO of an operating company.
While the terms and provisions of each SPAC differ, the sponsor that forms the SPAC generally receives a portion of ownership referred to as founder shares, with the remaining ownership interests held by the public shareholders. The interests purchased by the public shareholder will generally include both a common share and a warrant. However, with the increasing popularity of SPACs, all of these provisions are subject to negotiation. Until one, or many, target companies are identified, and a merger is successfully negotiated and completed, all funds received during the SPAC’s IPO are held in a trust. If a target cannot be identified and the merger completed within the defined timeline or the shareholder elects to not participate in acquisition, the shareholder will receive its pro rata share of funds held in trust. SPACs may also raise debt or other equity as they look to complete mergers for identified companies. Through this process, the target company, such as a mining company in need of capital, would then have the capital necessary to continue its exploration, development, and/or production plans.
Accounting events and reporting requirements of a SPAC
Upon successful IPO, the SPAC creates ongoing filing requirements as it’s now a publicly traded company subject to annual and quarterly filings with the Securities and Exchange Commission (SEC), just like any other publicly traded company.
The identification of and entry into an agreement for a merger of the SPAC and target create additional significant filing requirements associated with the shareholder approval and governance of the proposed merged entity. These filings are generally numerous and take place in a proxy statement or a Form S-4 and include, financial statements of the SPAC and target, pro forma financial information of the proposed combined entity, and management’s discussion and analysis, among others — all of which can be challenging and time-intensive to prepare. The process typically involves filing preliminary documents which are reviewed by the SEC and are subject to their comments, which are incorporated in subsequent filings, which may lead to the filing of multiple versions over numerous quarters before the document becomes effective.
Upon the successful merger of the SPAC and target, additional accounting and reporting considerations are created in addition to the ongoing annual and quarterly filings with the SEC. After the merger, the combined entity must then file a Form 8-K, often referred to as a “Super 8-K,” which results in the combined company filing information that would have been included as if the target had filed its own registration statement. While much of this information may be similar to what was previously filed by the SPAC upon entry into the agreement for merger, depending on the timing of that previous filing, that financial information may need to be updated to comply with the age of financial statements requirements as some of the prior information may now be stale, as defined by the SEC, as a result of time passing.
Additionally, the newly combined entity now has to determine which entity, the SPAC or the target operating company, is the acquirer for accounting purposes as defined by generally accepted accounting principles. (These transactions also have significant income tax and related financial reporting ramifications, which are not addressed in this article). This determination impacts the presentation of historical results of the newly combined entity. While the legal form of the transaction is that the SPAC acquires the operating company, the assessment of the accounting acquirer focuses on who is the controlling party. If the operating company is determined to be the acquirer for accounting purposes, the transaction is accounted for as a reserve acquisition, which results in the operating company accounting for the acquisition of the SPAC and the operating company’s historical results are presented for the newly combined entity. If the transaction is deemed to be a reverse acquisition, the merger is treated as an equity transaction and there is no step up in the historical basis of the assets of the operating company. Alternatively, if the SPAC is determined to be the accounting acquirer, the SPAC would account for the acquisition as a business combination resulting in valuing and recording the assets acquired and liabilities assumed at fair value, and only the historical results of the SPAC would be presented. When a combination of entities is affected through primarily exchanging equity interests, as is common in a SPAC transaction, this assessment and identification of the controlling party requires significant judgment. The assessment involves weighing several factors such as relative voting rights, composition of the board and of senior management of the SPAC and operating entity, as well as assessment of the terms of the equity interests exchanged.
Navigating the process
While the SPAC process of raising capital is generally less complicated than a traditional IPO process, it’s still a complex and time-intensive process from creation and capital raise through acquisition and integration. In addition to these financial reporting considerations, there are various, significant tax outcomes to also consider. The target operating company and the SPAC entity may need multiple advisors to assist with the many challenging aspects of this process. Some of the complexities that advisors often provide assistance with include:
- Financing structuring & marketing
- Legal
- Accounting & financial & SEC reporting
- Tax advisory & compliance
- Project management
Additional support can be provided by advisors related to the ongoing aspects of the new combined publicly traded company, including information technology, cybersecurity, operational efficiencies, and internal controls.
If you have any questions, please give our energy team a call.
