The Toronto Stock Exchange (TSX) has adopted new rules governing the listing of special purpose acquisition corporations (SPACs). These rules became effective as of December 19, 2008. In contrast to the TSX listing requirements for a company pursuing a traditional IPO (in which the listing entity is required to have an existing business and prescribed operating profits or prospects), a SPAC is essentially a publicly traded shell company or "blank-cheque company." TSX approval of the listing of SPACs follows similar approvals of the New York Stock Exchange (NYSE) and NASDAQ earlier in 2008. SPACs also trade on AMEX, AIM and Euronext.
The SPAC structure should give seasoned mining industry participants with successful track records an excellent opportunity to establish a clean, publicly listed "war chest" that can be used to make attractive acquisitions, as well as the opportunity to provide investors with a lower risk investment avenue to back these participants.
Comparison of SPACs and Capital Pool Companies
Canadian investors will be familiar with the TSX Venture Exchange’s (TSXV) Capital Pool Company (CPC) program. SPACs are similar to CPCs in that both involve a newly created shell company raising money through an IPO and the requirement to use the net proceeds to acquire an operating business within a certain timeframe. If a qualifying acquisition is not completed within the timeframe, the CPC or SPAC is liquidated and funds returned to investors.
CPCs operate in the smaller cap market sector and must raise a minimum of $200,000, but can only raise a maximum of $1.9 million in their IPOs. By contrast, SPACs are required to raise a minimum of $30 million (with no stipulated maximum) in order to list. The fifteen-fold (or more) difference between the IPO size for a CPC and for a SPAC, and the ability of a SPAC to arrange for debt financing and/or additional equity financing contemporaneous with the closing of its qualifying acquisition, results in SPACs having the potential financial wherewithal to make a truly significant acquisition (or a series of acquisitions that are collectively significant). Equity offering structures such as special warrants or subscription receipts may be particularly useful for these purposes.
Another key difference between SPACs and CPCs relates to investor protections. While the TSXV must approve a CPC’s qualifying acquisition (with shareholder approval only being required in certain circumstances, such as non-arm’s-length transactions), a SPAC must go further and give its investors the right to vote on any proposed qualifying acquisition.
The SPAC Process
There are two distinguishable stages in the life of a SPAC: (i) completing its IPO and TSX listing, and (ii) completing a qualifying acquisition.
IPO and TSX Listing
For a SPAC to become public, a prospectus relating to its securities must be cleared with the relevant securities regulators and a listing application cleared with the TSX, followed by a successful public offering of a minimum of $30 million in SPAC securities.
To obtain approval for a SPAC listing, the SPAC structure must include the following investor safeguards: (i) 90 per cent of the gross proceeds of the IPO must be held in escrow; (ii) investors have the right to vote on any proposed acquisition and also have a ‘conversion right’ under which any investor who votes against a proposed acquisition has the further right to receive a return of his or her pro rata share of the escrowed funds; and (iii) the SPAC must complete a qualifying acquisition within 36 months of its IPO, valued at a minimum of 80 per cent of the IPO proceeds held in trust.
SPAC securities can be either shares or units of securities but must be offered at a minimum price of $2. Units, if offered, must comprise one share and no more than two share purchase warrants. Warrants do not participate in any liquidation event and cannot be exercised until after the SPAC’s qualifying acquisition is completed. However, the warrants can be listed and traded prior to a qualifying acquisition.
To ensure alignment of interests, a SPAC’s founders are required to make an initial investment in the SPAC prior to the IPO. Instead of fixing a minimum and maximum allowable range, the TSX will use its discretion when determining what is an appropriate level of insider or management investment for any particular SPAC. The founders’ equity interest should reflect the credentials of the founders and their financial contribution to the SPAC, and the TSX expects such investment to range between 10 per cent to 20 per cent of the outstanding equity of the SPAC (post IPO completion) but acknowledges that it could be higher or lower. Founders may subscribe for shares, warrants or units of securities but may not transfer any of their founding securities before the completion of a qualifying acquisition, following which the TSX’s escrow requirements relating to SPACs, described below, will apply. The TSX also requires that the underwriters of a SPAC’s IPO agree to have 50 per cent of their commission held in escrow along with the IPO proceeds and released upon successful completion of the qualifying acquisition. This requirement is unique to the TSX’s SPAC rules, and not found in the US.
A SPAC has 36 months following its IPO to complete a qualifying acquisition, which must use at least 80 per cent of the IPO proceeds held in trust but may comprise one large acquisition or a series of concurrent smaller acquisitions.
A non-offering prospectus relating to the proposed acquisition must be filed with relevant securities regulators. Following approval of such prospectus, the TSX must give its "pre-clearance" to a proxy circular (in relation to the SPAC shareholder vote on the proposed qualifying acquisition) that also contains prospectus-level disclosure. Majority approval of the SPAC’s shareholders is then required followed by approval of a majority of the SPAC’s directors who are unrelated to the proposed qualifying acquisition.
If a qualifying acquisition is not completed within the 36-month timeframe following its IPO, the SPAC will have 30 days to distribute the escrowed funds to investors. A SPAC’s founders do not participate in any liquidation events in respect of their initial equity investment.
Since the SPAC process is not intended for use by entities that should be proceeding through a conventional IPO and listing process, at the time of its IPO a SPAC should not have identified a target for its qualifying acquisition. However, the TSX rules do permit a SPAC to have entered into confidentiality agreements or non-binding letters of intent with targets in respect of potential acquisitions.
There are also restrictions on a SPAC’s ability to undertake further debt or equity financings prior to successful completion of its qualifying acquisition. A SPAC cannot issue any further securities unless it is by way of a rights offering to existing investors, nor can it undertake any debt financing prior to completion of the qualifying acquisition. While a SPAC is permitted to enter into a credit facility, it can only draw upon the facility contemporaneously with, or following, the completion of its qualifying acquisition.
In an effort to further align interests of investors and insiders, the TSX has revised its Escrow Policy Statement to provide that in respect of SPAC insiders, 10 per cent (instead of the usual 25 per cent) of insiders’ securities will be released at the completion of the qualifying acquisition, with the remaining escrowed securities released over the following 18 months.
Some Considerations for Stakeholders in the SPAC Process
Investments in SPACs have certain benefits for investors, including flexibility, transparency and significant investor rights. SPACS are flexible because they are publicly traded, and are transparent because they are regulated by relevant securities regulators. Further, investors have a voice, exercised through their vote on proposed qualifying acquisitions. To investors, a SPAC investment has a more limited downside (thanks to both the required conversion feature and liquidation feature, which are described above), should an investor elect to vote against a proposed qualifying acquisition and to exit the SPAC.
Target companies, too, can benefit from doing transactions with SPACs. In the case of a private target company seeking to obtain a TSX listing, doing a qualifying transaction with a SPAC, which by definition is a "clean" shell, should make the process of going public less costly and time-consuming than if the target were to undertake a traditional IPO. On the other hand, the target of a SPAC’s proposed qualifying acquisition does face some deal certainty risk, since the transaction can be somewhat more prolonged and more uncertain. Once a deal has been signed between the SPAC and the target, the SPAC must still clear its non-offering prospectus with the relevant securities regulators, and the SPAC would need to ensure that all relevant public company filings were complete and that other required materials, such as financial statements, were prepared for inclusion in the non-offering prospectus. Even after securities regulatory approval, the SPAC must obtain pre-clearance from the TSX for its circular and must obtain the approval of a majority of shareholders and of directors unrelated to the acquisition. Somewhat mitigating the cost and delay that could be associated with the additional ‘pre-clearance’ requirement, the TSX has advised that it expects proxy circulars to "wrap around" the previously approved non-offering prospectus to reduce time and expense and ensure consistency in disclosure.
A further point for consideration by potential target companies is that customary deal protections usually found in acquisition agreements may not be present in a SPAC deal. A SPAC can walk away from the purchase agreement and a target would have no recourse to the escrowed IPO funds even where a reverse termination fee in favour of the target is included in the purchase agreement. Ultimately, however, since investors in a SPAC’s IPO are, in essence, investing in the experience of management, it would seem unlikely that there would be significant risk of shareholders rejecting a management recommended acquisition.
The Bigger Picture
SPACs have been an area of significant listing activity in the US for several years, and one hopes SPAC listings will inject much-needed activity into the TSX. However, the recent economic challenges facing all companies and investors have not left the SPAC market in the US untouched: 2008 saw a dramatic decline in SPAC listings there compared to the 2007 boom.
In the US, since 2003, 161 SPACs have completed an IPO for aggregate gross proceeds of approximately US$22 billion, with an average deal size of US$136 million. Average deal size peaked in 2008 at US$226 million while the number of SPACs listed peaked at 66 in 2007, dropping to 17 in 2008. Of the 161 SPACs that have completed an IPO since 2003, 66 have completed a qualifying acquisition, 37 are still looking for an acquisition, 15 have announced a target, and 43 have been liquidated.1
If we see a slow start to SPAC activity in Canada in 2009, it can likely be blamed on the challenging economic climate rather than any corporate or investor disfavour towards SPACs. Only time will tell whether SPAC listings will be welcomed by the market in Canada ? however, if the US experience is any indication, they may soon gain acceptance.