There has been rapid growth in food tech over the past decade, with plant-based meat, dairy and egg alternatives, cultured meat products, and other tech-driven food innovations being introduced at a rapid pace. In just the last few years, we have seen milestone initial public offerings (IPOs) in this space such as Oatly and Beyond Meat, as well as special-purpose acquisition company (SPAC) deals to bring businesses like AeroFarms and Ginkgo Bioworks public through this alternative process.
High valuations backed by successful IPOs, along with rising interest in sustainability, all indicate that this space will continue to receive investor attention — and more food tech companies will likely continue to go down the path of a public offering.
When valuations and investments are booming, there can be increased risk of heightened public scrutiny for companies that are not properly prepared to go public. For any food tech company looking to make this leap to become a publicly-traded entity, there are several valuation requirements that leaders must consider to prepare for and ease the IPO process.
The Value of Stock Options
When many venture-backed companies in the tech sector launch and expand, they commonly offer stock options to key employees. The options are a form of deferred compensation, saving businesses upfront cash while in a cash-burning phase of growth. This type of equity compensation is thus an important tool for attracting and retaining talent as well as recruiting and incentivizing a strong management team. One thing to keep in mind is that as a company gets closer to an IPO or SPAC acquisition, the options pricing and review process gets more strenuous for tax purposes and financial reporting. The Internal Revenue Service (IRS) and the Securities and Exchange Commission (SEC) might carefully review stock options pricing and stock compensation expenses for companies heading to the public markets. If regulatory entities believe that the pricing of the options was below market value, there could be a process delay which can have a negative impact on deal timing and, ultimately, closing — especially if market conditions shift, which can happen rapidly in today’s volatile marketplace.
Frequently, as a growth company that may not yet be cash flow positive is preparing for a SPAC acquisition or IPO, there is a need to secure relatively short-term bridge funding. This capital helps with short-term funding while the larger public deal is finalized. In these circumstances, the company may issue convertible notes, where the terms will offer investors the right to convert the notes into company shares when the company goes public, often at a 10-20% discount to the initial public price. These bridge rounds provide capital without the need to negotiate and establish a new preferred stock round price, which may save time and align the funding with a potential public pricing process.
However, once this funding is secured, there are accounting and valuation ramifications that are often quite complex. As the company prepares to become public, the notes will need to be assessed for complex features that may require separate accounting with recurring quarterly valuations of fair value for each required reporting period based on the terms of the notes and other key assumptions, including potential exit terms and probabilities. Additionally, if the notes are amended, the company is sold, or it secures another priced round of funding before going public, the note’s terms and values could change, which would also require a new fair value conclusion.
Another area that companies need to be aware of when considering key estimates is related to the ongoing accounting changes for leased assets. The Financial Accounting Standards Board (FASB) issued new standards — Accounting Standards Codification 842 — which became effective in 2019 for public companies, requiring them to capitalize and record leases on their balance sheets. Private companies are required to follow this standard for periods beginning after Dec. 15, 2021.
Under these new standards, the company needs to estimate what it would cost to have borrowed money to purchase a property it is currently leasing on a collateralized basis over a similar term and amount equal to the lease payments in a similar economic environment. With most food tech companies having subsidiaries in foreign jurisdictions, this may require determining the unique rates of individual leases or portfolios of leases. To help calculate this, a qualified expert must determine the company's synthetic credit rating and incremental borrowing rate (IBR).
One of the challenges for many companies about to go public and establish an IBR is a lack of established credit rating. Many companies have relied on venture equity capital or convertible notes and often carry little-to-no traditional debt. Accordingly, to meet the IBR requirements in ASC 842, one must build the company a synthetic credit rating, which is often done by looking at comparable companies. This may be difficult because banks are far less likely to lend money to unprofitable companies, and pre-IPO/SPAC companies in the growth stage may have yet to reach that threshold. Factoring in the company-specific financial results compared to the comps set helps establish the basis for the synthetic rating estimate.
Now, with this synthetic credit rating, it is possible to calculate what the IBR would be for that property at the point in time when the company started the lease. The figure can now be recorded on the balance sheet.
For IPO/SPAC Success, Start the Valuation Process Early
Any company taking steps towards an IPO or SPAC acquisition needs to get its valuations and financial reporting in detailed order. It is imperative that the IPO or SPAC readiness process begins early in the process of going to market so that the books will pass the heightened scrutiny the company will face from regulators. By starting early, a business can avoid valuation and financial reporting pitfalls that could delay, or even scuttle, a potential deal.
Kemp Moyer is a Partner in the Advisory Practice at BPM, one of the 50 largest public accounting and advisory firms in the U.S., where he leads the firm’s Valuations Team. With more than 15 years of experience in complex financial advisory, and a primary focus on valuation services, Moyer’s valuation experience includes M&A and IPO preparation and support, fairness and solvency opinions, and litigation support and dispute resolution, among other high impact analyses.