Although the IPO capital-raising vehicle of Special Acquisition Companies (SPACs) has been around for decades, in recent years they have become increasingly popular as a means of financing the acquisition of, or merger with an existing company.
In Q1 of 2021, 314 SPAC listings raised $100.3 billion, but in the next three quarters, 367 listings raised only $72 billion. Despite this significant drop-off in funding—as well as the recent re-visiting of tighter regulation by the SEC– industry experts say it is way too early to write off SPACs as an IPO-funding mechanism.
SPACs Simplified
A SPAC is a company that has no commercial operations of its own but is instead formed for the sole purpose of raising capital through an IPO in order to acquire an existing company or merge with one. They are generally formed by investors or sponsors who have expertise in a specific industry or sector of a broader industry, with the intention of concluding a merger or acquisition deal with a target company. However, they are distinguished from a regular IPO because of much more lax disclosure requirements, and, until recently, much less regulatory governance.
The SPAC’s founders may have had a specific acquisition target in mind at the time of SPAC formation; however, the target is not even identified prior to soliciting investor funds. For obvious reasons, SPACs are also known as ‘blank check companies.”
SPAC Mechanics
Typically, SPACs have been invested in by such global investment banks as Goldman Sachs, Deutsche Bank, and Credit Suisse, to name a few, but also by Hollywood celebrities and sports professionals. This has led the SEC to issue a public cautionary alert to investors not to make their SPAC investment decisions based on the predominance of celebrity participation.
Invested funds are deposited into an interest-bearing account from which they may not be disbursed except to conclude the acquisition, or, to liquidate the SPAC in cases where the acquisition was not completed within the mandatory 2-year deal completion period. In the event of liquidation, funds are returned to investors.
However, following target acquisition, the SPAC is then listed on a stock exchange.
Among recent high-profile SPACs have been deals involving Social Capital Hedosophia Holdings’ purchase of a 49% stake in Richard Branson’s Virgin Galactic, and Bill Ackman’s Pershing Square Tontine Holdings—the largest-ever SPAC, having raised $4 billion in its offering.
SPAC and de-SPAC Legal Considerations
Once the SPAC identifies a potential acquisition target, the acquisition process begins by way of a formal letter of intent, followed by a due diligence review in order to verify that the target company has made accurate representations. The due diligence phase typically involves a review by legal counsel, a tax and accounting review, and a business valuation conducted by third party consultants. There are also target valuation procedures required by the NASDAQ and NYSE.
The de-SPAC transition begins once a formal merger is announced: a merger agreement is signed, the deal is announced publicly, and investors are concurrently notified as to the identity of the target company which the SPAC is acquiring or merging with. The filing of an SEC form S-4 financial statement is required at this point, citing the financial health of both the SPAC and the target company, and is accompanied by an audit statement and a prospectus. In addition, the S-4 must contain a ‘managerial discussion’ about the SPAC and target company, historical financial data regarding both, share price information, the proposed post-acquisition structure of the company, and any de-SPAC debt financing agreements. The entire de-SPAC process can take anywhere from just one week to a month to complete.
Increased Regulatory Oversight Proposed
One of the advantages of a SPAC over a regular IPO filing has been the significantly reduced regulatory oversight when using a SPAC to raise IPO funds. However, recently, the SEC has raised criticism of de-SPAC transactions, because the liability apparatus for companies going public through a de-SPAC transaction differs from that of a traditional IPO. As a result of those concerns, on March 30, 2022, the SEC published proposed regulations regarding SPACs, which, if implemented, would increase the potential liability for SPACs, SPAC underwriters, and de-SPAC target companies. The proposed rules would require specialized disclosure obligations for SPACs in connection with their IPO offerings and de-SPAC transactions. The SEC rules proposal also includes a safe harbor provision under which SPACs would not be designated as investment companies under the Investment Company Act of 1940 (ICA). The SEC proposed rules are currently subject to a 60-day public comment period.
Bumps in the Road
Notwithstanding a rollercoaster 2021 for SPACs, industry experts point to the exceptional overall pace of the SPAC IPO market, and regard the drop-off in SPAC IPO investment in the latter part of the year as partially due to such factors as accounting changes to SPAC warrants that disrupted the market and caused many SPACs to restate their financial statements, the glut of SPAC IPOs that exceeded market demand, the participation by inexperienced SPAC sponsors who attempted to initiate multiple SPACs at one time, and, the shadow of celebrity investors too prominently publicized. The SPAC market adjustment was inevitable, but such factors have beenviewed as mere bumps in the road as this relatively new platform reaches maturity.
Executive Summary
The Issue
How to raise capital for an acquisition or merger with a target company without going through the highly regulated standard IPO process.
The Gravamen
Since 2019, SPACs have become an increasingly popular mechanism for raising IPO capital, despite the presence of various factors that have made for a volatile history.
The Path Forward
Being aware of all legal and actuarial steps necessary for sponsoring a SPAC and bringing it to de-SPAC completion can bear financial fruit for the client seeking to raise IPO funds for a target acquisition.
Action
1. Participants
Beware of over- dependence upon celebrity or sports figures in the promotion of your SPAC, lest the SPAC’s image becomes tarnished in the process.
2. Target Companies
Sponsors must be industry savvy enough to be able to ferret out which potential targets are ripe for acquisition or merger within that industry or within a particular sector of the industry.
3. Due Diligence
Become fully familiar with all steps required for due diligence review of the legal, accounting, and exchange compliance requirements for transitioning from SPAC to de-SPAC.
4. Regulatory Updating
SPAC sponsors and de-SPAC parties— including target companies–are coming under greater regulatory scrutiny, especially as to liability regimes. Therefore, advisors to SPACs must make sure that they are fully up to date as to those regulatory changes.
