A number of recent successful business combination transactions involving special-purpose acquisition companies (SPACs) led by prominent sponsors have driven a resurgence in the SPAC IPO market and an evolution in some SPAC terms. In this article, we provide an overview of SPACs and discuss the latest trends in SPAC structures and terms.
SPACs are blank-check companies formed by sponsors who believe that their experience and reputations will allow them to identify and complete a business combination transaction with a target company that will ultimately be a successful public company. In their initial public offerings (IPOs), SPACs generally offer units, each comprised of one share of common stock and a warrant to purchase common stock. The SPAC’s sponsors typically own 20 percent of the SPAC’s outstanding common stock upon completion of the IPO, comprised of the founder shares they acquired for nominal consideration when they formed the SPAC. An amount equal to 100 percent of the gross proceeds of the IPO raised from public investors is placed into a trust account administered by a third-party trustee. The IPO proceeds may not be released from the trust account until the closing of the business combination or the redemption of public shares if the SPAC is un-able to complete a business combination within a specified timeframe, as discussed below. In order for the SPAC to be able to pay expenses associated with the IPO—the most significant component of which is the underwriting discounts and commissions—the SPAC’s sponsors typically purchase warrants from the SPAC, for a purchase price equal to their fair market value, in a private placement that closes concurrently with the closing of the IPO.
Until the closing of the IPO, the SPAC cannot hold substantive discussions with a business combination target. Upon the closing of the IPO, the SPAC’s securities generally are listed on the Nasdaq Capital Market. Nasdaq has special listing requirements for a SPAC, including, among others, that its initial business combination must be with one or more businesses having an aggregate fair market value of at least 80 percent of the value of the SPAC’s trust account, and that it must complete a business combination within 36 months from the effective date of its IPO registration statement, or such shorter time as specified in its registration statement. Nasdaq listing rules also require that the SPAC have at least 300 round lot shareholders (i.e., holders of at least 100 shares) upon listing, and maintain at least 300 public shareholders after listing.
Following the IPO, the SPAC begins to search for a target business. Under the terms of the SPAC’s organizational documents, if the SPAC is un-able to complete a business combination with a target business within a specified timeframe, typically 24 months from the closing of the IPO, it must return all money in the trust account to the SPAC’s public stockholders, and the founder shares and warrants will be worthless. In addition, at the time of a business combination, the SPAC must prepare and circulate to its shareholders a document containing information concerning the transaction and the target company, including audited historical financial statements and pro forma financial information. This document typically is in the form of a proxy statement, which also is filed with the U.S. Securities and Exchange Commission (SEC) and is subject to SEC review. Most significantly, at the time of a business combination, each of the SPAC’s public shareholders is given the opportunity to redeem its shares for a pro rata portion of the amount in the trust account, which is generally equal to the amount they paid in the IPO for their units. If the target is affiliated with the SPAC’s sponsors, the SPAC generally is required to obtain a fairness opinion as to the consideration being paid in the transaction.
Once a business combination is completed, the post-closing company continues to be listed on Nasdaq, subject to meeting Nasdaq’s initial listing requirements, or it can apply to list on a different stock exchange. The founder shares are generally locked up for a one-year period following the business combination, often subject to earlier release if the trading price of the company’s stock reaches certain thresholds.
Latest Structures and Trends
SPAC securities. Most SPACs offer units in their IPO, each comprised of one share and one warrant. Until recently, most SPAC warrants were exercisable for a full share of common stock. In recent SPACs—depending on the size of the SPAC; the prominence and track record of the sponsors; and the particular investment bank leading the offering—the warrant may be exercisable for a full share of common stock, one-half of one share of common stock or even a one-third of one share of common stock. In any case, the warrants are almost always struck “out of the money,” so that if the per-unit offering price in the IPO is $10, the warrants often have an exercise price of $11.50 per full share. In addition, the trading price which triggers the company’s right to call the warrants for redemption historically was often $17.50 with a full warrant. Many SPACs that offer less than a full warrant have increased the trading price threshold to $24 to provide additional value. In addition, some SPACs have decided to offer just common stock in their IPOs. In order to compensate investors for the absence of a warrant, the sponsors of such SPACs “overfund” the trust account by placing an amount equal to 105 percent or more of the gross proceeds of the offering into the trust account, so that investors whose shares are redeemed receive a return on their investment. This additional cash comes from the investment the sponsors make in the private placement that occurs concurrently with the IPO, which, in this case, is for shares of common stock, and not warrants.
Size of offering and dual class structure. The amount that a SPAC will raise in its IPO is the subject of much discussion when the SPAC is being formed. A general rule of thumb is that the SPAC should raise about one-quarter of the expected enterprise value of its business combination target in order to minimize the effect of the dilution resulting from the founder shares and warrants at the time of a business combination. However, it is of course un-certain at the time of the IPO what the enterprise value of the target actually will be given that a target cannot have been identified at the outset. If it turns out that more capital is needed to be raised by the SPAC at the time of the business combination in order to complete the transaction, this may come from the sale by the SPAC of additional equity or equity-linked securities, which would dilute the percentage ownership of the sponsors represented by their founder shares below 20 percent. In order to maintain that percentage at 20 percent, some SPACs have recently implemented a dual-class structure, in which the founder shares are a separate class of stock that is convertible upon the closing of the business combination into that number of shares of the same class held by the public equal to 20 percent of the outstanding shares after giving effect to the sale of additional equity or equity-linked securities.
Warrant protection language. As noted above, the warrants (including both the public and private placement warrants) represent potential dilution to the shareholders of the post-business combination company. The significance of that potential dilution in any given transaction is generally the subject of discussion between the SPAC and the target, and depends on the number of shares underlying the warrants as compared to the total number of outstanding shares upon completion of the business combination, as well as the terms of the warrant (which are struck “out of the money” and are callable by the company only if the trading price of the stock appreciates meaningfully). In some recent business combination transactions, the SPAC has sought warrantholder approval of a proposal to amend the terms of the warrants so that the warrants are mandatorily exchanged at the closing of the business combination for cash and/or stock, or has conducted a tender offer for the warrants to exchange them for cash and/or stock. As a result of these proposals, which in a number of cases have been successful, some potential investors in newer SPAC IPOs have insisted on including terms that limit the ability of the SPAC to amend the warrants in such a manner unless certain conditions are met.
Term of the SPAC. Many SPACs historically have had their terms set at a specific number of months (e.g., 18 or 21 months) with an automatic extension for an additional number of months (e.g., an additional three or six months) if the SPAC has entered into a non-binding letter of intent prior to the initial expiration date. Given the relatively low bar of a non-binding letter of intent for an extension, some recent SPACs have eliminated the initial expiration date, and just have a flat 24-month (or more or less) term.
Requirements for redemptions. In the past, SPACs would require public shareholders to vote against the business combination transaction in order to redeem their shares. In recent SPACs, this requirement has been removed, so that a shareholder can redeem even if it votes in favor of the business combination transaction. Some SPACs still require shareholders to vote, either in favor or against the transaction, in order to redeem their shares. However, this requirement may make some investors reluctant to purchase shares in the open market after the announcement of a business combination transaction and after the record date for the shareholder vote on the transaction, because they would not obtain the ability to vote and, hence, redeem their shares.