Special purpose acquisition companies, or SPACs, are all the rage. It seems that a day cannot go by without the announcement of another new SPAC forming or a new blockbuster SPAC deal. SPAC transactions are intricate, which creates complexity and confusion. A SPAC is a means for a private company (i.e., a target) to go public as an alternative to a traditional IPO. In a traditional IPO a private company goes public by selling shares on the market; in a SPAC transaction, a private company goes public by merging with an already-public SPAC. While there are a lot of opportunities around the financial engineering of a SPAC, once it “de-SPACs” (i.e., merges with a target), the Wall Street Journal observes that the performance of de-SPACed companies lags that of companies that go public through a traditional IPO. To examine SPACs in detail, we’ll divide its lifecycle into three phases.
A SPAC’s life begins with its initial public offering. The key participants at this point are the SPAC sponsor, the underwriters, and the initial investors. The sponsor forms the SPAC and provides seed capital that will be used by the SPAC to pay expenses until it engages in a merger with an operating company (referred to as a de-SPACing transaction). The sponsor receives equity that is referred to as founder shares. Increasingly, the sponsor itself is an investment vehicle in that the individual or organization behind the Sponsor obtains third party investors who provide the seed capital.
The SPAC IPO follows a fairly standard formula that is different than a traditional IPO of an operating company. In a traditional IPO, the company going public sells common stock to the public at a price determined based on demand following the distribution of a preliminary prospectus and a “road show” to investors about the company. In a SPAC IPO, however, there is no operating company — just the SPAC sponsors and the promise to look for a future deal, Thus, the IPO is different, and to induce investors to commit funds, the SPAC sells a unit comprised of two securities. The unit is typically priced at $10 and consists of one share of common stock in the SPAC and a warrant for half a share at a price of $5.75 (i.e., $11.50 per SPAC share). The holders of the SPAC shares may redeem the common stock for $10 per share upon the closing of a de-SPACing transaction or the expiration of the lifecycle of the SPAC — in essence leaving them with a warrant that they have received for “free.” The warrant is the inducement for investors to buy units in the SPAC IPO.
To secure the SPAC’s obligation to redeem the common stock, proceeds of the public offering are placed in a trust and are only released to fund the redemption obligation or upon consummation of a de-SPACing transaction. Until the de-SPACing transaction is consummated, the only funds that the SPAC has to seek out transactions and to comply with its SEC reporting obligations are the seed capital provided by the sponsor. As a result, the offering underwriters will typically defer a portion of their fees until the de-SPACing transaction. Following the offering, the founder shares will typically constitute 20 percent of the SPAC’s outstanding capital.
Search for a De-SPACing Transaction
Following its initial public offering, a SPAC will have a defined time period in which to engage in a transaction with another entity. Thus, the principal focus of the SPAC is in consummating a de-SPACing transaction, which includes three key elements: finding a target seeking to go public through a de-SPACing transaction, obtaining capital for the transaction, and the steps taken to minimize dilution.
If a SPAC signs an agreement to acquire a target, approval of the acquisition agreement requires the approval of a majority of the SPAC shares. Upon closing the transaction, the SPAC shareholders have the right to have their shares redeemed at a price of $10 per share and to keep their warrants. Any cash that remains in the trust after that redemption is released to the former SPAC, now a public operating company. Holders of SPAC shares thus have an incentive to vote yes regardless of how they feel about the transaction. If they do not like the de-SPACing transaction, they still will want to vote yes, as then they can redeem their shares for $10 and keep the warrants for free in a public opco (which is better than “no deal” in which they received their $10 and the SPAC warrants are worthless). Or if they like the transaction, they will vote yes and either redeem their SPAC shares or keep them in the public opco.
Typically, the acquisition agreement will require either a cash payment to the owners of the target and/or a refinancing of the target’s indebtedness. Because of the redemption feature of the SPAC shares, neither the target nor the SPAC can be sure of how much money will be left in the trust upon consummation of the de-SPACing transaction. That makes alternate sources of funds an essential part of any de-SPACing transaction and are typically provided by either private sale of equity in the public opco that closes concurrently with the transaction (a classic PIPEs transaction) to private investors, and/or traditional sources of debt financing.
A target will seek to engage in a de-SPACing transaction as a less expensive means to go public than an IPO, and to obtain price certainty in its going-public process. Part of the cost to the target is the dilution resulting from the founder shares and the SPAC warrants. To reduce the dilution, the owners of the target will often negotiate that a portion of the sponsor’s equity is forfeited or subject to vesting based on the performance of the public opco stock.
No De-SPACing Transaction
If there is no de-SPACing transaction within the time period specified in the SPAC’s governing documents (often two years with some extension periods), then the holders of SPAC shares will redeem them for $10 per share and the SPAC will be dissolved. In that case, the founder will have lost their seed capital, the SPAC warrants will be worthless, and the underwriters will not receive their deferred fees. As a SPAC reaches the end of its life, the parties will seek to do any deal rather than face a winding up of the SPAC.
What this all means for the parties to a SPAC transaction will be addressed in my next post.
Maurice M. Lefkort W86 is a partner in the Corporate & Financial Services Department of Willkie Farr & Gallagher LLP and the former Chairman of the Corporation Law Committee of the Association of the Bar of the City of New York.
Editor’s note: This blog post is intended as general information on the law and legal developments, and is not legal advice as to any particular situation. Under New York ethical rules, please note that this post may constitute attorney advertising.