SPACs: Should Your Company Use One to Go Public?
The year 2020 has been a record-setting year for special purpose acquisition companies (SPACs), also referred to as blank-check companies. SPAC IPOs have raised more than $62 billion in 169 IPOs so far this year.
SPACs are not a new concept. In fact, the concept has been around since the 1980s and SPACs have existed in their current form since 2003. The recent popularity of SPAC IPOs is partly attributable to high levels of liquidity. Investors also have shown interest in rapidly growing companies.
The so-called SPAC craze started to take hold in the summer of 2020. At that time, billionaire hedge fund manager Bill Ackman debuted Pershing Square Tontine. That SPACis the largest ever blank-check company with at least $5 billion in cash equity capital it can draw upon. Pershing Square Tontine announced that it planned to acquire a mature unicorn. It initially approached Airbnb confidentially before filing for its SPAC IPO. Airbnb ultimately declined the acquisition. Instead, it is preparing for a traditional IPO.
The mechanics of SPACs has made them a popular choice for going public this year. These are some of their key characteristics.
Founders and Sponsors of SPACs
Experienced business executives form and sponsor SPACs. Private equity firms, hedge funds, or billionaire individuals sponsor a significant percentage of SPACs. These sponsors provide initial capital and in return get founders’ shares. These founders’ shares are purchased by the sponsor prior to submission of the S-1 registration statement with the Securities and Exchange Commission (SEC) to initiate the process of going public.
The SPAC management team usually determines an acquisition target at a time well after the SPAC IPO date. Thus, investors are highly reliant on the business acumen of the SPAC management team. The team must do proper due diligence on the private company target. When the SPAC raises funds, investors are merely getting a best efforts agreement from the SPAC management team. SEC rules requires disclosure in the registration statement that the SPAC does not have an acquisition target under consideration prior to the SPCA IPO closing. Moreover, disclosure is required that the SPAC’s directors and officers have not held discussions with underwriters or other advisors regarding potential business combinations.
IPO Registration Process
The SPAC IPO registration process is quite similar to the traditional IPO process, with a few distinctions. Similar to the regular IPO process, a SPAC must file an S-1 registration statement with the SEC. It must respond to SEC comments, negotiate underwriting agreements, and then conduct a roadshow to pitch investors before going public. The timeframe from filing the registration statement to going public is usually significantly shorter for a SPAC. Blank-check company financial statements are considerably shorter because SPACs are shell companies. There are no assets or historical financial results to report and business risk factors are minimal. In a traditional IPO for an operating company, financial statements in the IPO registration statement can take months to prepare.
SPACs Use Trust Accounts
The proceeds raised in the SPAC IPO are placed in an interest-bearing trust account until either disbursed to fund the business combination transaction or released upon the blank-check company’s failure to consummate a business combination by a specified date. The trustee typically invests the cash in the trust account in short-term U.S. government securities. The trust account proceeds cover transaction expenses, pay the deferred underwriting discount fee, and cover working capital needs of the company. The initial business combination must have an aggregate fair market value of at least 80% of the trust account balance.
Public Units, Public Shares, and Warrants
SPACs generally sell units to public investors. These public units are comprised of one share of common stock (the “Class A shares”) and a warrant or fraction of a warrant, which enables the purchase of common stock in the future. The purchase price is usually $10.00 per unit.
The warrants become exercisable after a certain number of days following the successful completion of the business combination. Participants also referred to this as the De-SPAC transaction. This time period is usually 30 days after the De-SPAC transaction. At this time, the Class A shares and the warrants become decoupled and start trading separately on the securities exchange. The warrants have a set strike price in excess of the IPO price. The strike price for the warrants is usually set at $11.50, or 15% above the $10.00 per unit IPO price.
Founder Shares in SPACs
While public investors hold Class A Shares, the sponsor purchases founder shares of the SPAC (the “Class B shares”) for a nominal price. The Class B founder shares and the Class A common shares usually vote together as a single class. The intent is for the founder shares to equal approximately 20% of the total shares outstanding after the IPO. In that way, the sponsors can retain approximately 20% of the SPACs equity. The 20% founder shares are also known as the “promote.”
The Acquisition Target
Often SPACs have specified some criteria for the type of target company they are looking to buy. These criteria can include a specific industry, size, or geographic region. Once investors contribute funds to the SPAC IPO, the SPAC has a specific amount of time to complete a merger with a private company. If the expiration date passes and the SPAC has not consummated a business combination, it must dissolve and liquidate. Many stock exchange rules allow this time period to extend up to three years after the SPAC IPO closing date. Most SPACs designate an 18- to 24-month window.
Once the parties have negotiated the merger agreement, the parties must obtain shareholder approval. This involves getting the required votes from both the SPAC shareholders and the target company shareholders. Additionally, SPACs must offer a right of redemption to SPAC shareholders. This redemption offer usually permits SPAC shareholders to redeem their public shares in exchange for an amount approximately equal to the IPO price.
Many of the same SEC rules on disclosure requirements that apply in a traditional IPO also apply during the De-SPAC process. In a traditional IPO, public companies must file a Form 8-K with the SEC within four business days of a major event. This serves as notice to investors of the major event. Similarly, SPACs are required to file a special Form 8-K, known as a “Super 8-K” within four business days of completing a De-SPAC transaction. The Super 8-K requires disclosure of audited financial statements and information on the people acquiring control.
Forward Purchase Agreement
At the time of the SPAC IPO, investors or affiliates of the sponsor may enter into a forward purchase agreement with the SPAC. Investors that enter into the forward purchase agreement commit to purchase IPO shares up until the closing of the business combination, to the extent additional funds are needed. Forward purchase arrangements therefore provide a degree of funding certainty to the company during the De-SPAC process.
Private Investment in Public Equity (“PIPE”) Commitments
To facilitate the business combination transaction, the SPAC may need to raise additional capital to finance a portion of the purchase price. This committed financing often comes in the form of a private investment in public equity (PIPE). In a PIPE, a blank-check company will identify institutional or accredited investors that can provide additional funds in exchange for a private placement of the SPAC’s public shares. The PIPE investors will often buy these securities at the IPO price. PIPEs have less stringent regulatory requirements compared with public offerings. A PIPE is a more efficient way for companies to quickly raise capital.
Research analyzing the returns of SPACs and the returns of traditional IPOs since 2015 reveals that SPACs on average had lower returns. Of the 223 SPAC IPOs that have occurred since 2015, 89 have completed mergers and taken a company public.
Notable SPACs of 2020
Chamath Palihapitiya is the former Facebook executive turned billionaire venture capitalist. He has used SPAC vehicles to facilitate a number of newsworthy SPAC deals recently. The first SPAC he created bought Virgin Galactic in 2019 and his second SPAC bought Opendoor in September. In light of his SPAC success streak, Palihapitiya has announced plans for three more upcoming SPACs.
Additional SPACs in 2020 include the Nikola merger with a SPAC called VectoIQ Acquisition. The DraftKings merger with a SPAC called Diamond Eagle Acquisition Corp. also occurred. Even former U.S. House Speaker Paul Ryan has participated in the 2020 SPAC craze. He backed a blank-check company that raised over $300 million in a SPAC IPO.