2020 has been a banner year for IPOs by special purpose acquisition companies, or SPACs. Over 100 SPAC IPOs have closed so far in 2020, with aggregate gross proceeds of approximately $42.1 billion and an average IPO size of $382.4 million. This represents a dramatic increase from 2019, in which 59 SPAC IPOs closed, with aggregate gross proceeds of approximately $13.6 billion and an average IPO size of $230.5 million. With all of this capital waiting to be deployed, many companies will be considering a SPAC business combination as an IPO alternative. Below, we provide a general refresher on SPACs and key considerations for those considering a SPAC business combination.
What is a SPAC?
A SPAC is a blank check company formed for the purpose of effecting a merger, asset acquisition or similar business combination with one or more businesses. SPACs are formed by “sponsors” (often with private equity experience or ties) whose sole objective is to identify one or more promising acquisition targets. When a SPAC completes its IPO, it places the net proceeds in a trust account until the earlier of a completed business combination or a specified outside date (typically 18-36 months after the IPO). At the closing of a business combination, the public SPAC shareholders must vote on whether to approve the merger and have the option to redeem their shares for their pro rata portion of the proceeds in the trust account (even if they vote to approve the merger). If the SPAC fails to complete a business combination prior to the outside date, all public shares are redeemed for a pro rata portion of the proceeds in the trust account.
SPACs typically offer units (common stock and warrants) in the IPO to give investors extra upside potential. Warrants can be exercisable for one share, one-half of one share or even one-third of one share depending on the size of the SPAC, the investment bank involved and the prominence and track record of the sponsors. Warrants are priced “out of the money,” become exercisable only if the business combination occurs and typically have a five-year term. Even if SPAC investors elect to have their shares redeemed in connection with a proposed business combination, they will retain their warrants.
Sponsors are compensated with founder shares issued in connection with the formation of the SPAC. These founder shares typically represent approximately 20% of the outstanding common stock following the SPAC IPO and are subject to a one-year lock-up following the business combination. Because of the requirement to place most of the IPO proceeds in a trust account, the sponsors often purchase warrants or shares of common stock at the IPO price to cover the cost of expenses related to the SPAC IPO and to fund pursuit of a business combination.
Why consider a SPAC Business Combination?
- Often Quicker: An IPO can take 5-9 months, but a business combination with a SPAC can be completed in 4-6 months.
- Less Market Risk: The valuation of the target business is negotiated with the sponsor. There is no need for investment banks and roadshows to secure investor support for pricing, which is uncertain and can be difficult in periods of market instability.
- Access to public markets: Like an IPO, post-business combination the target company will have access to the public capital markets to fund operations and/or growth and will be listed on a U.S. exchange.
- Disclosure: The disclosure required for a SPAC merger is similar to, but somewhat less burdensome than, the disclosure required in an IPO and also allows for the inclusion of projections, which are generally not used in an IPO due to liability concerns.
- Concurrent PIPE: Business combinations often include a concurrent PIPE, which provides a supplement to the proceeds in the SPAC’s trust account (which is subject to reduction resulting from redemptions by SPAC shareholders). PIPEs are often conducted to satisfy a business combination closing condition requiring that the SPAC have a minimum amount of cash.
Downsides to SPAC Business Combinations
- Liquidity Limitations: SPACs may have limited trading liquidity for some period following the closing of the business combination. This is particularly true when all or substantially all of the SPAC’s pre-business combination stockholders elect to have their shares redeemed.
- Shell Company Fallout:
- A SPAC is an “ineligible issuer” and is not entitled to use a free writing prospectus in registered offerings for 3 years following the business combination.
- Holders of SPAC securities may not rely on Rule 144 for resales of their securities after the business combination until one year after the company has filed current “Form 10” information with the SEC (a disclosure known colloquially as a “Super 8-K,” which is typically filed shortly after the completion of the business combination) reflecting its status as an entity that is no longer a shell company.
- A SPAC is not eligible to be a well-known seasoned issuer until at least 3 years after its business combination.
- A SPAC is limited in its ability to incorporate by reference information into long-form registration statements on Form S-1.
- A SPAC may not use the “Baby Shelf Rule” (which permits registrants with a public float of less than $75 million to use short-form registration statements on Form S-3 for primary offerings of their shares) for 12 months after the Super 8-K filing.
- The SEC recently issued guidance that it would likely not declare effective a registration statement on Form S-3 filed by a former SPAC following a business combination until it has filed public reports for the combined business for at least 12 months.
- Listing Requirements: A SPAC must satisfy stock exchange initial listing requirements upon the closing of the business combination, including the 300 round lot holder requirement. Nasdaq has proposed a rule change that would give a SPAC 15 calendar days to satisfy the round lot holder requirement if it demonstrates that it will satisfy all other listing requirements before the business combination closes.
Given the surge of SPAC IPOs, business combination activity will almost certainly follow over the course of the next 2-3 years. Our team is happy to help you evaluate whether a SPAC business combination might makes sense for your business.
See Nasdaq Listing Rule IM-5101-2 (b) which requires that a listed SPAC complete one or more business combinations having an aggregate fair market value of at least 80% of the value of the trust account (excluding any deferred underwriters fees and taxes payable on the income earned on the deposit account) within 36 months after the effectiveness of its IPO registration statement, or such shorter period that the SPAC specifies in its registration statement.