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A Primer on Special Purpose Acquisition Companies (SPACs)

I’ve been thinking…Just what is a SPAC?

A SPAC, or Special Purpose Acquisition Company, is a new company formed by an experienced team of executives (called a Sponsor), whose sole intent is to raise equity funds through an IPO to finance the acquisition of a yet-to-be-identified operating business.  Most SPACs use the following proven structure: The Sponsor typically raises sufficient funds necessary to orchestrate an acquisition of the intended size through a private placement followed by an appropriately-sized IPO.  The IPO offering document, typically a Form S-1 registration statement, spells out unique terms and conditions of the IPO, including among other things the acquisition approval process of any “qualifying business combination” to be presented to the IPO shareholders.  Since a SPAC is, by its nature, a two-step transaction involving SEC-regulated disclosures, the Sponsor works with experienced financial and legal advisors for both the financing and the acquisition components.

The private placement investors’ funds are at risk, and the Sponsor typically receives up to 20% promotional ownership in the common shares as well as warrants (packaged as “Units” of the SPAC) for a nominal amount, with the warrants subject to standard financing terms and conditions regarding pricing premium and exercise date. The risks include (i) a failed IPO, or (ii) a successful IPO but a failure to timely conclude a defined “qualifying business combination” within the prescribed time limit specified in the S-1 (typically 18 months).

In contrast, IPO investors (in the aptly named “blank check” company) are initially protected because IPO proceeds are placed in a specially designed trust (Trust), the terms of which are disclosed in the S-1 and the proceeds of which are for the exclusive benefit of IPO investors.  Only after the IPO has been completed does the Sponsor, assisted by financial and legal advisors, embark on the process of identifying acquisition candidates as described the S-1.  Rigorous business, financial and legal due diligence of viable targets follows, and, if warranted, negotiation of definitive merger terms and conditions are concluded with one or more qualified targets.

With negotiations set, the Sponsor and advisors prepare and distribute a proxy statement (Proxy) for the required shareholder vote.  SEC regulations require accurate and complete disclosure of material information so that shareholders have a reasonable basis to make an informed decision.  Importantly, to approve the proposed acquisition, no more than 20% of the IPO shares can vote against the deal.  Those IPO shares voting against an approved deal are entitled to a pro rata share of the Trust’s assets, including any investment income earned by the Trust, in lieu of continued ownership of the SPAC. A tender offer process following SEC rules is often used to effect the shareholder vote.  However, if the size of the proposed transaction is larger than the assets in the Trust, additional financing must be arranged and presented to the IPO investors. In the event that a qualifying transaction is not completed within the timeframe designated in the S-1, the Trust’s assets are distributed to the IPO investors on a pro rata basis.

Because of the Sponsor’s 20% promotional interest, the IPO investors suffer substantial dilution upon the closing of the IPO.  The Sponsor’s promotional interest, which is an essential element of the typical SPAC structure, is designed to act as a powerful incentive to Sponsors to ensure  the completed SPAC transaction is a success.  Among the key ingredients of a successful SPAC are the following: a rich IPO valuation, impeccable  M&A due diligence, favorable acquisition terms and conditions and an outstanding business plan and management team to run the acquired company.

The IPO Underwriters typically defer most of their underwriter fees contingent on a completed qualifying merger transaction.  Legal advisors also commonly defer payment of their full fees until a completed merger.  After the merger, the SPAC changes both its name and ticker symbol to align with the acquired company’s business.