Special purpose acquisition companies (SPACs), so called “blank-check companies,” are experiencing a resurgence in the current turbulent economic climate. SPACs are entities formed to raise capital through an initial public offering (IPO) for the purpose of taking an existing (but yet to be identified) private company public via an acquisition. Once derided for their early utilization in fraudulent schemes, in recent years SPACs have attracted experienced management teams, reputable underwriters, and high-profile sponsors. On July 22, 2020, Pershing Square Capital Management’s Bill Ackman priced the largest-ever SPAC IPO, which raised $4 billion and was underwritten by a group led by Citigroup, Jeffries, and UBS. The increased reputation of the players in the SPAC market, the high-profile targets acquired, and the unfavorable market conditions for traditional IPOs have thrust this once-overlooked investment vehicle into the mainstream. According to data from Bloomberg Law, SPAC IPOs accounted for 23.6% of the 250 U.S. IPOs that priced in 2019, raising a total of $13.6 billion. And despite the ongoing COVID-19 pandemic, 2020 has seen a continued uptick in SPAC activity. To date, according to data from SPACInsider, SPAC IPOs have already raised a record $19 billion in 50 IPOs.
As noted above, SPACs have no immediate business purpose of their own. Though the SPAC must go through the standard IPO process of filing a registration statement with the U.S. Securities and Exchange Commission (the SEC), the simplified balance sheet and boilerplate disclosure language often result in the process being considerably quicker than it would be for an established business. SPACs are largely marketed to investors based on the reputations of their sponsors and management teams and do not identify an acquisition target prior to the IPO.
Investors in the SPAC are typically sold units, comprised of one share of common stock and a fraction of a warrant to purchase a share of common stock in the future at a price above the IPO valuation. The warrants serve as an inducement for the investor to participate in the potential upside of the investment. Following the IPO, the proceeds of the IPO are deposited in a trust account reserved for the acquisition and the public may trade the units, common stock, or warrants separately. The warrants are typically detachable, meaning that following registration they can be traded separately from the common stock, creating the potential for arbitrage opportunities. The consummation of the IPO also starts the clock for the SPAC to identify and complete an acquisition within a set timeframe, usually 24 months, or it must return the trust account balance, net of liquidation costs, to the shareholders (referred to as “redeeming” the stock). Once a target is identified and the acquisition is approved by the SPAC, the deal is typically put to a vote of the shareholders, who retain the right to request that their shares be redeemed in the event that they do not like the transaction. The guarantee of a return of the trust account balance in the event either an acquisition isn’t consummated within the set timeframe or the investor dislikes the proposed deal provides attractive downside protection for potential SPAC investors.
There have been two key developments in the structure of SPACs that have led to their recent resurgence. First, in early SPACs, the shareholders were required to vote against the acquisition in order to redeem their shares. Now, it is typical for shareholders who vote in favor of the acquisition to retain the right to seek redemption of their shares (while retaining the warrants and the resulting upside in the event that the acquisition is successful), so there is little risk to the shareholders in approving the transaction. This has resulted in greater certainty for targets that the deal will be approved, increasing the attractiveness of SPACs as a vehicle for going public.
Second, as mentioned above, SPACs have enjoyed increased credibility and publicity from signing up higher profile sponsors, underwriters, and management teams. This has allowed SPACs to raise greater pools of money, unlocking the ability to pursue transactions with high-profile technology and life sciences targets previously believed to be unavailable to SPACs. Indeed, in the past year, several well-known startups such as sports-betting operator DraftKings Inc., Richard Branson’s private space company Virgin Galactic Holdings, Inc., and electric-truck maker Nikola Corp. have utilized combinations with SPACs as a vehicle to take their company public. Additionally, on July 12, 2020, healthcare services firm MultiPlan Inc. announced an $11 billion deal to merge with a SPAC, which, if consummated, will represent the largest-ever SPAC transaction.
In addition to the developments leading to the resurgence of SPACs, SPAC sponsors are also getting more creative in structuring SPACs to increase the likelihood that investors vote in favor of the identified business combination. For example, in Pershing Square’s SPAC, only a portion of the warrants are detachable, with the balance of the warrants remaining attached to the common stock and only being issued to those investors who do not redeem their shares in connection with the business combination. Furthermore, the attached warrants that would have otherwise been issued to investors who redeemed their shares are divvied up among the investors who did not redeem their shares. These features led to the term “Tontine” being used to describe Pershing Square’s SPAC, a reference to an old investment structure in which a group of investors pay money into an investment vehicle in exchange for future periodic payouts, but when an investor dies their payout is split among the living investors.
Furthermore, the traditional SPAC provides the SPAC sponsor with the opportunity to acquire 20% of the shares in the SPAC for nominal consideration, effectively compensating the sponsor regardless of the combination’s ultimate performance. The Pershing Square SPAC did not contain this provision, better aligning the sponsor with its investors in the success of the SPAC. This, combined with the “tontine” component, better incentivizes the sponsor to identify a good deal and the investors to then vote in favor of that deal.
Uncertainty in Traditional IPO Market
Another key factor in the recent SPAC boom is the turbulence in the traditional IPO market. A SPAC transaction provides a target company with a measure of certainty that a traditional IPO cannot. The target negotiates a fixed price per share with only one party – the SPAC – and though the amount to be raised is not guaranteed due to potential shareholder redemptions, the valuation is locked in. In the traditional IPO setting, the price per share is not fixed and may fluctuate wildly until the IPO is priced. While this was previously an exciting prospect for technology unicorns, recent disappointing IPO results, including the well-publicized failure of WeWork’s proposed IPO, caused a contraction in the traditional IPO market. The COVID-19 pandemic has only compounded these issues as it injected a level of volatility into the capital markets that left companies uncertain as to the prospects of their IPOs.
Risks to Consider
SPAC transactions are not without their risks. Given that SPACs are essentially just pools of money held in trust for public shareholders, the transactions lack many of the protections common in public mergers, such as breakup fees if the transaction falls through. This has become especially important given the recent market disruptions associated with COVID-19. For example, after agreeing to a merger with Global Blue in January of 2020, the board of directors of Far Point, a SPAC sponsored by Dan Loeb and Thomas Farley, is now recommending that investors reject the merger due to the adverse impact COVID-19 has had on Global Blue’s business. In a traditional public M&A transaction, Far Point would be required to pay a termination fee as a result of the board’s change of heart, but that is not typically the case for SPAC transactions.
Additionally, the total cost to the target, factoring in the percentage ownership the SPAC sponsor receives for taking on the downside risk of funding working capital and other expenses that are not recovered in the event that a target is not acquired, can be much higher than a traditional IPO. As the frequency and size of SPACs continue to grow relative to the pool of viable targets available for acquisitions, sponsors may be incentivized to initiate less favorable transactions in order to avoid reaching the end of the SPAC’s lifecycle without a deal. It is also important for a target to consider that, once the combination with the SPAC is complete, the newly-public operating company is not able to take advantage of many of the typical grace periods afforded by the SEC to companies in a traditional IPO. If a target does not have the systems in place to comply with SEC requirements on day one, this can result in regulatory difficulties, bad press, and lower market valuation. Notwithstanding these risks, in light of the ongoing uncertainty in the capital markets and the ever-expanding pool of capital available through SPACs, we expect the utilization of SPACs to continue to be a viable alternative to a traditional IPO in this challenging environment.
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