Special Purpose Acquisition Companies

By: David A. Curtiss, Proskauer Rose LLP

This article discusses recent market trends regarding special purpose acquisition companies (SPACs), covering notable transactions, deal structure and process, and other key market trends, and provides an outlook for the rest of the year.

THIS ARTICLE DISCUSSES RECENT MARKET TRENDS regarding special purpose acquisition companies (SPACs), covering notable transactions, deal structure and process, and other key market trends, and provides an outlook for the rest of the year.

The market for initial public offerings (IPOs) of SPACs experienced significant growth in 2019, a trend that has only continued through the first half of 2020. According to our proprietary database, 2019 featured 57 SPAC IPOs raising over $12 billion in the U.S. markets, an increase from 43 deals raising $9.6 billion in 2018. In addition, the first half of 2020 has shown that a steady market continues for SPAC IPOs, featuring 32 transactions raising over $9.3 billion. A few years ago, the SPAC market was considered a niche corner of the capital markets landscape, but this market has boomed, continuing to see larger and more well-established sponsors creating larger and more complex structures backed by the largest investment banks (so-called bulge-bracket banks) as their underwriters. This trend has continued virtually unabated through the COVID-19 pandemic.

SPACs raise funds through an IPO and, in turn, use the capital they raise to seek to acquire one or more businesses in the future. A SPAC is typically marketed to focus on potential acquisitions in a particular industry or geography, although at the time of the IPO a SPAC will not have identified a particular target. A SPAC normally offers units composed of shares of common stock and warrants, or fractions of warrants, to purchase common stock with a strike price higher than the offering price of the unit. 52 days following the pricing of the IPO, holders can usually separate the units into the underlying common stock and warrants, allowing the warrants and common stock to trade separately. The funds raised by the SPAC in the IPO are placed in an interest-bearing trust account which generally cannot be disbursed other than (1) for the closing of an acquisition or (2) to redeem shares that investors have elected to have redeemed upon an acquisition or extension of the life of the SPAC. In some SPACs, a portion of the interest earned on the trust account can be used to fund the working capital of the SPAC. A SPAC typically has between 18 months and two years from the IPO pricing date to consummate an initial business combination before its formation documents require the SPAC to liquidate and return the funds in the trust account to investors or seek approval from shareholders for an extension.

Notable Transactions

The SPAC market had several notable transactions in the last year, including ever-increasing transaction sizes highlighted by Pershing Square Tontine Holdings Ltd., sponsored by Bill Ackman’s Pershing Square funds, which raised $4.0 billion in its IPO in July. In addition, the business combination market provided some interesting companies to the public markets, including Richard Branson’s space exploration venture, Virgin Galactic.

Virgin Galactic

Our last update highlighted the Social Capital Hedosophia SPAC, led by Chamath Palihapitiya, a former Facebook executive, as a notable IPO raising gross proceeds of $690 million. Social Capital closed its initial business combination in 2019 by merging with Richard Branson’s Virgin Galactic, providing the commercial space exploration company with additional capital and access to the public markets. Mr. Palihapitiya will remain involved in the company as chairman and Virgin Galactic will continue to be led by its pre-transaction management team.

In connection with the transaction, Social Capital domesticated from the Cayman Islands to Delaware and valued the merged company at an enterprise valuation of $1.5 billion. The transaction is an example of SPAC transactions increasingly becoming the focus of private companies looking to enter the public markets without using a traditional IPO structure.

Pershing Square Tontine Holdings

Continuing a trend of sponsor-backed transactions and highlighting the ever-increasing deal size at the top of the market, Bill Ackman came to market with a SPAC, Pershing Square Tontine Holdings, Ltd., featuring a unique unit structure and massive deal size. Pershing Square Tontine raised $4 billion in its IPO and includes an additional $1 billion in forward purchase commitments from Pershing Square funds, giving it a $5 billion equity war chest to seek out an initial business combination aimed at mature unicorns. In addition, Pershing Square Tontine Holdings structured its unit in two unique ways: first, the economics are based on a $20.00 per unit IPO price, double the typical SPAC deal and, second, a portion of the warrants are subject to forfeiture to the extent the related shares are redeemed in connection with an initial business combination.

First, fundamentally the higher share price is largely just a feature of the larger transaction because all of the other economic terms (other than the fractional warrants discussed below) are also effectively doubled from the usual $10.00 per unit terms in a typical SPAC. Second, and more interestingly, the warrants issued as part of the unit are uniquely structured to incentivize shareholders not to redeem in connection with an initial business combination. At the IPO, the units included one share of common stock; one-ninth (1/9) of a warrant to purchase common stock; and the right to receive a pro rata portion of warrants (the Tontine Warrants) representing, in the aggregate, two-ninths (2/9) of a warrant to purchase common stock per unit issued in the IPO. Effectively, this means that in the IPO each unit consists of one share and one-third of one warrant but the tontine structure of the warrants incentivizes shareholders not to redeem in the initial business combination because any shares that are redeemed lose their participation in the Tontine Warrants.

Deal Structure and Process

Initial Public Offering

A sponsor typically forms the SPAC entity prior to making an initial filing of a registration statement—usually on Form S-1. A SPAC is most often sponsored by either (1) well-known professionals in the specific industry or geography of focus for the SPAC or (2) private equity funds seeking acquisitions outside the focus of their general funds.

The registration statement for a SPAC follows the same form requirements as any other IPO. However, since the SPAC has no operations to describe, the disclosure is relatively simple. The registration statement includes current financial information of the SPAC, including audited financial statements, and a detailed description of the SPAC structure. In addition, although the SPAC will not have identified a target, the registration statement will (1) describe the expertise of the sponsor and the executive team and (2) generally include a description of the investment opportunity in the industry or geography on which the SPAC will focus.

Upon consummation of an IPO, the typical capitalization of a SPAC is as follows:

• 20% of the outstanding shares are issued for a nominal amount to the sponsor(s) in what is referred to as the sponsor promote or the founders shares.
• 80% of the outstanding shares are issued to the public in the IPO as part of a unit that also contains a warrant or a fraction thereof. The proceeds of the IPO, after paying part of the underwriting discount and other expenses, are placed in a trust account. The remaining part of the underwriting discount is only paid upon the consummation of an initial business combination.
• The sponsor also purchases warrants to fund the difference between the offering price to the public and the commissions and expenses paid by the SPAC such that there are enough funds in the trust to repurchase shares at the offering price of a unit upon redemption. The proceeds received by the SPAC from the privately placed warrants are referred to as the sponsor’s at risk capital because upon a liquidation, these amounts are paid out to the public shareholders and the warrants purchased would not have any value and would not receive any distributions.
• In addition, many SPACs include forward purchase arrangements or other equity commitments with their sponsor, its affiliates, and other investors at the time of the IPO to provide additional equity financing in connection with the initial business combination, providing the SPAC with greater certainty that any equity funding necessary to complete the transaction will be available.

Business Combination

Upon consummation of the IPO, the SPAC is typically listed on either Nasdaq or the New York Stock Exchange (NYSE) and management of the SPAC turns its attention to seeking an existing business or assets to acquire in the SPAC’s initial business combination. Management of the SPAC is typically a group of people affiliated with or on loan from the sponsor who dedicate part of their time to seeking an initial business combination. Pursuant to Stock Exchange rules, the initial business combination must occur with one or more target businesses that together have an aggregate fair market value of at least 80% of the assets held in the trust account (excluding the deferred underwriting commissions and other items) at the time of the definitive transaction agreement.

After signing a definitive agreement for the initial business combination, the SPAC must either (1) seek stockholder approval of the initial business combination—in connection with which stockholders may seek to have their shares redeemed (regardless of whether they vote for or against the initial business combination)—or (2) provide stockholders with the opportunity to sell their public shares to the SPAC by means of a tender offer. Whether through redemption or a tender offer, the price the SPAC must pay for the shares is an amount in cash equal to the holder’s pro rata share of the aggregate amount then on deposit in the trust account, including interest but less amounts permitted to be withdrawn for taxes and for working capital purposes. Many SPACs restrict holders (together with others they are acting in concert with) from redeeming more than a certain percentage—generally 10% to 20%—of the outstanding public shares in order to discourage holders from accumulating large blocks of shares. This is often referred to as the Bulldog provision (named after an activist investment fund that in 2008 accumulated a large stake in TM Entertainment and Media, a SPAC, and attempted to replace the board of directors and force an early liquidation of the SPAC).

The choice to seek stockholder approval of the initial business combination or to conduct a tender offer for its shares is in the discretion of the SPAC, generally in consultation with the counterparties to the business combination. The decision is based on a variety of factors, including whether the completion of the business combination otherwise requires approval of the SPAC’s stockholders (such as authorization to amend the formation documents or to issue 20% or more of the outstanding shares) and the timing of the transaction. In addition, a business combination is often structured to supplement the trust account (or to backstop any redemptions) through issuance of new equity in the combined company at closing through previously arranged equity instruments or through a private investment in public equity (PIPE) investment. The PIPE, the terms of which may vary widely, may be committed at signing or marketed to potential PIPE investors between the signing and closing of the business combination. The transactions also often include committed debt financing, either to refinance existing debt of the target company subject to acceleration upon the completion of the transaction or as consideration to purchase the target company. The process from signing to closing typically takes two to five months, depending on the stockholder and regulatory approvals necessary to complete the transaction.

Proxy

If the SPAC submits the combination to a shareholder vote, it will typically prepare and file a proxy statement with the Securities and Exchange Commission (SEC) on Schedule 14A to be mailed to shareholders. The SPAC proxy contains all the information that is typical for a large merger, including the target’s current and historical audited and interim financial statements as well as other detailed disclosure about the target company or companies. Often targets in initial business combinations are not regularly preparing financial statements that meet SEC filing requirements or being audited under the standards of the Public Company Accounting Oversight Board. In that case, preparing the information can be a significant impediment to timely filing the proxy statement, which affects the timing of closing the transaction. The proxy will also contain a complete description of the post-transaction company and its management, directors, governance structure, and material contracts (including debt financing agreements related to the de-SPACing transaction). If the transaction structure contemplates an entity other than the SPAC as the surviving public company, the proxy could be combined with a prospectus and filed as a registration statement on Form S-4 to register new shares in the surviving company. The proxy is also used to offer the shareholders their redemption rights pursuant to the SPAC’s charter documents.

If the business combination contemplates a tender offer in lieu of a proxy/redemption, the SPAC will prepare a Schedule TO which includes a similar level of disclosure about the target company or companies and the terms of the transaction as the proxy statement.

Liquidation

Pursuant to its formation documents, if a SPAC is unable to complete the initial business combination within a set time period (usually 18 months to two years from the IPO, subject to extension), the SPAC will (1) cease all operations except for the purpose of winding up; (2) redeem the then-outstanding public shares for cash  at a per-share price equal to the aggregate amount then on deposit in the trust account, including any earned interest, divided by the number of then outstanding public shares; and (3) as promptly as reasonably possible following such redemption, dissolve and liquidate, subject in each case to the SPAC’s obligations under applicable law, including to provide for claims of creditors. A SPAC can also seek to have the initial time period to seek a business combination extended, so long as it concurrently offers holders of the outstanding public shares the redemption rights they would have upon liquidation. The SPAC’s officers and directors waive their rights to liquidating distributions from the trust account with respect to any shares held by them prior to the IPO, but not with respect to any public shares they acquire in or following the IPO.

Other Key Market Trends

As the SPAC IPO market has expanded in the last couple of years, we have continued to see the size of SPAC IPOs grow. While Pershing Square Tontine Holdings is the largest SPAC IPO to date, our data shows in the first half of 2020, 34% of SPAC IPOs raised more than $300 million, compared to 10% in 2019. As larger and more sophisticated sponsors continue to enter the SPAC market, backed by larger and more diverse investment banks as their underwriters, we see this trend continuing even as the number of smaller SPACs continues to grow. In addition, over the past few years we have seen more SPACs list on the NYSE than in the past, likely due to a reduction in the NYSE listing fees applicable to SPACs. In addition, SPACs can experience challenges complying with the exchanges’ round lot and public holder requirements prior to the consummation of an initial business combination because their shares often trade among a relatively limited number of investors. Both the NYSE and Nasdaq have been working to adjust to their listing rules to mitigate obstacles faced by SPACs in listing their shares and keeping their shares listed, though many of the changes have not survived SEC review. The exchanges are expected to continue to work with the SEC and the SPAC community to avoid outcomes where SPAC companies are subject to delisting proceedings.

Market Outlook

SPACs continue to be an attractive vehicle for raising capital and an efficient pathway for privately held businesses to become publicly traded on an expedited timeline compared to a traditional IPO, diverting less of management’s time to the transaction process and allowing management to focus on running the business. Market interest remains strong, both in new SPAC IPOs and in de-SPACing transactions. 2019 was a strong year for SPAC IPOs, and there are numerous SPACs that are well on their way to a successful de-SPACing transaction. The active market in 2020 should ensure a robust de-SPACing pipeline on the heels of a few strong years of SPAC IPO activity.

David A. Curtiss is a corporate partner in the New York office of Proskauer Rose LLP. His practice focuses on capital markets, including the representation of sponsors, companies, and underwriters in equity and debt offerings. David has worked on a number of significant high-profile corporate matters for marquee clients.

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