6.8 Reverse Acquisitions

ASC 805-40-25-1 states that the guidance in ASC 805-40 on reverse acquisitions only applies if the accounting acquiree/legal acquirer meets the definition of a business in ASC 805 (see Section 2.4). Otherwise, the transaction is accounted for as either a reverse asset acquisition or a capital transaction, depending on the substance of the transaction. See Appendix C for more information about accounting for asset acquisitions.

In a reverse acquisition, the accounting acquiree/legal acquirer typically issues its shares to the owners of the accounting acquirer/legal acquiree as consideration in the transaction. However, to apply the acquisition method of accounting, the accounting acquirer/legal acquiree must calculate the hypothetical amount of consideration that it would have transferred to acquire the accounting acquiree/legal acquirer and obtain the same percentage of ownership interest in the combined entity that results from the transaction. Accordingly, the fair value of the consideration transferred is determined on the basis of the number of equity interests that the accounting acquirer/legal acquiree would have had to issue to the accounting acquiree’s/legal acquirer’s owners to provide the same ratio of ownership of equity interests in the combined entity as a result of the reverse acquisition. Generally, the fair value of the consideration transferred equals the fair value of the accounting acquiree/legal acquirer.

In some reverse acquisitions, the accounting acquiree/legal acquirer may issue cash or other consideration, as well as shares, to acquire the shares of the accounting acquirer/legal acquiree. The payment of cash to the shareholders of the accounting acquirer/legal acquiree should be considered a distribution of capital and, accordingly, a reduction of shareholders’ equity of the accounting acquirer/ legal acquiree.

For reverse acquisitions between a public company and a private company in which the public company is the legal acquirer but is determined to be the accounting acquiree, the fair value of the public company’s shares generally is more reliably determinable than the fair value of the private company’s shares. Thus, the determination of the consideration transferred might be based on the fair value of the legal acquirer’s shares rather than the fair value of the legal acquiree’s shares.

In a reverse acquisition accounted for as a business combination, the accounting acquiree’s/legal acquirer’s assets and liabilities are measured in accordance with the guidance in ASC 805 on business combinations. ASC 805-40-55-12 clarifies that an entity should measure goodwill in a reverse acquisition “as the excess of the fair value of the consideration effectively transferred” (emphasis added) by the accounting acquirer/legal acquiree divided by the fair value of the accounting acquiree’s/legal acquirer’s identifiable assets and liabilities. The consideration effectively transferred is calculated as described in Section 6.8.2.

In some reverse acquisitions, the accounting acquirer/legal acquiree owns shares of the accounting acquiree/legal acquirer before the transaction. To calculate the amount of goodwill to recognize, the accounting acquirer/legal acquiree must remeasure its previously held interest in the accounting acquiree/legal acquirer at its acquisition-date fair value and add it to the consideration transferred. See Section 6.5 for more information about the accounting for previously held interests.

If the accounting acquiree/legal acquirer does not meet the definition of a business and the acquisition is accounted for as a reverse asset acquisition, the accounting acquiree’s assets and liabilities are measured in accordance with the subsections in ASC 805-50 on the acquisition of assets rather than a business. See Appendix C for more information about accounting for asset acquisitions.

In some reverse acquisitions, some shareholders of the accounting acquirer/legal acquiree may not exchange their interests for interests in the accounting acquiree/legal acquirer, which results in noncontrolling interests in the combined entity. Because the noncontrolling interest holders own ownership interests in the entity determined to be the acquirer for accounting purposes, “the noncontrolling interest reflects the noncontrolling shareholders’ proportionate interest in the precombination carrying amounts of the legal acquiree’s net assets even though the noncontrolling interests in other acquisitions are measured at their fair values at the acquisition date.”

In some cases, a nonoperating public shell company legally acquires a private operating company by using cash, other assets, equity, or a combination thereof. A nonoperating public shell company is a registrant that has no or nominal operations and no or nominal assets (other than possibly cash). The owners and management of the private company generally have actual or effective operating control of the combined company after the transaction, and the private company gains access to the public market without going through an IPO. The SEC staff considers the acquisition of a private operating company by a nonoperating public shell company to be, in substance, a capital transaction rather than a business combination (or asset acquisition). That is, the transaction is a reverse recapitalization, equivalent to the issuance of shares by the private operating company for the net monetary assets of the public shell company accompanied by a recapitalization. The accounting is similar to that resulting from a reverse acquisition, except that no goodwill or other intangible assets are recognized.

In other cases, a SPAC, sometimes also called a “blank check” company, legally acquires a private operating company. A SPAC is a newly formed company that raises cash in an IPO and uses that cash or the equity of the SPAC, or both, to fund the acquisition of a target. After a SPAC IPO, the SPAC’s management looks to complete an acquisition of a target (the “transaction”) within the period specified in its governing documents (e.g., 24 months). In many cases, the SPAC and target may need to secure additional financing to facilitate the transaction. For example, they may consider funding through a private investment in public equity (PIPE), which will generally close contemporaneously with the consummation of the transaction. If an acquisition cannot be completed within the required time frame, the cash raised by the SPAC in the IPO must be returned to the investors and the SPAC is dissolved (unless the SPAC extends its timeline via a proxy process).

Before completing an acquisition, SPACs hold no material assets other than cash; therefore, they are nonoperating public “shell companies,” as defined by the SEC (see paragraph 1160.2 of the SEC Division of Corporation Finance’s Financial Reporting Manual [FRM]). However, SPACs engage in significant precombination activities (e.g., raising cash in public markets, identifying investment opportunities). Therefore, entities must analyze transactions in which a SPAC acquires an operating company to determine whether the SPAC or the operating company is the acquirer for accounting purposes (“accounting acquirer”).

The ASC master glossary defines an acquirer as follows:

Entities must first consider the guidance in ASC 805-10-25-5, which states, in part, that “in a business combination in which a [VIE] is acquired, the primary beneficiary of that entity always is the acquirer. The determination of which party, if any, is the primary beneficiary of a VIE shall be made in accordance with the guidance in the Variable Interest Entities Subsections of Subtopic 810-10, not by applying either the guidance in the General Subsections of that Subtopic, relating to a controlling financial interest, or in paragraphs 805-10-55-11 through 55-15.” Consequently, entities must consider whether the legal acquiree (i.e., the operating company) is a VIE on the basis of the guidance in ASC 810-10-15-14.

To qualify as a VIE, a legal entity needs to have only one of the following characteristics:

• The legal entity does not have sufficient equity investment at risk (see Section 5.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
• The equity investors at risk, as a group, lack the characteristics of a controlling financial interest (see Section 5.3 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest). In this assessment, there are specific requirements for entities that are limited partnerships or similar legal entities such as limited liability companies with managing members. Some of these entities may be VIEs depending on what voting rights are provided to limited partners in a limited partnership or to nonmanaging members for certain limited liability corporations (see Section 5.3.1.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
• The legal entity is structured with disproportionate voting rights, and substantially all of the activities are conducted on behalf of an investor with disproportionately few voting rights (see Section 5.4 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).

If the legal acquiree is a voting interest entity rather than a VIE, entities should identify the acquirer by first considering the guidance in the general subsections of ASC 810-10 related to determining the existence of a controlling financial interest. If they cannot identify the acquirer on the basis of that guidance, they should consider the factors in ASC 805-10-55-11 through 55-15.

ASC 805-10-55-11 states that in an acquisition “effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer usually is the entity that transfers the cash or other assets or incurs the liabilities.” Therefore, if the acquisition is effected primarily by the SPAC’s transfer of cash or other assets rather than its equity, the SPAC will usually be identified as the accounting acquirer.

ASC 805-10-55-12 states that in an acquisition “effected primarily by exchanging equity interests, the acquirer usually is the entity that issues its equity interests. However, in some business combinations, commonly called reverse acquisitions, the issuing entity is the acquiree.” That is, if the acquisition is effected primarily by exchanging equity interests, the SPAC is the entity that issues its equity interests to effect the transaction and is therefore the “legal acquirer.” Sometimes, the SPAC may also be identified as the accounting acquirer. However, in certain transactions, the operating company whose equity interests are acquired and is therefore the “legal acquiree” is determined to be the accounting acquirer. Entities should consider the following factors in ASC 805-10-55-12 and 55-13 when identifying the accounting acquirer in business combinations effected primarily by exchanging equity shares:

• “The relative voting rights in the combined entity after the business combination” (ASC 805-10- 55-12(a)).
• “The existence of a large minority voting interest in the combined entity” (ASC 805-10-55-12(b)).
• “The composition of the governing body of the combined entity” (ASC 805-10-55-12(c)).
• “The composition of the senior management of the combined entity” (ASC 805-10-55-12(d)).
• “The terms of the exchange of equity interests” (ASC 805-10-55-12(e)).
• The “relative size (measured in, for example, assets, revenues, or earnings)” of the combining entities (ASC 805-10-55-13).

See Section 3.1 for more information about identifying the acquirer.

If the SPAC is determined to be the accounting acquirer, the entities must determine whether the operating company meets the definition of a business (see Section 2.4). If it does, the transaction is a business combination and the SPAC recognizes the operating company’s assets and liabilities in accordance with the guidance in ASC 805-10, ASC 805-20, and ASC 805-30, generally at fair value. If the operating company is determined to be a group of assets that does not meet the definition of a business, the transaction is an asset acquisition and the SPAC recognizes the operating company’s assets and liabilities in accordance with the guidance in ASC 805-50 at relative fair value (see Appendix C). By contrast, if the operating company is determined to be the accounting acquirer, generally the SPAC’s only precombination asset is the cash raised from its investors and the substance of the transaction is a recapitalization of the operating company (i.e., a reverse recapitalization). Accordingly, the accounting for the transaction is similar to that of an acquisition of a private operating company by a nonoperating public shell company (as described above).

Because a reverse recapitalization is equivalent to the issuance of shares by the private operating company for the net monetary assets of the public shell company, the transaction costs incurred to effect the recapitalization may represent costs related to issuing equity and raising capital that are recognized as a reduction to the total amount of equity raised (i.e., reduction of APIC) rather than expensed as incurred.

See Section 5.7 of Deloitte’s Roadmap Initial Public Offerings for more information about offering costs. Also, for further discussion of reporting considerations related to acquisitions by public shell companies and SPACs, see SAB Topic 5.A and Deloitte’s October 2, 2020 (updated April 11, 2022), Financial Reporting Alert.