square blocks forming circle

Perspectives

Digital asset companies and SPACs: What emerging companies should know

Appeals and challenges of SPACs for digital asset start-ups

As the market for crypto, blockchain, and digital assets has expanded, so has the popularity of going public via special purpose acquisition company (SPAC). The industry and method seem to be a fit. But although digital asset SPAC transactions have important potential benefits, they’re not without hurdles.

Digital asset companies and SPACs: The intersection of two major trends

During 2021, there was a notable increase in the activities of, and market interest in, special purpose acquisition company (SPAC) transactions with digital asset companies. SPAC mergers enable private operating companies—known as target companies—to go public in a way that permits the target to negotiate pricing upfront, thereby offsetting the risk of market volatility and allowing companies to include forward-looking projections in their Securities and Exchange Commission (SEC) filings.

The expanding digital asset market has resulted in considerably increased interest from investors, and in particular SPACs, that are seeking new avenues into this industry.

Despite its popularity, going public via a SPAC merger is, generally speaking, not easier than a traditional IPO. The target company must devote substantial time and resources to technical accounting, disclosure requirements, SEC regulations, and structuring considerations, as well as internal controls implications, all the while upgrading to be public-company ready. For digital asset companies, the matter is further complicated by a host of challenges that often arise from applying current accounting standards and tax regulations to these transactions.

Big upside: The benefits of a SPAC merger for a digital asset company

Digital asset startups have a unique ability to raise capital through other means and may be generally profitable or sufficiently capitalized out of the gate. But if a company is going to be competitive long-term, it will typically need to turn to public markets. This is not uncommon among disruptive technology companies where early capital is necessary for growing market share at an expedited pace. SPAC mergers may be an effective route to acquiring capital and going public.

Beyond capital costs and the need for the right talent, going public comes with a host of compliance issues, including:

  • Complexities of securities laws, as well as pertinent banking rules and regulations
  • Increasing regulation and compliance requests from government entities and organizations
  • Know your client (KYC) issues, including compliance with the Travel Rule
  • Anti-money laundering (AML) requirements

And, of course, there are the many complex issues of governance. After all, players in the digital asset ecosystem do not have complete control of their universe. They typically rely on platforms over which they do not have full or direct control. Hence the need for strong governance procedures and practices.

SPACs created by seasoned management and business leaders as well as financial services companies are well positioned to provide the capital and much of the broader guidance that young companies and their founders need in order to go public. As companies grow, many SPACs can provide access to private investment in public equity (PIPE) investors. These entrepreneurs can provide additional and vital capital that can help a company scale up, capture, grow, and maintain market share in a highly competitive arena.

Finally, and perhaps most importantly, by their nature and inclination, SPACs may be open to taking greater informed risks in order to realize a higher upside, especially with early stage and emerging companies. What are other major considerations?

This section is an infogram

This message and the space it occupies will not be displayed when viewing this page either in Live, Preview, or "View as published" modes

Big questions: The challenges of a digital asset company going public via SPAC

For young and emerging digital asset companies seeking to go public, there are a number of basic accounting, tax, and control questions and considerations.

It’s worth noting that the more complex the digital asset business is, the more challenges there may be in applying the existing accounting models to those transactions.

Companies using crypto in a manner similar to a financial asset are required to account for it as a non-financial intangible asset. That leads to a number of accounting challenges. One of the more specific impacts is that crypto assets are subject to impairment rules under ASC 350 when the market value for the held crypto asset declines but cannot be written back up as the market recovers. This often leads to recorded balances within the financial statement that represent the lowest market value in the company’s holding period and not the value at the reporting date.

As the American Institute of Certified Public Accountants (AICPA) taskforce laid out in its 2021 guide Accounting for and auditing of digital assets, there are several important implications and challenges associated with that reality. Those challenges may ultimately force companies to adopt even more robust disclosures to describe those transactions both in the financial statements and when speaking with regulators.

In addition, from an SEC reporting perspective, digital asset companies seeking to go public via a SPAC should also be aware of recent staff interpretations issued by the SEC through Staff Accounting Bulletin No. 121 and consider its applicability to the Company’s accounting and reporting.

Given the scarcity of pertinent court cases, private letter rulings, rules, and, as of yet, full legislation, developing a tax position in the crypto-SPAC universe is often a demanding process. It frequently relies heavily on analogy and judgment. This increases the need for scrutiny of all tax positions for a newly public company.

To be sure, the IRS has issued IRS Rev. Rul. 2019-24 that provides guidance on the tax implications for gross income of “hard forks” as well as a set of Q&As that provide broad guidance on some 40 topics. But this guidance is not comprehensive for all of digital assets and cryptocurrencies and further clarifications and legislation are in the works.

In the starkest of terms then, one might contend that in this space every tax position is potentially an uncertain tax position (UTP). This creates risk in an SEC filing that requires appropriate consideration of disclosures in the registration document, from a tax perspective.

There is no specifically designed risk and control framework for digital asset companies beyond already existing frameworks such as COSO. But, when it comes to SPACs and digital asset IPOs, the most important considerations are the target company’s business processes and model that are unique to digital asset companies.

One area to focus on is the controls around custody of digital assets and auditability of that custody. When SPACS approach a digital asset company, they’ll likely want information about how assets are custodied. If a company self-custodies, then robust protocols and processes need to be in place around private key security. If a company relies on a third party, then it’s important to check that their system and organizational controls (SOC) report provides adequate coverage of crypto-specific controls in addition to the general IT and business process controls. That can also help the auditor determine the nature of the company’s control/ownership of the assets and allow them a level of confidence in their ability to audit the company’s assets, among other things.

No company wants to be labeled “unauditable”. In May 2020, the Public Company Accounting Oversight Board (PCAOB) issued a Spotlight, “Audits Involving Cryptoassets” that underscores the need to identify and assess the risks for any material misstatement related to those assets.

Time to consider a SPAC?

Being the target of a SPAC merger can hold immense promise for younger and emerging companies in the digital asset ecosystem. The volume and value of the activity is tremendous. But navigating the complexity of a SPAC merger along with the complexity and innovation that animate this digital asset ecosystem defies easy categorization or solutions.

Deloitte has a team of professionals with experience advising companies throughout the life cycle of the SPAC process . We can advise and assist with the following:

  • Technical accounting assistance for digital asset companies.
  • Seller assistance, vendor due diligence, or both.
  • Implementation of public company GAAP.
  • Preparation of quarterly financial statements.
  • Preparation of pro forma financial statements.
  • Responding to SEC comment letters.
  • Drafting the MD&A and providing advice on non-GAAP measures.
  • Evaluating the significance of business acquisitions and the resulting reporting requirements.
  • Drafting SEC waiver requests (as applicable).
  • Assessment and build-up of an internal control environment for public companies.
  • Assistance with SOX implementation and certification, including blockchain- and digital asset-specific considerations.
  • Designing automated solutions for financial reporting processes and controls.
  • Tax planning/UP-C strategy and compliance, including considerations for digital asset companies.
  • Information technology system assessment and implementation.
  • Preparation for, and management of, additional audit procedures to conform to PCAOB standards.
  • Corporate governance structuring and reporting.
  • End-to-end project management.

Contact us

Our Blockchain & Digital Assets leaders are ready to help your business trailblaze in this space – with a multi-lens perspective that provides clarity through the complexity. Reach out to ask a question, start a conversation, and select “yes” below to subscribe for the newest insights and reports about Blockchain and Digital Assets.

 
 
 
 
 
 
 
  Yes         No

Did you find this useful?