SPACs, shorthand for special purpose acquisition companies, have become this year’s most popular alternative option for private companies to access the public capital markets and become publicly traded. Earlier this year, capital market experts declared 2020 a banner year for SPACs. The latest numbers from DealPointData back the claim. As of November 30, 2020, SPACs raised more than $64.35 billion in 203 IPOs, more than five times the amount SPACs raised—$12 billion in 38 listings—in all of 2019, also a record year.
The growing deal volume and value of SPACs across industries, from technology to healthcare to space tourism, coupled with a list of high-profile transactions, such as the transactions completed by DraftKings and by Virgin Galactic Holdings, have spurred unprecedented interest among investors and targets alike. Although some signs are starting to point to a possible leveling in months to come, companies that want to create liquidity or go public continue to consider a SPAC transaction as a strategic alternative to a traditional IPO or a direct listing.
What do you need to know about SPACs in order to decide if it is the right fit for you as a private company seeking access to the public markets or as investors looking for an exit strategy or an investment opportunity? The Fenwick team worked up some FAQs to consider.
SPACs are formed strictly to raise a blind pool of cash through an IPO with the objective of acquiring or merging with privately operating companies. These shell companies are initially formed by a group of investors or “sponsors.”
The following is the typical structure of a SPAC:
The scope of SPAC targets in 2020 has been expanding with deals getting done across a variety of sectors. So far this year through November 30, there have been 14 technology transactions and seven deals in business services, a sector which only recorded one deal last year and had not seen a SPAC acquisition since 2013, according to DealPointData. There have also been nine industrial deals, 13 consumer acquisitions, nine financial services transactions, 14 healthcare deals and one energy deal. These figures include completed and pending transactions.
But even though it appears that SPACs are now common across almost all industries, the ideal targets for successful mergers generally have the following in common:
Both transactions have the same overall strategic goal: to go public and establish a currency and a public valuation. Additionally, as we see from most IPOs as well as SPACs, in most instances, the founding stockholder group or management team continues to have majority control of these entities after the IPO or SPAC merger. But SPACs and the traditional IPO differ in how valuation is determined: in the former, negotiation with a single counterparty (tested in the PIPE process), and in the latter, setting a valuation range with underwriters and a book building process with institutional investors through a roadshow.
From a target company perspective, here are some of the advantages:
Some of the potential downsides of partnering with a SPAC include the potential for higher costs of capital due to sponsor promote, warrant dilution and fees; headline valuation may not necessarily be indicative of true equity value due to dilution; deal and capital risk due to redemption potential; and significant stockholder overhang and churn in the months post-merger.
In addition, while the liability standards related to disclosure of company information that apply to a registration statement on Form S-4 or Form S-1 registration statement for a traditional IPO are somewhat different, liability still attaches with respect to those disclosures, including projections that are not accompanied by adequate cautionary statements. Further, the marketplace may hold issuers accountable to live up to the projections that are provided to investors by the SPAC.
The requirements with respect to target disclosures in a Form S-4 registration statement or proxy are similar to an S-1 (though not identical), including disclosures regarding the target’s business, historical financial performance and other topics like executive compensation or risks related to the operating business.
Unlike in an S-1, SPAC targets have the discretion to disclose five-year financial projections and KPIs in the S-4. Financial requirements with respect to the target are largely the same as an IPO, so an independent registered public accounting firm under applicable PCAOB and SEC standards will need to audit financial statements of the target; and an extra year of audited financials may be required depending on the filing status of the SPAC and target. Generally, the target company will bear full liability for the completeness and accuracy of its disclosures. Directors at the close of the transaction consent to being named as such in the registration statement, assuming liability for its contents. With increasing numbers of companies going public through the SPAC process, however, such projections may become a greater area of focus for shareholder-driven securities litigation. See also Fenwick’s “Financial Projections in SPAC Transactions: Mitigating Class Action Litigation Risk.”
Private investments in public equity (PIPE) play a key role in the success of SPAC transactions. Attracting a marquee list of PIPE investors serves several purposes, including providing some risk mitigation against redemptions and helping validate valuation. By the nature of its structure, SPAC shares and warrants are separate and freely tradable. Stockholder churn can be significant during the deal process, and the risk of excess redemptions can leave the SPAC without expected cash balances in the absence of a PIPE financing. Securing established PIPE investors or other more stable financing sources can often influence public market sentiments.
In an IPO, financial institutions and intermediaries help market the story, create a prospectus for which they take responsibility, underwrite the offering and provide research coverage. In contrast, financial institutions in a de-SPAC transaction act as advisors who help structure the transaction and market the story through the PIPE transaction.
In the right circumstances, SPACs offer private companies a viable alternative exit strategy and a very attractive method of reaching public markets. As with any complex corporate transaction, successfully executing a SPAC transaction will require careful consideration and execution and close coordination with proper counsel and other advisors. For more information on SPACs, check out our recent joint webinar with KPMG and Bank of America, “SPACs: Unlocking a ‘Blank Check’” and reach out to the Fenwick authors of this article.
Originally published December 22, 2020, on Crunchbase.