Return of the SPAC: A Brief Introduction to Recent IPO Alternative
SPAC continues to gain momentum as a public listing alternative
SPAC, Special Purpose Acquisition Company, is a legitimate shell company used to raise capital through an initial public offering (IPO) that serves as a temporary cash box, typically within two years, to facilitate public stock listing access for the target company by merging with it.
SPAC is similar to M&A’s Special Purpose Vehicle (SPV) in terms of its non-operating nature, but different in terms of its capital raising methods.
Recently, SPAC seems to be the preferred route for those who want to go to public stock listing on a faster timeline, avoiding the paperwork, costs and investors roadshow hassles in traditional IPO or Direct listing.
If direct listings were the most-talked-about way to go public in 2019, SPACs are the new direct listings — Sophia Kunthara
How Does a SPAC Work?
SPAC Formation
Anyone who can persuade investors to buy SPAC shares can form it. Generally, a SPAC is formed by an experienced management team and an institutional investor or private equity firm with expertise in a particular industry or geographic area, with the intention of pursuing deals in that area. The founder(s) will:
- Handle SPAC’s IPO and any additional funding needed
- Pay a nominal amount of the founder(s) shares
SPAC can’t identify potential targets for acquisition prior to its IPO, but it can specify an industry or geographic area.
The reason SPACs are hot right now is the lack of innovation in the IPO process — Reid Hoffman
Initial Public Offering
Since SPAC is unable to identify potential target specifically, SPAC is selling its potential target’s industry/geography, their team, and their experience to potential investors.
Its IPO process follows a traditional IPO route. According to PwC, SPAC’s shares are typically structured as ~20% founder(s) shares and ~80% public shares offered in an IPO. Furthermore, PwC observed that SPAC’s public shareholders will held “unit” that consists of a share of common stock and a fraction of a warrant (e.g., ½ or ⅓ of a warrant).
The differences between founder(s) shares and common shares usually are:
- SPAC directors can only be elected by founder(s) shareholders
- Public shareholders are able to exercise warrant if they held full warrant (not fraction of it).
After SPAC raises its capital, the proceeding is moved into an interest-bearing blind trust account. This fund cannot be disbursed until SPAC merger or at the end of the agreed SPAC time frame (if the SPAC is unable to close a merger deal).
From this point, SPAC’s management team will start to reach out potential merger candidates and decides which company or companies to merge with.
It’s the quality of the sponsor that has become more intriguing and seeing them (SPACs) run by executives of successful corporations — NASDAQ’s Jay Heller
What Makes a Target?
SPAC typically screens and targets companies in a specific industry or geography. According to law firm Vinson & Elkins, the minimum size of the target company is roughly around 80% of the SPAC trust fund, with no limitation on the maximum size.
However, if the target company is many times larger than the SPAC itself, SPAC can invite institutional investors under confidentiality agreement to finance the deal.
The SPAC deal is similar to common M&A transaction process which consist of financial, legal, and tax due diligence process. However, the process is much more accelerated than a typical M&A due to SPAC’s agreed time frame.
Companies that make the best candidates for SPAC are the ones that want to bring on seasoned management — NASDAQ’s Jay Heller
The SPAC Merger
When an agreement reaches on which target company is going to be proceed, a SPAC is required to get merger approval from shareholders. Once the shareholders approve its merger and all of the regulatory matters have been cleared, the merger will close and the target company survives as the publicly listed entity (stock ticker will change to reflect the name of the acquired company).
If a SPAC is unable complete a merger within the agreed time frame, it will be liquidated and its trust will be returned to the shareholders.
SPAC Considerations
Accelerated public market listing with less labor-intensive process than the traditional IPO and access other forms of flexible capital clearly become attractive benefits for the target companies besides gaining significant capital from the SPAC’s deal proceeding.
Participating in SPAC is considered as low-risk since investors can simply “get their money back” by trading or redeeming their shares and/or warrants if they do not like the proposed target company.
They (investors) might not know or care about your company until it’s time to merge — Elizabeth Lopatto
Despite the positives, there are also challenges and concerns regarding the structure of the SPAC method.
For Target Company
Target companies that pursue public listing through merger with SPAC need to fully understand that transaction with SPAC will results in a hybrid transaction structure between M&A and IPO.
SPAC’s accelerated nature of transaction creates a unique time constrain for target companies compared to the traditional IPO. They need to be mindful of the following considerations according to Deloitte and PwC:
- Limited time frame requires target company to implement comprehensive project management.
- Who is the accounting acquirer?
- What is the nature of transaction, acquisition or recapitalization?
- Proforma financial information must be presented as transaction requirements.
- Fully ready as public company before merger transaction.
- Audited annual and interim financial statements must be presented (including MD&A disclosure) before the merger deal.
- Current senior management team position in post merger structure.
Furthermore, Bloomberg columnist’s Matt Levine wrote that traditional IPO may cost a company 1% — 7% to pay investment bank from capital raised from IPO whereas a merger with SPAC may end up costing a company 5.5% to pay underwriter before other fees associated with merger transaction (such as advisory for the deal, etc.)
For those who are interested to form a SPAC
From SPAC’s perspective, it inherits its own risk and downside, which may occur if not managed carefully. Despite of its sponsors’ quality improvement over the years, according to CB Insights Research, the agreed SPAC’s time frame, which is typically around 24 moths, tends to rush target selection and due diligence that potentially harms investors. The SPAC “thunder storm” in 2020 may also outnumber companies that are willing to go public via SPAC.
It’s not for everyone but it may be the best way for some — John Tuttle from NYSE Group
SPAC Momentum and Trend
Current market volatility and uncertainty continues SPAC’s momentum to gain popularity as an effective option for private companies to obtain capital liquidity, to be publicly listed, and at the same time to bring on seasoned top level management in an efficient manner.
SPAC’s time frame remains as a unique challenge that requires the related parties to manage comprehensive project management, tp prepare company listing readiness, and to pursue transaction accountability and transparency in using an alternative method of IPO.
IPO as a traditional way to publicly listed may not be in jeopardy today, but SPAC points out the lack of innovation in IPO process. On the other hand, SPAC will be less attractive and rewarding when the market regains stability and SPAC outnumbers the private companies that are willing to merge with it.
It may not be the dot-com bubble, but it sure feels like a SPAC attack — Marker Editors
