The Basics of a Special Purpose Acquisition Company
November 15, 2017
Understanding the Basics of a Special Purpose Acquisition Company
A special purpose acquisition company (SPAC) is created for the sole purpose of raising capital, usually through an IPO, and using those funds to acquire or merge with an existing private company. The unique business structure essentially allows investors to pool their money together to acquire a “company to be named later.” This is tantamount to being an insider in a private equity fund deal, with the benefits of a daily exit opportunity and regulatory and disclosure rules providing some protections on the downside. As long as its net tangible assets exceed $5 million, a SPAC is exempt from regulation as a “blank check” company under the Rule 419 prohibition of trading until an acquisition occurs.
In the 1980’s, after some abusive penny stock schemes and other forms of investment fraud, so-called “blank check” companies got a bad name. However, with the advent of better regulatory rules and supervision, SPACs have been steadily growing in popularity and legitimacy over subsequent decades.
Earlier this year, TPG Pace Energy Holdings became the first SPAC to be listed on the main NYSE market. The SPAC, which is operated by energy industry executive Steve Chazen, floated 60 million shares at $10 on the NYSE. In July, the parent company of cannabis-industry magazine High Times became a public company without needing to conduct an IPO after being acquired by a SPAC.
How Does a SPAC Work?
SPACs are typically formed by seasoned executives that have experience running profitable public companies. After all, given that a SPAC is essentially a shell company, the founders/management team is the primary selling point when seeking investors.
Sponsors, often the management team, provide the initial capital to form a SPAC. They typically hold a 20 percent equity stake in the SPAC and, therefore, stand to obtain a sizable stake in the acquired public company.
During the IPO, securities are offered at a unit price, often $10 per unit. Each unit represents one or more shares of common stock and one or more warrants exercisable for one share of common stock, usually at or near the offering price and exercisable for a significant period after the acquisition. Since the company has no performance history, revenue, or business plan, the prospectus focuses almost exclusively on the SPAC sponsors and would include information about the specific target industry.
While SPACs benefit from a streamlined registration review process, there are several strict SEC registration and disclosure requirements to satisfy. SPACs are required to meet market cap listing rules, as well as having number of holders purchasing required amounts of securities in the offering. The offering must also be reviewed and approved FINRA, and a “no objection” letter obtained from FINRA. FINRA review is primarily for issues related to underwriter compensation and related matters. The funds raised through the SPAC’s IPO are placed into a trust account administered by a third-party trustee. The money is held in the trust account until the SPAC identifies and closes on a potential merger or acquisition target. Expenses and underwriting fees associated with the IPO are covered through a private placement of warrants to insiders. SPACs must avoid any contact with potential target businesses before and during the IPO.
Once the IPO is completed, the management of the IPO has a set amount of time, typically 18 or 24 months, to complete a merger or acquisition. The target business must have a fair market value that is equal to at least 80 percent of the SPAC’s trust assets. Investors are generally sent proxy materials regarding the acquisition and have a say in whether the deal should be consummated.
Investors who vote against an acquisition are entitled to a pro rata return of the funds held in escrow. In addition, should the SPAC fail to come to terms with a private company within the specified timeframe, the IPO revenues are returned to investors in pro rata shares.
What Are the Risks and Benefits of a Special Purpose Acquisition Company?
Special purpose acquisition company IPOs differ significantly from traditional equity IPOs, and it is important for investors and business professionals to understand the difference.
For investors, the primary risk is that SPAC managers will err in choosing a target that uses the SPAC’s capital to effect a business plan that fails. There is also the risk that the SPAC management will fail to acquire a private company. However, because all investor funds are held in escrow and must be returned in the event there is no acquisition, there is significant downside protection in that regard. And then, there is always a market risk if the acquired business fails or from a down market, even if a quality transaction eventuates.
The upsides for investors include the ability to sell their securities on the secondary market while awaiting a merger or acquisition. There is a specified deadline to consummate a transaction, and investors not only have a say in the final deal but can also opt out of a proposed deal and elect to receive reimbursement of their funds. For traders, these deals offer a potential and relatively quick profit: the securities sold in the IPO are usually structured in units with separable shares and warrants. This means that a trading market in the SPAC securities will consist of these pieces trading separately, and the total value of the separately trading pieces will often exceed the IPO offering price, particularly in a stable market when a deal is announced.
For target companies, there are also several benefits. In most cases, merging with a SPAC is quicker and less costly than conducting a traditional IPO because the SPAC has already done the funding and most of the regulatory legwork. While the target company becomes subject to meeting the numerous quarterly, annual and other public filing reporting requirements, including costly accounting reporting, the target company management is relieved of the time-consuming funding effort and can promptly proceed with effecting the business plan to grow the business and increase market value. Additional funding avenues at improved rates, an existing shareholder base, better banking relationships and new attractive employee incentive plans are important considerations for target companies being offered a SPAC funded merger. SPACs are being used in industry combinations and industry roll-ups, and are often still active and available to target companies when the IPO market cools off. The target company can also often benefit from the SPACs’ experienced management and industry professionals.
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.