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SPAC Merger Business Due Diligence Checklist: A Comprehensive Review of Operations, Law, and Finance

The window for completing a de-SPAC business combination has narrowed materially since the US Securities and Exchange Commission (SEC) issued Staff Legal Bulletin No. 14M (CF) in December 2024, which effectively rescinded prior informal guidance on warrant accounting and redemption liability classification. This shift, combined with the SEC’s continued focus on forward-looking statement safe harbours under the Private Securities Litigation Reform Act of 1995 (PSLRA), means that sponsor and target due diligence must now verify not only financial accuracy but also the structural resilience of the SPAC vehicle itself. For Hong Kong-incorporated targets or those with PRC operations, the added layer of the Holding Foreign Companies Accountable Act (HFCAA) and the SEC’s December 2023 amendments to the Access to PCAOB Inspection Reports rule further complicate the timeline. A failure to audit the SPAC’s trust mechanics, warrant schedule, and sponsor economics before signing a definitive agreement can result in a termination fee of 3-5% of the trust value — a risk that a structured, three-pillar due diligence framework (operational, legal, financial) is designed to mitigate.

Operational Due Diligence: Revenue Verification and Customer Concentration

Revenue Recognition Under ASC 606 and PRC GAAP Convergence

The first operational checkpoint is the target’s revenue recognition policy, particularly where the entity files under US GAAP (ASC 606) or has converted from PRC GAAP. The SEC’s Division of Corporation Finance has flagged revenue recognition as the most frequent comment topic in de-SPAC filings since 2023. For a target with a PRC parent, the auditor must confirm that the revenue waterfall — from contract signing to delivery to payment — maps identically under both standards. A discrepancy of more than 2% in revenue between the two GAAP bases in any fiscal year triggers a mandatory restatement under SEC Rule 12b-20. The sponsor’s legal counsel should request the target’s last three years of audited financial statements, with a reconciliation schedule prepared by a PCAOB-registered auditor. Where the target uses a variable interest entity (VIE) structure, the revenue attributed to the VIE must be isolated; the SEC’s December 2021 guidance on VIE disclosures requires that the SPAC’s proxy statement state the percentage of total revenue derived from the VIE and the contractual arrangements that enforce control.

Customer and Supplier Concentration Thresholds

The SEC’s 2023 Staff Accounting Bulletin No. 121 (SAB 121) did not directly address customer concentration, but the SEC’s review of de-SPAC proxy statements consistently demands disclosure of any customer representing 10% or more of total revenue. For a target with a single customer exceeding 25% of revenue, the sponsor must obtain a letter from that customer confirming the continuation of the commercial relationship for at least 12 months post-merger. The due diligence checklist should include a request for the top 10 customers by revenue for each of the last three fiscal years, with contracts and any amendments. Supplier concentration follows the same threshold: any single supplier representing more than 30% of cost of goods sold (COGS) requires a supplier dependency analysis. The SEC’s Division of Corporation Finance has issued comment letters in 2024 to at least four de-SPAC registrants where the target’s supplier was also a shareholder, creating a related-party transaction that required disclosure under Item 404 of Regulation S-K.

Intellectual Property Ownership and Licencing Audit

Operational due diligence must extend to the target’s intellectual property (IP) portfolio, especially for technology or biotech targets. The sponsor should verify that all patents, trademarks, and copyrights are registered in the target’s name and not in the name of a founder, affiliate, or PRC entity that could be subject to export controls. The US Patent and Trademark Office (USPTO) assignment database should be searched for each patent family. For PRC-domiciled targets, the PRC Patent Law (as amended effective 1 June 2021) requires that any patent assignment to a foreign entity be recorded with the China National Intellectual Property Administration (CNIPA) within three months of execution. A failure to record renders the assignment unenforceable against third parties. The due diligence report must include a schedule of all licenced-in IP, with the royalty rates and termination clauses; a termination right triggered by a change of control (common in many PRC technology licences) would constitute a material adverse change (MAC) under the SPAC’s definitive agreement.

VIE Structures and PRC Regulatory Filings

For any target with a PRC operating entity, the legal due diligence must confirm that the VIE structure complies with the PRC Foreign Investment Law (FIL), effective 1 January 2020, and the subsequent Negative List (2024 edition). The FIL prohibits foreign investment in certain sectors, including internet content provision and education, through any VIE arrangement that confers de facto control. The SEC’s December 2023 amendments to the PCAOB access rules require that the target’s auditor be based in a jurisdiction where the PCAOB can conduct full inspections. As of February 2025, the PCAOB has full access to inspect audit firms in mainland China and Hong Kong, but the SEC has stated it will reassess this access annually. The sponsor’s legal counsel should obtain a legal opinion from a PRC law firm (licensed by the PRC Ministry of Justice) confirming that the VIE structure does not violate the FIL and that the target has obtained all necessary approvals from the Ministry of Commerce (MOFCOM) and the Cyberspace Administration of China (CAC) for data cross-border transfers under the Personal Information Protection Law (PIPL), effective 1 November 2021.

The legal due diligence must scrutinise the sponsor’s economics, particularly the founder shares and private investment in public equity (PIPE) commitments. The SEC’s Staff Legal Bulletin No. 14M (CF) clarified that warrants issued by a SPAC must be classified as liabilities, not equity, unless they meet specific criteria for equity classification under ASC 815-40. This reclassification has a direct impact on the SPAC’s balance sheet: a warrant liability of USD 10 million at fair value reduces net tangible assets by the same amount, potentially triggering a Nasdaq minimum stockholders’ equity requirement failure (Nasdaq Listing Rule 5450(b)(1) requires at least USD 10 million in stockholders’ equity for a Nasdaq Global Market listing). The due diligence checklist should include a schedule of all warrants, their exercise prices, and the fair value calculation methodology (Monte Carlo simulation or Black-Scholes). Founder shares are typically subject to a 12-month lock-up from the closing date, but the SEC has required that any early release of lock-up shares be disclosed in the proxy statement and justified by a legitimate business purpose, such as a PIPE backstop arrangement.

Regulatory Licenses and Permits Inventory

The target must provide a complete inventory of all regulatory licences, permits, and approvals required for its operations. For a fintech target, this includes money transmitter licences in each US state where the target operates, plus any required approvals from the Consumer Financial Protection Bureau (CFPB) under the Dodd-Frank Wall Street Reform and Consumer Protection Act. For a healthcare target, the list includes Clinical Laboratory Improvement Amendments (CLIA) certification, HIPAA compliance documentation, and any state-level pharmacy board approvals. The sponsor’s legal counsel should verify that each licence is current and that no enforcement action is pending. The SEC’s Division of Enforcement has brought actions against at least three de-SPAC entities since 2023 for failing to disclose that a key licence had expired before the merger closing, constituting a material omission under Section 10(b) of the Securities Exchange Act of 1934.

Financial Due Diligence: Trust Mechanics and Redemption Modelling

Trust Account Structure and Redemption Rights

The financial due diligence must model the trust account mechanics with precision. The SPAC’s trust agreement typically requires that at least 90% of the gross proceeds from the initial public offering (IPO) be deposited into a trust account, with the remainder available for underwriting fees and expenses. At the time of the de-SPAC vote, public stockholders have the right to redeem their shares for a pro rata portion of the trust account, typically at a price of USD 10.00 per share plus accrued interest. The sponsor must calculate the maximum redemption scenario — where 100% of public shares are redeemed — and confirm that the trust account balance, after redemptions, is sufficient to fund the PIPE commitment and the target’s minimum cash requirement. The SEC’s December 2023 guidance on redemption modelling requires that the proxy statement include a sensitivity analysis showing the impact of redemptions at 25%, 50%, 75%, and 100% of public shares on the post-merger cash position. The due diligence report should include a trust account waterfall schedule, showing the allocation of trust proceeds to redemption, PIPE funding, sponsor loan repayment, and working capital.

Working Capital and Net Tangible Assets Verification

The target’s working capital position must be verified against the definitive agreement’s minimum net tangible assets (NTA) covenant. Nasdaq Listing Rule 5450(b)(1) requires a minimum of USD 10 million in stockholders’ equity for a Nasdaq Global Market listing, but many SPAC agreements set a higher threshold, often USD 20-30 million. The financial due diligence should reconcile the target’s last audited balance sheet to the pro forma post-merger balance sheet, isolating any adjustments for the SPAC’s trust account, warrant liability, and deferred underwriting fees. The SEC’s Staff Accounting Bulletin No. 121 (SAB 121) requires that the pro forma balance sheet reflect the fair value of all warrant liabilities as of the closing date. A common error is the failure to include the sponsor’s promissory note conversion as equity: if the sponsor has loaned the SPAC funds for working capital, the note must be converted into equity at the merger closing, and the conversion ratio must be disclosed in the proxy statement.

Tax Due Diligence: Section 7874 Inversions and PRC Tax Implications

The tax due diligence must address the risk of a Section 7874 inversion under the US Internal Revenue Code. If the SPAC is a US corporation and the target is a foreign corporation, and the target’s shareholders end up owning more than 80% of the combined entity (by vote or value) after the merger, the combined entity may be treated as a US corporation for tax purposes, eliminating the tax benefits of the inversion. This is particularly relevant for PRC targets where the target’s pre-merger shareholders may hold a large stake in the post-merger entity. The sponsor should obtain a tax opinion from a US tax counsel confirming that the transaction does not trigger Section 7874. For PRC targets, the PRC Enterprise Income Tax Law imposes a 10% withholding tax on dividends paid to non-PRC shareholders, but this can be reduced to 5% if the shareholder is a Hong Kong resident company that meets the beneficial ownership requirements under the PRC-Hong Kong Double Tax Arrangement. The due diligence should confirm that the target’s post-merger dividend policy and shareholder structure are compatible with this reduced rate.

Closing Section: Actionable Takeaways

  1. Verify revenue recognition under ASC 606 with a PCAOB-registered auditor and obtain a reconciliation to PRC GAAP if the target has a PRC parent, as any discrepancy exceeding 2% triggers a mandatory restatement under SEC Rule 12b-20.
  2. Model the trust account redemption at 100% of public shares and confirm that the post-redemption cash position meets both the Nasdaq minimum stockholders’ equity requirement (USD 10 million under Listing Rule 5450(b)(1)) and the definitive agreement’s minimum NTA covenant.
  3. Obtain a PRC legal opinion confirming VIE compliance with the Foreign Investment Law (2020) and the Personal Information Protection Law (2021), and verify that the target’s auditor is based in a jurisdiction where the PCAOB maintains full inspection access.
  4. Audit the warrant liability classification under ASC 815-40 using a Monte Carlo simulation, and ensure that the fair value is disclosed in the pro forma balance sheet, as the SEC’s Staff Legal Bulletin No. 14M (CF) requires liability treatment unless specific equity criteria are met.
  5. Secure a US tax opinion confirming that the transaction does not trigger Section 7874 inversion treatment, and structure the post-merger dividend policy to qualify for the reduced 5% withholding tax rate under the PRC-Hong Kong Double Tax Arrangement where applicable.