What are SPACs?
Portugal's equity market needs to implement urgent measures to meet the needs and enormous capital challenges that are facing its economy.
Among the various possible measures are special purpose acquisition vehicles (SPACs), the introduction of which in Portugal has been recommended by the Organisation for Economic Co-operation and Development (OECD) following its study of the domestic market (for further details, please see "Portuguese equity market: existing issues and recommendations for improvement"). This recommendation is based on recent global experiences with this model, which have seen SPACs effectively bringing companies into the equity market.
SPACs use a hybrid model that combines investments in instruments that are admitted to trading on the market with investments in other instruments. Further, as an alternative to the traditional initial public offering (IPO) process, SPACs bring clear advantages not only for the companies that use them but also to Portuguese venture capital fund managers, who will have one more tool at their disposal.
SPAC promoters are usually private equity investors or other types of investors with a similar investment track record.
The first advantage of SPACs is that they provide permanent access to a market of retail and institutional investors in listed companies for the collection of investments. Secondly, it is possible to exit in a shorter period of time. This is because the increase in the share price to certain average thresholds during a certain period usually allows for exceptions to the minimum holding period of the investment by promoters (known as the "lock-up"). Finally, there is a shorter period for raising capital and greater flexibility in the choice of investments (eg, size, location and sector).
Alternative to IPO
As stated above, SPACs offer an alternative to the traditional IPO process. This requires investing in a company that is subject to an IPO and is incorporated for the exclusive purpose of investing in a company that has not yet been identified (hence the name "blank cheque company"). This culminates in a combination operation with that company through an acquisition or merger, called "de-SPACing". Such a process is not unlike venture capital investment, where investors rely on the judgement and experience of promoters when choosing investment targets.
The two major milestones in the life of a SPAC are the IPO and the merger and acquisition (M&A). The M&A is subject to approval by the shareholders of the SPAC and must occur within 18 to 24 months of the date of the IPO. The SPAC must be liquidated at the end of that period if the M&A has not taken place and, in such a case, investors who are not promoters should receive their investment back with interest.
The IPO process can be quick and simple, considering the absence of both company activity and the search for a target company. There are also legal safeguards to ensure that the proceeds of the IPO can only be used for the M&A operation. This is done by depositing them with a trustee.
For target companies, this is an advantageous way to conduct an IPO, for the following reasons:
- It is quicker and simpler, with less disruption for the company;
- It involves an M&A operation led by experienced promoters, with an inherent valuation of the business that can be backed by a capital increase when additional capital is needed to fund the M&A operation (through private investments in public equity).
- It allows access to the capital market in times of instability, with additional advantages over some aspects of a traditional IPO. These advantages include a greater margin for the use of estimates regarding the future of the business in the materials disclosed for the general meeting that approves the M&A transaction.
There are multiple solutions as regards control and governance after a company has initiated the SPAC. These include alternatives that make it possible to ensure greater control for investors that were shareholders of the target company (eg, different categories of shares and multiple voting). The M&A operation may also have exchange or consideration conditions that allow the shareholders of the target company to maintain a certain level of control and have access to liquidity.
While advantageous, there have been some abuses of SPACs, many of which are a result of inexperienced promoters or the involvement of celebrities. However, the disadvantages can be overcome easily with proper regulation,
In terms of investment protection, besides the ringfencing granted to the IPO proceeds, investors are also protected by the fact that promoters contribute in their investment in the SPAC with "at risk capital", which should be used to support the IPO and operating expenses.
Market practice involves a myriad of technical details that, as a whole, seek to ensure the position of all stakeholders. These include the simultaneous issuance of shares and warrants and the allocation of 20% of the capital to the promoters at a price substantially lower than that of the other investors. Almost all of their contribution ends up in the subscription of warrants that constitute the "at risk capital".
SPACs have several advantages over instruments that already exist in the market, some of which can help overcome many of the obstacles that seem to prevent greater use of the equity market. The introduction of SPACs in Portugal, accompanied by incentives to use them (tax incentives in particular), will certainly contribute to the development of the national equity market.
For further information on this topic please contact Bruno Ferreira at PLMJ by telephone (+351 213 197 300) or email ([email protected]). The PLMJ website can be accessed at www.plmj.com.