Certain structural features of special-purpose acquisition companies (SPACs) that offer benefits to their public investors often put SPACs at a competitive dis-advantage when they are among multiple bidders for a target company. Recent SPAC business combination transactions demonstrate, however, that careful structuring of a transaction to meet the needs of the target’s owners can overcome these structural challenges and level the playing field for SPACs in a competitive bidding process.
The hallmark feature of the SPAC structure is that the gross proceeds of the SPAC’s initial public offering (IPO) are placed into a trust account for the benefit of the SPAC’s public stockholders. The public stockholders have a right to receive their pro rata share of the trust account if they choose to redeem their common stock in connection with the SPAC’s intial business combination transaction, or if the SPAC is unable to complete an initial business combination within a specified period of time, generally 24 months from the closing of the IPO. The cash in the trust account cannot be accessed until the SPAC’s initial business combination is closed. Only a limited amount of additional cash is invested in the SPAC by its sponsors and held outside the trust account to pay the SPAC’s expenses in connection with identifying, investigating, negotiating and closing its initial business combination transaction.
The Appeal of SPACs
For the SPAC’s public investors, the trust account structure is intended to eliminate the downside risk of their investment. If the SPAC fails to complete a business combination transaction within the specified time period, or if an investor redeems its shares in connection with the SPAC’s initial business combination transaction, the investor receives substantially all of its initial investment back. For target companies, a SPAC’s public company status allows them to go public more quickly than the timing of a traditional public offering. It also provides a path to go public for companies whose stories may not be appreciated by public market investors. Perhaps more significantly, a business combination transaction with a SPAC provides a significant amount of flexibility for the target’s owners to receive a portion of their business combination consideration in cash and a portion in public company stock, which will allow them to participate in the future growth of the business.
The SPAC Challenges
While the SPAC structure provides public investors with safeguards to protect their investment, it also creates obstacles to closing a business combination. The redemption rights of SPAC stockholders and the short SPAC lifespan can create deal un-certainty and timing obstacles, making targets reluctant to sell to a SPAC. Targets often want at least some cash consideration or for a specified amount of cash to remain in the company for future growth—and always desire certainty of closing—but the ability of the SPAC stockholders to redeem their shares can impact both. Even if SPAC business combination agreements include a minimum cash condition to protect a target from a closing if more redemptions than expected occur, a SPAC generally cannot offer the deal protection of a breakup fee due to its lack of access to the trust account funds prior to closing a business combination. Further, a large number of redemptions can put the post business combination’s public company status at risk due to a reduced market float that does not meet public company listing requirements. The time it takes to close a SPAC business combination adds to these impediments, putting a SPAC at a dis-advantage against private equity funds and strategic buyers in a competitive bidding process. In a SPAC business combination transaction, the parties must file disclosure documents with the U.S. Securities and Exchange Commission (SEC), which include extensive information about the transaction and the target, including audited financial statements, pro forma financial information and other information that is typically disclosed in an IPO prospectus. The process of preparing and resolving SEC comments on these documents is time-consuming and expensive. Unless these obstacles are addressed, some sellers may discount the bid of a SPAC and not enter into a sale process with a SPAC.
Recently completed SPAC business combinations demonstrate how SPACs can be successfully utilized in the private equity dominated mergers-and-acquisitions (M&A) market. To compete with private equity bidders’ access to cash, SPACs can enter into arrangements with third-party investors or the SPAC’s sponsors to “backstop” a specified amount of potential redemptions by public stockholders at the same price per share as the redemption price per share. These arrangements can guarantee cash certainty at closing and provide validation of the SPAC’s valuation of the business combination transaction, which in turn supports the trading price of the SPAC’s shares. These arrangements encourage targets to be more accepting of the timing and public disclosure requirements and the redemption process of SPAC bidders.
In addition, the attenuated timing to closing inherent in SPAC transactions for sellers who are seeking cash can be addressed through these arrangements. For example, the recent $500 million acquisition of Del Taco Holdings, Inc. by Levy Acquisition Corp. included a novel two-step structure. In the first step, the SPAC’s sponsor and third-party investors made an upfront cash investment of $120 million in the equity of Del Taco by purchasing stock from Del Taco stockholders and the company itself. The upfront investment provided stockholders with immediate liquidity for a portion of their holdings and allowed Del Taco to re-finance its indebtedness—making its debt/equity ratio a more suitable investment for public investors. In addition, at the time of entering into the agreement for the business combination transaction, the SPAC arranged for a $35 million private placement to take place at the closing of the business combination to provide additional cash and additional deal certainty. Moreover, because the price paid in both the step-one cash investment and the closing private placement was based on the proposed $500 million enterprise value for Del Taco in the business combination transaction, it demonstrated to the market and SPAC stockholders that third-party investors and the SPAC’s sponsor supported the proposed valuation of the transaction. The additional cash investments also helped support a SPAC common stock price at or in excess of the redemption price that SPAC stockholders would receive if they redeemed their shares. The transaction was well-received by the public markets, with the SPAC’s common stock trading up to more than $5 above the per-share trust amount prior to the closing of the business combination transaction, resulting in nominal redemptions by public stockholders.
In Boulevard Acquisition Corp.’s recent acquisition of AgroFresh, a business of The Dow Chemical Company, more than two-thirds of the purchase price was paid with cash infused in the business combination in the form of a private placement completed concurrently with the closing, increased debt on the target and standby agreement under which the seller and an affiliate of sponsor agreement to provide up to $50 million in the event that the SPAC had insufficient cash to pay the full cash consideration. Similar to the Del Taco transaction, a significant portion of the cash infusion came from parties to the business combination, an affiliate of the sponsor and The Dow Chemical Company, which served as an endorsement of the business combination valuation to the market. The AgroFresh transaction demonstrates how a business combination with a SPAC can be an alternative to the traditional spin-off transaction.
These recent SPAC transactions demonstrate that SPACs can significantly increase deal certainty and their competitive position in bidding processes by utilizing one or more of the following:
- An upfront cash investment to provide owners of the target immediate cash liquidity and validation that the equity value of the SPAC post-business combination is greater than the redemption price (thus discouraging redemptions)
- Re-financing the post-business combination company to make it in line with debt/equity leverage ratios of public companies of similarly situated businesses
- Obtaining additional support by means of a capital infusion or continued investment in the company by the sellers and/or sponsor to show confidence in the valuation of the business combination