The last several years have seen a dramatic increase in the number of special purpose acquisition companies (SPACs). SPACs are publicly traded companies that raise capital through an initial public offering (IPO) in order to acquire or merge with a company within a set time frame, typically 24 months. In 2007, SPACs raised more than $7 billion, a significant increase over 2006. Although there are unique risks associated with any special purpose investment vehicle, the comparative advantages associated with SPACs appear to be outweighing these risks and leading to an even greater number of SPACs.
Many SPACs possess many characteristics that make them more attractive to potential investors than other special purpose investment vehicles. First, SPACs typically require that a business transaction be completed within 18 to 24 months of the SPAC IPO, depending on whether a signed agreement with a target company has been reached. This provides shareholders with some temporal certainty that is not usually available with other kinds of investments, such as private equity funds. Second, SPACs generally permit shareholders who vote against a proposed business combination to demand conversion of their shares into cash. This mechanism provides shareholders with a degree of control over the SPAC’s investments that hedge fund investors and other investors do not normally enjoy. Further, if a certain percentage of investors opt for conversion (usually between 20 percent and 40 percent, as established by the particular SPAC), then the SPAC is barred from completing the transaction. Third, between 95 percent and 98 percent of a SPAC’s proceeds are placed in trust and invested in low-risk debt instruments, further reducing a SPAC investors’ risk. Finally, SPACs are generally operated by seasoned management teams, providing investors with greater assurance of a successful deal.
There are also some drawbacks to SPACs compared to more traditional investment vehicles. First, although the 18 to 24 month “hunting” period may be viewed as a positive attribute for some investors, the downside is the need for a SPAC to locate a target company, negotiate a merger or acquisition agreement, and comply with intensive, highly scrutinized U.S. Securities and Exchange Commission (SEC) initial filings, all within this narrow timeframe. A SPAC is also a public company, and therefore subject to federal securities laws, including Sarbanes-Oxley. A “hunting” period of 18 to 24 months is a relatively short period for all of those activities to occur, thereby raising deal execution risk. Second, the SEC has recently increased its focus on conflicts of interest while reviewing SPAC deals. If an affiliate of a SPAC sponsor is found to have an interest in the transaction, then there will often be an enhanced review period involving extensive comments. Some SPACs have responded to the SEC’s focus by agreeing not to target companies affiliated with the SPAC’s sponsors. This limitation will generally assuage the SEC, but it also limits the SPAC’s investment options. Lastly, a SPAC is not an operating company and has no initial revenue stream, so investors are essentially making a blind wager that a target company will be found. However, given that nearly all of the SPAC’s proceeds are invested in low-risk instruments, there is minimal downside to investors.
SPACs are a relatively new entry into the mergers and acquisitions marketplace, and the unique attributes of SPACs may leave some investors with uncertainty as to whether a SPAC investment is appropriate for the investors’ specific circumstances. While there is no one-size-fits-all investing method, four practice pointers may help clarify some of a SPAC’s qualities and allow investors to make an informed decision:
- A SPAC has an abbreviated time horizon from the date of the IPO in which to close a deal, usually 18 to 24 months. Consequently, investors should familiarize themselves with the potential management team and possibly even the other investors.
- In order to close a deal, a SPAC typically must clear a proxy statement with the SEC, a potentially time-consuming process. Again, diligent research into the skills of the management team and the proposed investment itself will help investors determine the SPAC’s likelihood of success.
- SPACs have free liquidity and may not be able to fund a reverse break-up fee, that is, the payment to a seller by a buyer of a stipulated sum if the buyer fails to meet its obligation to close in accordance with the acquisition agreement. In recent years, reverse break-up fees have become widely adopted by well-advised sellers as deal protection devices. The precise terms and conditions of reverse break-up fees are often the subject of intense negotiation and vary among deals. If a seller has choices among rival buyers and is keen on deal protection, a SPAC’s potential difficultly in agreeing to a market break-up fee may place it at a competitive disadvantage.
- SPACs, like private equity funds, are dependent upon the ability to secure acquisition financing.
A strong and well-regarded management team will have a greater chance of securing sufficient financing, as will a well-researched investment strategy. While no risk-management is perfect, investors as well as sellers should conduct sufficient research to feel confident in the skills and ideas of a specific management team.
SPACs represent an alternative, viable option to sellers when considering a sale transaction. As with any significant business event, all parties must employ forward thinking to ensure that a deal can be completed within the SPAC’s limited time frame. SPAC sponsors, regular investors and potential target companies must familiarize themselves with the characteristics of SPACs to understand the impact that a SPAC structure can have on any particular transaction.