During 2020, a year of surprising strength in the deal industry, one of the most noteworthy market phenomena was the boom in special purpose acquisition companies (SPACs), which are companies expressly formed to acquire operating companies. According to SPACInsider, as of December 19, 2020, 242 SPACs had gone public in 2020, four times the number of SPAC initial public offerings (IPOs) in 2019. Those SPACs had raised an average of $335 million, significantly higher than the amounts raised in prior years. Much of that capital has not been deployed, so there are numerous SPAC acquirers on the hunt for potential targets and more going public every week. Amidst this SPAC boom, what are some of the key considerations for chief executive officers of potential SPAC targets?
A SPAC, which initially has no assets or operations and no business plan but to buy an operating company, will raise capital in an IPO to fund that acquisition. Its governing and IPO disclosure documents may or may not specify the potential industries and geographies of the proposed targets, but the IPO disclosure documents will certainly contain information on the backgrounds of the founders or sponsors and their investment criteria. (SPAC sponsors are increasingly higher profile executives and investors, which is one reason for the success of SPAC IPOs in 2020.)
The SPAC’s governing documents and IPO disclosure documents will specify a time frame during which the acquisition must be consummated. That period is usually 18 to 24 months, but it can be extended by a vote of the SPAC shareholders. The IPO proceeds are retained in a trust account during the process of seeking a target and attempting to close a transaction, but are returned to investors if a target is not found and the transaction is not consummated before the time limit elapses. If a transaction is closed, the target itself will become the public company.
Key benefits of merging with a SPAC vs. traditional IPO:
• Speed. The process of merging with a SPAC can, under some circumstances, be faster than an IPO. However, that will depend on how long it takes to negotiate the merger itself and the time required to prepare and undergo Securities and Exchange Commission (SEC) review of the proxy/registration statement on Form S-4, the SPAC merger functional equivalent of the registration statement/prospectus in a traditional IPO. In particular, the target company’s financial statements must be compliant with public company GAAP and SEC rules and audited under public company standards, a standard that some potential SPAC targets might not be able to meet without significant investment of time and resources.
• Valuation certainty. The merger agreement with the SPAC will lock in the deal price (sometimes higher than a strategic acquirer would offer). On the other hand, in the case of an IPO during a period of market volatility, demand and the IPO price per share can collapse for a variety of reasons beyond the company’s control.
• Longer lockup. After a SPAC merger, the target stockholder’s equity may be more restricted that it might be after an IPO. A typical IPO lockup is 180 days, but SPAC sponsor lockups are typically one year; in some cases, SPACs are demanding one-year lockups from the executives of the target company to align their terms with those of the sponsors.
• Potential cash challenges. SPAC stockholders who do not support the proposed acquisition have the right to have their shares in the company redeemed. So if redemptions are too high, after paying out any merger consideration to target stockholders, the combined company may have insufficient cash for post-closing operations and to fund future growth plans. As a result, business combination agreements between SPACs and targets often have a “minimum cash” closing condition, which are typically met by having a financing transaction close simultaneously with the merger.
• Interest alignment. CEOs of SPAC targets should also be aware that some critics of SPACs have argued that the interests of SPAC sponsors are not necessarily aligned with those of the stockholders of potential targets. SPAC sponsors receive their own shares in the SPAC for de minimis consideration and can profit whether or not their future target stockholders do. That being said, prominent executive/investor sponsors with reputations to protect certainly have skin in the game.
In an overheated SPAC market, conduct your own due diligence.
Given the current number of SPACs on the hunt for potential targets, some target companies will have more than one SPAC bidder. In addition to considering merger terms and the share of the future company to be retained by sponsors, companies should conduct their own due diligence into the various SPAC sponsors who approach them, including with respect to operational and deal expertise, reputation and relationships with potential investors.