SPACs have never been hotter than they are today. Within a two-week period, we have seen both the largest announced SPAC acquisition in history – Churchill Capital Corp. III’s proposed $11 billion acquisition of health cost management services provider Multiplan – as well as the largest SPAC IPO ever – the $4 billion IPO of Bill Ackman’s Pershing Square Tontine. In addition, among other well-publicized deals, the electric car manufacturer Fisker has agreed to go public at a $3 billion valuation through a SPAC controlled by Apollo Global Management, online sports betting company DraftKings has gone public this year through a SPAC and last year Richard Branson’s Virgin Galactic Holdings went public through a SPAC. Online casino company Golden Nugget Online Gaming also recently announced it would be acquired by a SPAC. Blackstone, TPG, Goldman Sachs, Fortress and other major institutions have sponsored SPACs.
For private companies and their shareholders seeking an exit, going public via merger with a SPAC may offer various benefits as compared to a traditional IPO, especially in times of increased market volatility. Most significantly, the company can avoid market and pricing uncertainty by agreeing up front on the key pricing terms with the SPAC. In addition, the company may avoid the need for a traditional lengthy roadshow in which investors evaluate the company’s business, projections and prospects. The company may also benefit from the involvement, often through board representation, of the SPAC founders who are generally sophisticated market professionals and who may have particular expertise in the company’s industry or in the financial markets generally.
Structurally, SPAC transactions are hybrids of IPOs (both in the fund-raising sense and because the target company will become publicly-traded and need public company governance) and merger transactions. In addition, the economic terms of a SPAC vehicle – the ability for SPAC shareholders to redeem for any reason, thereby decreasing the funds available to a target company, and the significant economic dilution caused by the SPAC founder shares and warrants – create different dynamics as compared to IPOs or traditional mergers. These structural and economic aspects taken together can lead to numerous considerations that set SPAC transactions apart from either an IPO or a merger with an operating company.
Based on our extensive experience, we describe below twenty key considerations for the management and controlling shareholders of companies considering going public by merging with a SPAC in negotiating a letter of intent and business combination agreement with the SPAC.
- Merger Consideration: Will the merger consideration be all stock or partially cash? Transaction consideration for target company shareholders is most often stock but can also be a combination of stock and cash. Sometimes, the cash payment to target stockholders is structured as a stock redemption rather than as cash consideration. In some cases the consideration is estimated at closing, a portion of the consideration is placed in escrow, and the final consideration amount is determined within a specified number of days post-closing.
- Minimum Cash Condition: What is the minimum amount of cash the SPAC must have at closing after giving effect to any possible redemptions? Because SPAC mergers are generally viewed, at least in part, as capital raising events, one of the principal issues for a target company in evaluating a business combination with a SPAC is the amount of cash that will be available in the SPAC’s trust account (where it is required to preserve substantially all of the cash raised in its IPO), less cash used for shareholder redemptions, upon closing of the transaction. Because SPAC shareholders have the right at closing to redeem any or all of their shares for cash, even if they vote to approve the transaction, it is never certain how much cash will remain in the SPAC’s trust account at closing. In order to protect a target company against this risk, the business combination agreement may include as a condition that a certain amount of cash must remain on the SPAC’s balance sheet at closing after giving effect to all redemptions. Typically, this includes cash raised in the SPAC’s IPO as well as additional cash the SPAC raises in connection with the business combination.
- PIPE: What amount of PIPE proceeds, if any, will be raised by the SPAC to counteract potential redemptions? There are several ways that SPACs can mitigate the cash drain from shareholder redemptions. One of the most common approaches is to obtain committed financing from investors in a PIPE (public investment in private equity). Most often the PIPE investors, which sometimes include the SPAC’s sponsor, acquire common stock, but in some cases, they may also acquire warrants. Often the PIPE investors will execute purchase commitments at the time of signing the business combination agreement, the equity will be issued to them at the closing of the business combination, and the surviving company will agree to file a registration statement covering the resale of the securities within a short period of time after closing. However, in some cases, PIPEs are negotiated in connection with the closing of the business combination with new third parties who are investing to replace capital that is likely to be redeemed. Another approach used in some transactions is for the SPAC to enter into forward purchase agreements at the time of their IPO in which specific investors agree to purchase SPAC equity at the time of the business combination, often at a discount. In all cases, SPAC targets should be careful to document how PIPEs will be implemented to ensure the desired economic effect.
- Earnout: Will any part of the consideration be subject to earnout based on the stock price of the surviving public company? Sometimes a portion of the equity consideration payable to the target company shareholders is subject to an earnout based on the trading price of the public company’s stock over a period of time. If the stock price does not reach the target price by the end of the specified period, the earnout shares are never issued or are forfeited.
- Vesting of Sponsor Equity: Will any of the SPAC sponsor’s equity be subject to vesting based on the surviving company’s stock price? Similar to the earnout that a target company may be subject to, in some transactions the sponsor’s equity is put at risk and made subject to vesting based on the achievement of stock price thresholds over time, with the sponsor forfeiting the stock if the stock price does not reach the designated milestones.
- Forfeiture of Sponsor Equity: Will the SPAC’s sponsor forfeit any of its equity as part of the deal? In connection with the SPAC’s IPO the SPAC’s sponsors/founders typically (i) acquire 20% of the SPAC’s outstanding shares for essentially no consideration and (ii) purchase warrants which are largely the same as the warrants issued to the public in the IPO. In connection with business combinations, SPAC sponsors often agree to forfeit a portion of their equity in order to minimize overall deal dilution. In addition, founder shares and warrants may also be transferred to PIPE investors in order to entice them to come into the transaction.
- Warrants: Should the SPAC seek to repurchase some or all of its warrants or amend the terms of its warrants as part of the business combination, in order to minimize dilution caused by the warrants? SPACs generally go public through the issuance of units which contain common stock and warrants. Typically, SPAC warrants allow the holder to acquire a specified number of shares of SPAC common stock at a specified strike price but the warrants are not exercisable until the SPAC consummates its business combination. Given the dilution and overhang caused by the warrants, target companies and SPACs may wish to consider alternative ways to redeem some or all of the warrants, including by repurchasing a certain amount of the warrants from a few holders or conducting a tender offer for some or all of the warrants.
- Extension: Is the SPAC close to the deadline when it must complete its initial business combination? Does the SPAC need to have a shareholder vote to obtain an extension of the deadline? If a SPAC does not complete its initial business combination within a specified time period (usually 24 months from the time of its IPO), the SPAC is required under the terms of its charter documents to redeem all of its outstanding public shares for cash with the funds in its trust account and then dissolve and liquidate and cease its operations. To the extent a target company signs a business combination agreement with a SPAC within a few months of this deadline, the parties should include a provision in the business combination agreement pursuant to which the SPAC agrees to obtain shareholder approval for an extension of its deadline in order to allow it to complete its business combination with the target company. The extension of this deadline will require the vote of SPAC shareholders who must also be given an opportunity to redeem their shares in connection with this vote.
- Termination Fee: Should there be a termination fee payable by the target company in any circumstances? Most recent SPAC transactions do not have termination fees. However, some recent deals include termination fees payable by the target company if it accepts an alternative acquisition proposal under certain circumstances.
- Lock-Ups: Which stockholders will be locked up, and for how long? Generally, the SPAC sponsor and certain other SPAC shareholders and significant target company shareholders will be prohibited from selling some or all of their shares for some specified period of time post-closing. The lockups typically differentiate between the SPAC stockholders and significant target company shareholders (who may be asked to refrain from selling for a year or even two years) and other less significant shareholders (who may be locked up for only six months or less).
- Registration Rights: What registration rights must be provided by the surviving company to the SPAC founders, the target company shareholders, and PIPE investors? The exemption utilized most typically for selling stock received in a private placement – Rule 144 – is not available for shareholders of SPACs or former SPACs until 12 months after the closing. As a result, both target company shareholders and the SPAC founders will focus on post-closing liquidity and the need for registration rights. Typically, the surviving company in the transaction will agree to provide registration rights to the holders of founder shares, to shareholders of the target company who would be considered affiliates of the surviving company, and to the purchasers of PIPE shares.
- Support Agreements: What percentage of the target company’s shareholders will sign support agreements and agree to vote in favor of the transaction? The SPAC will typically request that directors, officers and certain other major target company shareholders sign support agreements pursuant to which they agree to vote in favor of the business combination. This parallels the agreement of the SPAC’s own founders to vote in favor of the deal at the SPAC’s shareholder meeting. The target company shareholder support agreements are typically provided upon signing the business combination agreement.
- Capital Structure: What adjustments are necessary for the target company’s capital structure in order to become a public company? Will preferred stock or convertible debt convert into common stock? Is a dual class structure preferred? Will any debt be repaid or new debt incurred? In many cases, the target company will have one or more series of preferred stock or convertible debt outstanding that will need to be converted into common stock just prior to the closing. Most typically the conversion will be automatic in accordance with the terms of the applicable instrument but, if not, restructuring of these instruments may be required. The parties may also seek to create a dual-class structure where certain shareholders receive high vote stock. In some transactions the parties may require that some of the target’s debt be repaid at or prior to closing, or loans from the sponsor may be required to be repaid at closing.
- Board: Who will be the directors of the surviving public company? How many representatives will the target’s controlling shareholder have on the board, and how many representatives will the SPAC have on the board? The target company and the SPAC will need to determine the size of the board of the surviving company, how many representatives the SPAC and the controlling shareholder of the target will have on the board, and how many independent directors will be appointed. Often the board will be a classified board and the parties will also need to determine which directors are included in each of the three classes of directors. Depending on the structure of the transaction, the target company and the SPAC may be required to have three independent directors qualified to serve on the audit committee at the time of closing, including at least one audit committee financial expert, and may also be required to have fully independent compensation and nominating/governance committees. Board rights may be documented in the merger agreement or in a separate shareholders agreement or investor rights agreement.
- Management: Will management enter into employment agreements? Some business combinations require the surviving company to enter into employment agreements with one or more members of the target company’s senior management team. Most typically the SPAC requires employment agreements with the officers listed on a disclosure schedule at or prior to the closing of the business combination.
- SPAC Shareholder Approval: Which items require shareholder approval from the SPAC shareholders? The SPAC will typically hold a special shareholder meeting for the approval of the business combination and the business combination agreement. At this meeting, SPAC shareholders also may need to approve any changes to the SPAC’s certificate of incorporation and may also need to approve the issuance of SPAC common shares under NYSE or Nasdaq shareholder approval requirements to the extent any equity to be issued, for example in a PIPE, exceeds 20% of the SPAC’s outstanding shares. SPAC shareholders may also need to approve any contemplated new equity incentive plan.
- Governmental Consents: Is Hart-Scott-Rodino (HSR) clearance necessary? Are any other regulatory approvals needed? The target will need to evaluate whether Hart-Scott-Rodino approval is necessary or whether any antitrust or competition approvals are needed in any non-US jurisdictions. In addition, regulated companies such as insurance or gaming companies will need to evaluate whether the transaction constitutes a change of control or otherwise requires regulatory approval under the laws and rules of applicable states and countries. All deals also require listing approval with respect to newly issued shares from the New York Stock Exchange or Nasdaq, as applicable.
- Financial Statements: Does the target company have PCAOB-compliant financial statements prepared and ready for filing with the SEC? In many cases the target company will not have PCAOB-compliant audited financial statements prepared for the required number of years at the time that it starts discussing a potential transaction with a SPAC. The target’s financial statements will need to be audited and ready for inclusion in the proxy statement or Form S-4 / F-4 as soon as possible after signing the business combination agreement. The parties will need to coordinate with the target’s auditors as early in the process as possible with respect to the number of years of audited financial statements that are required in the proxy statement or Form S-4 / F-4.
- Structure: Will the target company become a subsidiary of the SPAC? Will a new holding company acquire both the SPAC and the target company? The most typical structure for domestic SPAC acquisitions involves the SPAC setting up a merger subsidiary which merges with and into the target company so that the target company becomes a wholly-owned subsidiary of the SPAC. However, there may be significant reasons for considering alternative structures, for example for tax or accounting purposes, or for avoiding change of control provisions in contracts, or in order to change one of the companies’ domiciles.
A number of SPAC transactions, particularly involving non-US target companies, have utilized a “double dummy” structure whereby the SPAC or the target company have set up a new holding company and the holding company acquires both the SPAC and the target company in exchange for new holding company shares. The new holding company files a proxy statement / prospectus on Form S-4 or F-4 in order to register some or all of the shares issued and becomes the continuing public company after closing.
- Domicile: Should the SPAC or target company be re-domiciled into a different jurisdiction? Most typically the SPAC will be organized in Delaware and remain a public company organized in Delaware after the closing. But, in some cases, it may be advantageous for various reasons, including tax, to reorganize the continuing public company in a different jurisdiction, including potentially in a non-US jurisdiction, usually by way of an SEC-registered reincorporation merger.