Special Purpose Acquisition Companies (SPACs)

What is a SPAC?

A special purpose acquisition company (SPAC), often referred to as a “blank-check company,” is a shell company formed to raise capital through an initial public offering (IPO). Once public, the SPAC seeks to find a privately-held operating company or business or assets to acquire, known as a “business combination” or “de-SPAC merger,” for the purposes of taking the private company/business public.

How does a SPAC IPO work?

Once a SPAC sponsor files a registration statement with the SEC (Form S-1), it will begin negotiating underwriting and ancillary agreements. Once cleared by the SEC, the SPAC management team begins its roadshow to investors, highlighting their experience and sharing their vision and strategy for the SPAC. The SPAC will typically offer units comprising one share of common stock and either a fractional warrant or a right to acquire a share of common stock following the business combination. Upon the closing of the SPACIPO, cash will be placed in a trust account and may only be withdrawn for limited purposes until the closing of a business combination. Public shareholders retain a redemption right if the SPAC does not complete a business combination by its deadline. If the SPAC’s business combination is consummated, the capital in the trust account will ultimately be used to fund the acquisition and share redemptions by SPAC stockholders, who have the right to have their invested capital returned through the exercise of their redemption rights around the acquisition date.

How do SPAC sponsors make money?

SPAC sponsors are compensated in founder shares received in a private placement transaction in connection with the formation of the SPAC entity, also referred to as the “promote,” which usually represents 20% of the shares in the SPAC after its IPO. Once the SPAC completes its business combination with a target company, the SPAC sponsors will generally have the same class of shares as the SPAC’s public investors, subject to any lock-up or other restrictions negotiated between the sponsor and the target company. Sponsors are also sometimes issued private placement warrants or rights to acquire additional shares to fund the operations of the SPAC until a business combination is completed.

What factors do SPAC sponsors consider when targeting companies?

• Industry. Many SPACs have a specific industry or geographic focus, particularly SPACs founded by sponsors with prior operational experience.
• Deal Size. Deal size is critical to sponsors and target companies – in order to satisfy the 80% value requirement of the stock exchanges for a qualifying transaction, to lessen the dilutive impact to the target of the sponsor’s promote and the SPAC stockholders’ warrants, and so that the SPAC’s trust account (together with any PIPE proceeds raised concurrently) meets the capital needs of the target business.
• Public Company Readiness. Sponsors examine the readiness of a target to comply with the rigorousness of being a public company, including reporting requirements, public scrutiny of financial results, and having the necessary internal controls and systems in place.
• Market Opportunity. Sponsors typically seek targets in markets with potential for large growth now and in the future or a differentiated value proposition which will offer attractive risk-adjusted equity returns.
• Financial Statements. Sponsors review financial statements to ensure they can be timely audited and used in public SEC filings required to complete the transaction.
• Management Team. The quality of the management team – including whether it has an experienced, public company-ready CEO, CFO and general counsel – is an indicative measure of whether the target is ready to be a public company.

What issues arise between a SPAC and target company during negotiation?

During negotiation of a SPAC deal, there are a few key points that often arise, including:

• Valuation
• Sponsor promote and whether it will be subject to forfeiture/earn-in if certain conditions are not met (typically based on whether a certain amount of proceeds are raised in the deal and the post-closing trading price of the stock)
• Treatment of employee equity awards
• Lock-ups to which the target stockholders will be subject
• Dual-class voting structures that provide a target’s founders with enhanced voting control after closing
• The composition of the post-closing board of directors of the public company and contractually negotiated rights to seats for the sponsor
• Registration rights for the sponsor and certain stockholders of the target
• Deal certainty (including closing conditions and whether the respective boards of directors of the SPAC and target are permitted to change their recommendation in favor of the deal)
• Representations and warranties and interim operating covenants of the SPAC and target

What happens when a target company and SPAC enter into an agreement?

Following entry into a definitive business combination agreement and its public announcement, the SPAC and target company, as co-registrants, will cooperate to file and make effective with the SEC a proxy statement, or Form S-4 (dependent on whether there is an exemption to registration available to issue shares to the target stockholders). Once the parties’ shareholders have approved the transaction and any other proposals required as a condition to closing and have satisfied all other closing conditions, if additional financing is required, the SPAC may raise funds from existing or new investors through a PIPE transaction. After the parties’ shareholders approve both the transaction and the business combination agreement, the merger is affected (resulting in the trust account being liquidated and the trust funds, net of redemptions, released to the combined company), and the stock ticker will change from the SPAC’s ticker to the new company’s ticker and begin trading on an exchange as a public company.

What happens at a SPAC shareholder meeting?

Prior to the SPAC shareholder meeting, SPAC shareholders who wish to exercise their redemption rights notify the transfer agent and follow the required procedures to submit their shares for redemption.  Redemptions have no impact on SPAC shareholders’ ability to vote in favor of the transactions and other proposals.

What are other key legal issues in SPAC deals?

Advisors in SPAC deals typically counsel on issues around:

• Merger-related structuring and process
• Compliance with securities laws (including various public filing requirements and navigating the SEC review and comment process)
• Public company corporate governance
• Public company D&O and other insurance requirements
• SPAC due diligence of the target and assessing whether there are any contractual, regulatory, litigation or other red flags that would make the transaction difficult to market and consummate to the public markets
• Disclosures made to the PIPE investors in investor presentations, including target projections
• Providing appropriate disclosure in the proxy statement, Form S-4 or other public filings
• Negotiating the PIPE offering terms, including closing certainty, protections against offering superior terms to other investors (e.g., MFN clauses), registration rights, and representations and warranties

What are the risks of a de-SPAC transaction?

From the sponsor’s perspective, the principal risk is that it will not identify a suitable business combination by its original deadline (18 to 24 months from IPO) or the stock exchange deadline (36 months from listing). Equally, sponsors must also guard against being perceived to have overpaid for a target, resulting in potential difficulties in successfully marketing a PIPE or avoiding significant redemptions by the SPAC’s shareholders.

The principal risks for targets are closing certainty and transaction expenses; since SPAC deals still require relatively long lead times and often involve early- or emerging-stage companies without significant existing capital, an unsuccessful business combination can result in the company needing to quickly raise alternative capital. Moreover, business combinations do not include termination or break fees in the current market, meaning there is usually no practical recourse for the deal failing to close. Targets in SPAC mergers often do not have the benefit of significant ramp time to become public company-ready as they would in a traditional IPO; this can create pressure on the target’s management to quickly adapt after closing the business combination to being a reporting company and immediately put in place various corporate governance and other internal controls.

What is the advantage of a de-SPAC transaction vs. an IPO?

De-SPAC transactions are generally viewed as being quicker to complete from start to finish (on average by a few months). Perhaps more important, SPACs allow a target to essentially set its enterprise valuation in direct negotiations with the SPAC sponsor months ahead of the deal closing, and then later boost that valuation through the PIPE fund raise. These two steps provide substantially more assurance to a target that it will raise proceeds at its targeted valuation rather than having to price the IPO immediately before it launches.