A special purpose acquisition corporation, commonly known as a “SPAC,” and formally a “development stage company,” is generally incorporated with the primary objective of raising funds through a public offering of its securities primarily for purpose of acquiring one or more operating companies. However, it will typically begin as a corporation formed by a small group of industry executives or sophisticated investors (“Founding Stockholders”). The Founding Stockholders purchase the company’s common stock for nominal consideration and generally retain, after completion of the IPO, 20% of the SPAC’s common equity, although this percentage is less if the underwriters’ over-allotment option is exercised. Some or all of the Founding Stockholders also serve as the SPAC management team that will search for prospective target operating companies.
The most distinguishing characteristic of a SPAC is that it gives investors the opportunity to vote on potential transactions and redeem a portion of their proceeds held in the trust account if they vote against a proposed transaction.
Why a SPAC?
Because a SPAC is a very clean public shell, it provides a private company with the option of accepting stock versus cash in a transaction and thus avoiding tax requirements. The target company is also able to immediately become a public company without the risk, expenses and time associated with the IPO process. In addition, by selling to a SPAC versus selling to another public buyer, there is no merger process as the company would continue to be a standalone company. Current management would stand a better chance of continuing to run the company themselves, whereas if it were bought by a competitor, management would be competing with the acquirer's management team. The time and effort required to consummate an initial public offering via traditional means continues to grow. As private companies are finding it harder to access capital in the public market, the opportunity to become a public company through an extremely clean public shell has become more attractive and cost effective.
Management of SPAC’s Expenses
In addition to the offering proceeds typically held in trust account (about 90% of the total SPAC IPO proceeds), the remaining proceeds of a IPO generally remain available for use by the SPAC in connection with its search for prospective target operating companies, as well as to satisfy general operating expenses of the company prior to completion of a business combination. The Registration Statement filed with appropriate security exchange for SPAC’s IPO will typically include detailed information regarding its intended use of the net offering proceeds not held in trust account, which excludes any amounts to be paid in connection with offering related expenses. Typically, SPACs will reserve a portion of their net offering proceeds not held in trust account for such items as directors and officers insurance and legal and accounting expenses related to ongoing SEC reporting obligations. A significant portion of the proceeds not held in trust account, however, will generally be reserved for due diligence investigations of prospective target businesses, along with legal and accounting expenses related to the negotiation, structuring and shareholder approval of a business combination.
In addition, SPACs will typically designate the bulk of their net offering proceeds not held in trust account as working capital. Such working capital may generally be used for a variety of purposes, including, among other things, the reimbursement of out-of-pocket expenses incurred by a SPAC’s officers and directors on its behalf, the retention of independent valuation firms and third-party consultants in connection with the evaluation of prospective target operating companies, and other expenses related to the completion of a business combination, including the making of a down payment or the payment of exclusivity or similar fees and expenses.
Managerial Requirements And Remuneration
Founder members or management of SPAC in order to preserve insider ownership of the company’s stock are required to buy atleast 20% shareholding out of the total SPAC’s IPO. Incase of the over-allotment of the IPO, the size of the IPO is generally increased in order to concurrently adjust insider ownership to maintain the 20% shareholding with the Founder members.
Management is generally required to purchase warrants or units at the IPO in order to further align management interests with investors’ interests, in addition to providing support for the warrants once they begin trading. Furthermore, management’s investment is not subject to the same liquidation benefits as shareholders. If a transaction is not consummated, management does not participate in the liquidation of the trust account, and their shareholding become worthless.
Typically, the Founding Stockholders and other directors and officers of the SPAC do not receive salaries or management or finders’ fees prior to or in connection with the consummation of the initial business combination. They do receive reimbursement of expenses. Monthly costs for space and secretarial and other administrative services are paid only from the money not held in trust account. Having paid nominal consideration for up to 20% of the SPAC’s stock, the SPAC management team hopes for delayed, but substantial, capital appreciation upon successful consummation of the first business combination.
Steps For The Running Of A SPAC
1) Filing of Registration Statement
The Registration Statement of SPAC which is required to be filed with appropriate registrar of companies should describe the target sector in which the SPAC intends to acquire operating companies, as well as any objective criteria that management intends to consider in evaluating prospective target operating companies. The Registration Statement should also set forth a description of the offering, the securities to be offered in the IPO, biographies of management of the SPAC and other relevant information.
2) Mode of Offering of Securities
The purchase price of SPAC securities as mentioned hereunder is based on US Practice only and value of purchase price may differ country wise.
In a typical SPAC IPO, the securities are offered in terms of units and one unit is equivalent to one share of common stock and 2 warrants. Investors are able to purchase each unit, typically at a purchase price of $6.00. Each warrant offered with a unit, entitles its holder to purchase one share of common stock generally offered at a price of $5.00. Each warrant may be exercised on the later of (i) consummation of an acquisition or (ii) one year after the date of the prospectus, typically expiring four years after the date of the prospectus. If the SPAC’s common stock trades at a substantial premium for 20 trading days within a 30-day trading period, the warrants are redeemable for $0.01 per warrant at any time after the warrants become exercisable. Depending on whether and when the underwriters exercise their over-allotment option, the common stock and warrants will begin to trade separately.
As the amount of funds raised by SPAC’s has increased, an alternative structure has emerged whereby a unit consists of one share of common and one warrant (versus two warrants offered in the earlier structure) and is priced at $8.00. This has become more popular because bigger deals make it harder for the target company to absorb the warrants. Each warrant entitles the holder to purchase one share of common stock at a predetermined price which has generally been $6.00. One concern with the larger SPACs, however, is that they are then going after much larger companies and thus competing with the top tier private equity firms who have the ability to close a transaction much faster (as they do not need to get shareholder approval to close the transaction).
3) Listing of IPO
SPAC securities may be traded in a variety of ways once an offering is complete. The decision as to where the shares will be listed is a fundamental one for any SPAC, as many consequences relating to distribution and resale flow from that initial choice.
To register particularly on the London Stock Exchange’s Alternative Market Investment (“AIM”), which is the current hot spot for SPACs, a company in addition to certain other formalities is required for undergo the following steps (i) the company must be registered as a public limited company (ii) the company must receive approval from its recognised nominated advisor (“Nomad”), (iii) the company must appoint a broker (iv) the company must prepare an AIM admission document, and (v) the company must ensure that its shares are freely transferable in the United Kingdom.
4) Search for Prospective Buyers
A SPAC after the completion of its IPO will usually begin its search for prospective target operating companies. The officers and directors of a SPAC will often play a significant role in locating and evaluating prospective target operating companies. A SPAC may also designate special advisers, who hold no formal position with the SPAC, to assist management in locating and evaluating prospective target operating companies.
5) Due Diligence of Identified Companies
Process of performing due diligence is initiated by a SPAC’s management on its successfully locating one or more prospective target operating companies. In connection with this due diligence process, the SPAC may seek the assistance of legal counsel, as well as independent valuation firms and third-party consultants. A SPAC may also opt to pay an exclusivity or similar fee to a prospective target operating company to prevent the sale of that company to a third party during the due diligence process.
6) Merger & Acquisitions
Once the due diligence process has been completed, a SPAC will generally negotiate merger or acquisition agreements with each of the prospective target operating companies selected by the SPAC. In the event that a SPAC intends to acquire multiple operating companies, it must generally do so in a single business combination. As a result, any agreements relating to the acquisition of separate operating companies must be drafted to ensure that the individual acquisitions occur simultaneously in order to satisfy one of the key elements of the SPAC structure. The board of directors of a SPAC will then be required to approve any formal merger or acquisition agreements relating to a proposed business combination
7) Shareholders Approval for Prospective Business Combination
After the board of directors has approved a proposed business combination, including any merger or acquisition agreements relating to the proposed business combination, the SPAC must then obtain stockholder approval of the proposed business combination. To that end, the board of directors of a SPAC must establish record and meeting dates for a special meeting of the stockholders of the company in order to approve the proposed business combination.
8) Successful Business Combination
After stockholders have approved a proposed business combination by the requisite majority of votes, IPO proceeds deposited in the trust account will be released to the SPAC in order to complete the proposed business combination. In the event, however, that disapproving stockholders holding more than 20% of the SPAC’s outstanding shares opt to convert their outstanding shares into a pro rata portion of the IPO proceeds held in trust account, the same would not be released to the SPAC, and the SPAC would be prevented from completing the proposed business combination. Once the IPO proceeds held in trust account are released to the SPAC, it will typically complete the proposed business combination shortly thereafter.
SPACs generally self impose certain restrictions on their own activities, as well as those of their respective management teams, subsequent to their IPO to provide protection for their investors. These restrictions generally include, among other things, the following:
- Submission of Offering Proceeds in a Trust
– As an essential investor protection in a SPAC, a large percentage of the IPO proceeds (generally above 90%), net of a portion of the underwriters’ compensation, but not of other offering expenses, is deposited into a trust account where the funds are invested exclusively in short-term government securities until the earlier of (i) the consummation of a business combination that has been approved by stockholders, and (ii) liquidation of the SPAC as discussed below.
- Limitation on Fair Value of Target Businesses
– In order for a SPAC to consummate a business combination, the target business must have a fair market value representing at least 80% of the SPAC’s net assets (excluding deferred underwriters’ discounts and commissions held in trust) after the time of acquisition.
- Limitation on Exercise of Warrants
– The warrants included as part of the units issued by a SPAC will often not become exercisable until the later of (i) the consummation of a business combination, and (ii) some fixed date subsequent to consummation of the SPAC’s IPO (usually one year after the IPO date).
- Opportunity to Approve a Business Combination
– SPACs are required to seek stockholder approval of a proposed business combination, and any business combination must be approved by at least a majority of the shares of common stock purchased in connection with the IPO and no more than 19.99% may choose to liquidate their shares in order for a transaction to proceed.
- Conversion Right of Disapproving Stockholders
– The terms of a typical SPAC offering allow stockholders to vote on a proposed business combination. The SPAC will send each public investor a proxy statement, and any investor who votes against the business combination and affirmatively declares his or her election to convert his or her shares will have the right to receive his or her pro rata share of the trust account in accordance with the procedures disclosed in the prospectus. In the event that greater than 20% of disapproving stockholders elect to convert their shares, a SPAC would also be prevented from completing a proposed business combination and would be liquidated.
- Business Combination Deadline
– A SPAC must typically consummate a business combination within twelve months of its IPO or within eighteen months of its IPO if it enters into a letter of intent, agreement in principle or definitive agreement with a prospective target operating company within twelve months of its IPO. Some SPACs have also used eighteen and twenty-four month time periods, respectively.
- Liquidations Requirement
– In the event that a SPAC fails to complete a business combination within the required time period, it typically is required to liquidate and distribute a pro rata share of the then Trust funds to its stockholders. Founding Stockholders are generally not eligible to receive any distribution of Trust funds with respect to any shares they acquired prior to the SPAC’s IPO, however.