Fairness opinions issued in connection with SPAC transactions present several significant issues that financial advisors and their counsel should take into account when drafting fairness opinions.

In the current economic environment, companies are finding it extremely difficult to raise capital through equity or debt offerings, and are often considering merging with a special purpose acquisition company (SPAC) as a means of raising capital.  In connection with obtaining board approval, a SPAC may engage an independent financial advisor to provide a fairness opinion with respect to the consideration in a proposed merger.  A “fairness opinion” is an opinion given by a financial advisor to the board of directors of a company regarding the fairness of the consideration in a transaction from the perspective of the company or its shareholders.  A fairness opinion provides the board of directors (or a committee of the board) with an impartial analysis and perspective on the consideration in a transaction, and can be an important factor in helping to demonstrate that the board of directors fulfilled its fiduciary duties in approving the transaction.

Each different type of transaction poses a different set of issues from the party requesting the issuance of a fairness opinion and from the perspective of the financial advisor charged with issuing a fairness opinion.  Though such opinions are categorized generally as “fairness” opinions, they at times vary from the typical “fairness from a financial point of view” or adequacy opinions which financial advisors generally opine.  Fairness opinions issued in connection with business combinations involving SPACs differ in certain material aspects from other fairness opinions, though they retain many of the same elements of a traditional fairness opinion.

SPACs

A SPAC is an entity formed with the immediate purpose of raising capital in a public offering, and, when formed, is created as a “blank check” or shell company.  At its formation, a SPAC includes a reputable and experienced management team that draws initial investors.  Rather than holding assets or demonstrating an attractive record of operations, investors are drawn to this management team, which is then expected to find and close an attractive business combination.

At its formation, the SPAC engages in a typical initial purchase offering (IPO) process with the U.S. Securities and Exchange Commission.  The IPO process for a SPAC is typically shorter than that for an operating company precisely because a SPAC does not have any operating history.

In the IPO, the SPAC issues units, which typically consist of one share of common stock and one warrant to acquire a share of common stock.  Virtually all of the proceeds raised in the IPO are placed into a trust account that is liquidated only upon the closing of the business combination or the liquidation of the SPAC.  The prospectus of the SPAC will typically describe the type of transaction anticipated as well as the industry in which the management team expects to later invest.  These expectations are taken into consideration in determining how much money the SPAC will initially seek to raise, as the transaction typically must be with one or more businesses whose fair market value, individually or collectively, is equal to at least 80 percent of the balance in the trust account at the time of the business combination.

The business combination that the management team decides to pursue must be closed within a certain specified time period.  The time period is typically 24 months but is often subject to certain limited extensions.  If the management team of the SPAC cannot successfully close a deal within the specified time period, the SPAC will liquidate and the cash in the trust account is distributed to its public stockholders.  This is one of the major reasons independent directors in SPAC transactions should always consider getting a fairness opinion, because the management team is incentivized to consummate a transaction or they lose that opportunity, and, therefore, management may be willing to overpay to consummate the transaction.

The business combination typically must be approved by holders of a majority of the shares of common stock that were issued in the IPO, who vote on the transaction.  Shareholders who disapprove the business combination have the right to convert their shares into a pro rata portion of the funds held in escrow.  If more than a specified percentage (generally somewhere between 20 and 40 percent) disapprove the combination and demand conversion, then there will be no business combination.

Fairness Opinions

Fairness opinions issued in connection with SPACs are in many aspects consistent with fairness opinions that are issued for other types of transactions.  Certain elements, however, are unique to the SPAC context, including, often, the content of the fairness conclusion, indemnification issues and the relationship of the financial advisor to the parties.

Fairness opinions issued in the context of SPACs are typically sought by a SPAC’s board of directors (or committee of the board) when it is deciding whether to approve a specific business combination proposed by the SPAC’s management.  SPACs often state in their IPO prospectuses that they will obtain a fairness opinion if the SPAC seeks to engage in a business combination with any entity that is affiliated with an insider of the SPAC.  Whether or not the opinion is required, it can serve the usual function of being an important factor in helping to demonstrate that the board of directors fulfilled its fiduciary duties, but can also be misused in persuading shareholders to vote in favor of the business combination.  In this vein, when a fairness opinion was not obtained at the time the transaction was entered into, the SPAC will occasionally decide to get a fairness opinion prior to consummation of the transaction.

The SPAC fairness opinion will look very similar to any fairness opinion letter.  The opinion will include a general overview and description of the proposed transaction and the transaction’s structure; a list of the documents reviewed by the advisor in its analysis, including publicly disclosed information, projections, industry reports, conversations with management and any other items which the financial advisor used in structuring its analysis; disclosure of any qualifications, limitations or assumptions used by the financial advisor in the course of its analysis; and disclosure of any prior (at least within the last two years) relationships between the financial advisor and any party involved in the transaction.

A financial advisor drafting a fairness opinion in a SPAC will provide an opinion with qualifications like those seen in an opinion-only engagement, which are typically more extensive than those which would be expected in a sell-side mandate.  Specifically, a SPAC fairness opinion will typically contain the disclaimer that the issuer of the fairness opinion did not engage in negotiations and was not aware of any alternative transactions, as well as that the financial advisor is not offering an opinion as to the merits of the proposed transaction relative to any alternative transaction or business strategy (including liquidation).  In providing this type of disclaimer, the SPAC fairness opinion limits itself to an evaluation of the fairness, from a financial point of view, of the consideration in the business combination at issue.

The most striking difference between SPAC fairness opinions and fairness opinions issued in connection with other types of transactions is found in the conclusion of the opinion.  While all SPAC fairness opinions contain the basic conclusion that the consideration in the transaction is “fair, from a financial point of view,” some contain the additional opinion that the fair market value of the target or targets, individually or collectively, is equal to at least 80 percent of the balance in the SPAC’s trust account at the time of the business combination.  This additional opinion would be advantageous from the perspective of the management team and the board of directors of the SPAC, as it would provide a third party view of their success in fulfilling the mandate of the SPAC; that is, the financial advisor would have helped to assure the shareholders that the deal meets the criteria and fulfills the special purpose for which the entity was originally created.  Opining as to this additional matter may, however, expose the financial advisor to greater potential liability.

Some SPAC fairness opinions have slightly untraditional indemnification provisions, providing for an escrow account to be created by the entity engaging the financial advisor in order for the financial advisor’s fees and expenses be paid before any of the other fees and expenses of the SPAC are paid.  These provisions may be bargained for to insure against the potential dissolution of the SPAC if the transaction is not approved.  Rather than becoming involved in the dissolution process in order to be paid for any liabilities that later arise, the escrow account provides that the financial advisor’s fees will be immediately paid out and not delayed.

In addition, financial advisors typically agree to waive any claims they may have against the trust account, which waiver is generally solicited from all vendors doing business with the SPAC in order to provide the SPAC’s investors with assurance that the monies in the trust account are protected.  The SPAC’s principal sponsors often agree to indemnify the SPAC for any claims by vendors who did not sign a waiver.  It might be expected that financial advisors who waive claims against the trust account would also turn to the principal sponsors and seek joint and several liability in their indemnification, so that the financial advisor would not be limited to recovering only from the limited funds remaining outside the trust account.  This is not observed, however, in publicly available SPAC opinions.

The financial advisors typically engaged to provide the SPAC fairness opinions are not the underwriters of the IPO, because of the potential conflict of interest that could arise.  Most SPAC underwriters defer a portion of their underwriting discount until the successful completion of a business combination, so the underwriter’s interest in seeing the transaction go through creates conflicts of interest that are not easily avoided. 

Conclusion

SPAC fairness opinions contain many familiar concepts but also novel concepts that respond to the unique risks and circumstances of SPAC transactions.  As the environment for successfully closing SPAC business combinations becomes ever more challenging, careful planning and execution will be even more important in order to gain the most benefit for all parties involved.