SPAC Mergers and Acquisitions:
Structuring and Deal Terms, SEC Scrutiny
Pricing and Consideration, Recourse, Earnouts, Closing Conditions, Allocation of Board Seats
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Presenting a live 90-minute webinar with interactive Q&A
Natasha Allen, Partner, Foley & Lardner LLP, Palo Alto and San Francisco Brandee L. Diamond, Partner, Foley & Lardner LLP, Palo Alto and San Francisco
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SPAC Mergers & Acquisitions
Structuring and Deal Terms, SEC Scrutiny
Natasha Allen
[email protected] (650) 251-1112
August 2021
Brandee L. Diamond
[email protected] (415) 438-6401
SPAC
Background &
Structure
Development of SPAC Market
• Penny Stock Exchange Act of 1990 and SEC Rule 419 regulated Blanc Check Companies
• SPAC was workaround new regulations
1990s
• Grew in popularity 2000-2007 due to increasing difficulties faced by small companies looking to raise money through IPOs
• 2008 financial crisis dried up SPAC market
2000-2009
• New regulations in 2010 make SPACs more attractive
• SPACs gradually come back into play
• Beginning in 2020, SPAC IPOs increase significantly
2010-2021
What is a SPAC?
A SPAC, or Special Purpose Acquisition Company, is a newly-formed
corporation which raises money in an initial public offering (“IPO”), with the proceeds to be held in trust until used to acquire a business. At the time of the IPO, the SPAC does not have any operating business or other operations.
The company to be acquired cannot be identified at the time of the SPAC’s IPO.
The SPAC has a defined term – generally 18-24 months – in order to complete an acquisition, though the SPAC may extend the outside date to 36 months
through a shareholder vote.
Following the acquisition, the acquired company becomes the surviving publicly traded business.
The SPAC Lifecycle
Stage 3 – The De-SPAC Transaction
Duration: 3-6 months
Stage 2 – Preparation for the De-SPAC Transaction
Duration: 18-24 months
Stage 1 – The Initial Public Offering (“IPO”)
Duration: 2-3 months
The SPAC Capital Structure
In the IPO, the SPAC sells Units, each consisting of one share of common stock and a warrant (or a fraction of a warrant) to purchase one share of common stock (the “Public Shares” and “Public Warrants”).
Units are sold at $10/Unit and listed for trading on either NASDAQ or the NYSE.
Shortly after the IPO, the Public Shares and Public Warrants can be traded separately from the Units.
The Public Warrants are exercisable at $11.50/share (15% above the IPO price) only after the business combination is completed but no earlier than one year after the IPO.
The Public Warrants are usually exercisable for a period of five years following the business combination.
The SPAC Capital Structure (cont.)
100% of the IPO proceeds are placed in a Trust account and can be used only to fund the SPAC’s business combination or to redeem the Public Shares.
– In some SPACs, a portion of interest earned by the Trust can be withdrawn for working capital.
The SPAC’s working capital comes from a concurrent private placement, typically equal to 3- 4% of the IPO proceeds, wherein sponsors typically purchase warrants (“Private Warrants” or
“Sponsor Warrants”).
– This money remains outside of the trust account and is known as the “at-risk capital.”
– The terms of the Sponsor Warrants are generally identical to the Public Warrants, with two exceptions:
The Sponsor Warrants have a cashless exercise feature, while the Public Warrants can only be exercised for cash except in certain limited circumstances.
The Public Warrants are redeemable at a nominal price if the common stock trades above a fixed price (usually
$18/share) after a business combination. The Sponsor Warrants are not redeemable.
Founder Shares
The SPAC Sponsor is usually an LLC, which is owned by the SPAC’s
management group. (The owners of the Sponsor may include other investors if the management team does not have sufficient resources to fund the Sponsor Risk Capital, described below).
– A number of SPACs have been sponsored by private equity or other investment firms, which own the Sponsor entity.
Prior to the IPO, the Sponsor purchases shares of common stock for a nominal price (usually $25,000). These are generally referred to as “Founder Shares.”
Founder Shares typically equal 20% of the amount of common shares outstanding after the IPO, and may be of the same class as IPO shares;
however, the SPAC may use a dual class structure.
Founder Shares (cont.)
In a dual class structure, the Founder Shares convert to class A at the time of the initial business combination
Charter usually includes an anti-dilution provision that will increase the number of Founder Shares in the event of a third-party equity investment at or prior to the closing of the business combination, such that the Founders retain 20%
ownership.
If the SPAC does not complete a business combination within its specified term, and the SPAC is liquidated, the Founder Shares become worthless.
Founders generally waive redemption rights and rights to liquidating distributions.
Founders generally commit to vote in favor of the initial business combination
CLASS A SHARES (HELD BY PUBLIC
INVESTORS)
CLASS B SHARES
(SPONSOR) PUBLIC
WARRANTS SPONSOR
WARRANTS
SPAC ACQUISITION CORP.
(All Proceeds from IPO held in Trust Account)
SPAC Structure After Initial IPO
Redemption Rights of Public Shares
If the SPAC does not complete a business combination during its specified term, it must liquidate and redeem the Public Shares for a pro rata share of funds in the Trust Account.
– The Public Warrants are not redeemed, and expire worthless.
At the time of the business combination, the SPAC must offer its holders of Public Shares the right to redeem their Public Shares for a pro rata share of funds in the Trust Account.
– If too many holders of Public Shares request redemption, it could cause the SPAC to have insufficient funds to complete the business combination.
Limitations on Redemption Rights
The Founder Shares, the Sponsor Warrants and the Public Warrants do not participate in any redemption of shares from the Trust account proceeds.
A Bulldog Provision is often included in the SPAC’s charter preventing a single investor from redeeming more than a set percentage (typically 15-20%) of the total number of IPO shares if they vote against the business combination
Considering whether a
SPAC is the
right fit
Comparing Public Market Vehicles
Traditional IPO
Minimum offering size on a US national securities exchange is typically
>$100M+ and minimum enterprise value is typically >$1B
A
+ Prestige
+ Source of capital
+ Valuation
+ Acquisition currency for strategic acquisitions
+ Best liquidity
– High cost of capital – Longest (6-12 months) – Complex public company
readiness project required – Registration requirements for
resales by insiders
Pros Cons
Reverse Merger with SPAC
Look for existing SPACs that have raised largest amount of capital and sponsor groups that are most lenient with target stakeholders exiting
Look for SPAC sponsors with demonstrated focus in the area where portfolio company is focused
Need capital markets advice that the business that would be publicly traded would be successful in achieving liquidity and source of capital for the future requirements of the business
Raise concurrent PIPE in private markets
B
+ Fastest path to public listing – streamlined SEC review process
+ Source of capital
+ Valuation
+ Acquisition currency
+ Lower cost of capital compared to traditional IPO
– Little financial protection for SPAC Target if transaction falls apart – SPAC sponsors retain significant
equity in combined company, and PIPE investors may acquire a significant interest too
– A former SPAC cannot become a well-known seasoned issuer under SEC rules for at least three years after the business combination
Pros Cons
Additional Considerations
Non-Deal Road Show
As opposed to a traditional IPO that includes a pre-trading road show where underwriters market new shares to generate investor interest, in a SPAC transaction, the SPAC and target company typically undertake a “non-deal road show” (marketing campaign) after signing the
definitive merger agreement and announcing the proposed business combination in order to gain market support for the proposed transaction and to keep the trading price of the common stock above the redemption price.
PIPE Financing
The SPAC will often arrange for investors to purchase new equity in a private investment in public equity (“PIPE”) financing, which occurs at the time of the business combination, in order to cover potential redemptions, provide additional capital to complete the business
combination, provide the company with additional post-closing working capital, and provide visible market support for the transaction.
Target companies should look beyond SPAC sponsors’ offered valuation and operational expertise to consider their ability to corral institutional investors into a PIPE deal.
PIPE capital guarantees enough funding to support the transaction in case several SPAC investors dump stock after a target is announced.
Transaction Timeline
For targets of SPACs, the process of going public can happen in as short as four months, but more often six months, from signing of LOI with SPAC, to preparing for PIPE, de-SPACing transaction, SEC review, HSR, etc.
SEC Filing Requirements
Proxy, S-4, S-8 registration statements; S-3 resale registration statement; form 8-K super filing
Additional Considerations
Engagement with Independent Registered PA Firm
Independence requirements applies to directors and officers of listco.
Required Financial Statements
Two years of audited annual balance sheet, statements of income, cash flows (subject to qualification as “emerging growth company”); if not, or if recommended by investment banks, three years
Eight quarters of financials recommended
Three years of selected financial data (which can be as many as five)
Carve-out and pro formas required for combination with SPAC as well as for acquired or divested businesses subject to same significance tests
Internal Controls over Financial Reporting
Very little work will have been done at existing SPAC, almost all of the work required for an IPO has to be done in limited time.
Extensive disclosures required
Audit testing within a limited period of time
Expense, management time
Additional Considerations
Regulatory Oversight
Same as traditional IPO: new SEC, PCAOB oversight of financials and disclosures
Capital Structure
Units composed of separately traded shares of common stock and warrants to exercise shares of common stock at the IPO price
In addition to public units, sponsor has carry stock and warrants Governance
Following close of de-SPACing transaction, need to appoint a majority of independent board members that satisfy US national securities exchange criteria
Board committees to supervise audit, compensation and governance functions, comprised of independent directors
Directing governance and management of SPAC post-merger would be limited
Personnel, Opex
Same as for IPO: Additional personnel required to support financial statement preparation, accounting, treasury, equity comp, internal audit and legal (estimate 4% increase in G&A expense)
Stock Offered
All target stock converts into SPAC stock
Target stock typically locked up for 180 days to 4 years
Resale registration required for target insiders to sell shares they receive if affiliated with SPAC or target (e.g., >10% holder + board seat)
Public Trading
Investors can lock in a fixed return of approximately 7% on day one and are not incentivized to approve a business combination unless SPAC and target can show significantly greater upside potential.
Many deals have to be restructured to obtain stockholder approval by decreasing overhang of sponsor promote.
Convincing fundamental investors to purchase shares of SPAC from hedge investors who typically vote for a return of capital
Dealing with overhang of public warrants Use of Proceeds
Flexible; pay-down of debt must be disclosed; probable M&A must be disclosed
Issues to Consider as Target Company
Most merger agreements will include closing conditions that the SPAC has a minimum amount of cash or a maximum amount of redemption requests. Excess redemptions without backstop financing can adversely impact the transaction.
As the SPAC has limited cash outside of the Trust, there is little protection for a Target in the way of break-up fees or expense reimbursement if the transaction is not completed.
– Potential targets are generally required to include a provision in NDAs, letters of intent, and merger agreements, agreeing not to seek recourse against the Trust assets.
The Sponsor retains significant equity in the combined company, and there may be PIPE investors who acquire a significant interest as part of the financing of the business
combination.
– The SPAC and Target often enter into shareholder agreements governing post-combination board composition and management of the combined company.
– The company will have an obligation to register the Founder Shares and shares underlying the Sponsor Warrants for resale under the Securities Act of 1933.
Issues to Consider as Target Company (cont.)
When comparing a SPAC transaction to other IPO, financing or sale alternatives, the Target should consider:
– the dilution and impact on valuation of the Founder Shares and Sponsor Warrants, as well as the Public Warrants;
– the potential value of the SPAC’s management team and/or investors on a favorable reception by the public markets, or in improving the company’s business prospects;
– the company’s readiness and staffing needed to comply with public company reporting requirements following the merger; and
– the availability of (or ability to obtain) three years of audited financial statements needed to satisfy SEC requirements for a public offering.
The need to audit or re-audit prior years’ financial results can delay the filing of the S-4 Registration Statement/Proxy Statement.
De-SPAC
Structure and
Deal Terms
The Business Combination – aka “de-SPAC” Transaction
Once the SPAC is public, sponsors search for a target company to acquire
Typically, sponsors have 2 years to find and announce an acquisition or the SPAC will dissolve and shareholders get their money back
Once identified, sponsors negotiate the terms of the acquisition
Initial SPAC shareholders vote on the acquisition
Even if acquisition is approved, SPAC shareholders can redeem their shares for their money back
Once approved and all redemptions completed, acquisition may proceed (subject to other closing conditions)
Key Transaction Terms
Valuation / Consideration:
– Consideration type – cash / stock
– If stock, post-Closing ownership percentage
– Earn-outs
Minimum Cash:
– Condition requiring minimum cash at closing
– Obtained from trust account (net of redemptions) and proceeds of PIPE
Covenants:
– Restrictions on transfers of founder shares and share consideration
– Registration rights for sponsor, sellers and PIPE investors
Governance
– Post-Closing executive team
– Post-Closing Board composition
De-SPAC Structure
The business combination is usually structured as a typical reverse triangular merger: the SPAC forms a wholly-owned subsidiary, which merges into the
Target company. Following the merger, the Target is a wholly-owned subsidiary of the SPAC.
– The SPAC generally changes its name to the name of the Target company.
– If the Target is an LLC, the parties may use a new holding company as the surviving public
company in order to obtain tax-deferred treatment for the LLC owners who receive shares of the SPAC in the business combination.
A business combination with an LLC Target may use an Up-C structure. An Up-C transaction allows the Target company members to retain the tax benefits of a pass-through structure until they choose to sell their shares in the public company, and to obtain potentially significant incremental proceeds when they sell their shares by implementing a tax receivable agreement.
CLASS A SHARES (HELD BY PUBLIC
INVESTORS)
CLASS B SHARES
(SPONSOR) PUBLIC
WARRANTS SPONSOR
WARRANTS
SPAC ACQUISITION CORP.
(All Proceeds from IPO held in Trust Account)
SPAC Structure After Initial IPO
Typical Target Company Structure
PREFERRED
SHARES COMMON
SHARES
OPTIONS TO PURCHASE
COMMON SHARES
Target Company, Inc.
Step 1: Formation of Merger Sub
SPAC ACQUISITION CORP.
SPAC MERGER SUB, INC.
Step 2: Merger & Pipe Financing
SPAC ACQUISITION CORP.
SPAC MERGER SUB, INC.
Target Company, Inc.
PIPE INVESTORS
Final Structure after de-SPAC
COMMON STOCK
PUBLIC
WARRANTS SPONSOR
WARRANTS STOCK OPTIONS
TARGET CORP.
Target Company, Inc.
Target Stockholders SPAC Sponsor
SPAC Public Stockholders PIPE Investors
SEC Requirements
SEC Filings Related to a SPAC Merger
While there may be variations for a particular transaction, the basic SEC filing requirements consist of the following:
Letter of Intent: No filing or disclosure is required when the SPAC enters into an LOI with a Target company. No filings are generally made until the parties enter into a binding, definitive merger agreement.
Definitive Agreement: When the SPAC and Target sign a definitive merger agreement, the SPAC files a Form 8-K which summarizes the terms of the
agreement. The Merger Agreement and press release announcing the agreement are filed as exhibits to the 8-K, along with any investor presentation and, if
applicable, agreements related to financing for the transaction.
SEC Filings Related to a SPAC Merger (cont.)
S-4 Registration Statement/Proxy Statement: This is a combination filing that acts as a registration statement for the shares of the SPAC to be issued to the Target’s
stockholders, and a proxy statement for the meeting of the SPAC’s stockholders to approve the acquisition. This typically goes through several rounds of amendments to respond to SEC comments and to update the information for any changing
circumstances, transaction terms or financing arrangements which occur prior to the S-4 being declared effective by the SEC and sent to the SPAC stockholders.
Closing-Related Filings: The SPAC (which, post-closing, means the Target as the
surviving public company), will file 8-Ks announcing the results of the SPAC stockholder vote and the merger closing. The company will also file a so-called “Super 8-K”, which brings current all of the information about the Target and combined companies which
would be required in a Form 10 Registration Statement in a traditional IPO, including any agreements entered into as part of the closing.
SEC Filings Related to a SPAC Merger (cont.)
Filings Between Initial Announcement and Closing: During this period, the SPAC files copies of any press releases, investor presentations, transcripts of investor calls, and other soliciting materials that are used in connection with acquisition.
Post-Closing Filings:
– Following the Closing, new officers and directors of the company (i.e. individuals from the Target who become officers and directors of the public company) must file Form 3s to disclose their
ownership interests in the company, and new 5% stockholders resulting from the merger will need to file Schedule 13Gs disclosing their ownership.
– The company will file an S-1 Registration Statement to cover the resale of the Founder Shares, shares underlying the Sponsor Warrants, securities issued in any PIPE financing, and if applicable, shares underlying options and warrants of the Target outstanding prior to the merger.
– The company will file a Form S-8 Registration Statement to cover shares issuable upon exercise of employee incentive plans.
SEC Provisions Related to Former SPACs
As a company with assets consisting solely of cash and cash equivalents, a SPAC is considered to be a “shell company” under SEC rules.
As a former shell company, following the business combination the company will remain subject to certain limitations. These include:
– A former SPAC is not eligible to register offerings of securities under employee benefit plans on Form S-8 until at least 60 days after it has filed a Super 8-K;
– Stockholders of former SPACs are required to hold their shares for a period of 12 months from the filing of the Super 8-K before they can sell shares in reliance on Rule 144; and
– A former SPAC cannot become a well-known seasoned issuer under SEC rules for at least three years after the business combination.
SEC Scrutiny
Due diligence disclosures
Forward-looking statements
Warrant accounting
SEC Scrutiny – Due Diligence Disclosures
Due diligence for SPAC process often not as rigorous as traditional IPO
Can result in inadequate disclosures
SEC Staff indicated that it would be looking closely at adequacy of disclosures in offering documents
Examples:
– Disclosures about conflicts of interests
– Disclosure relating to sponsors’ obligations to parties other than the SPAC
– Whether post-SPAC public company complies with rules and regulations governing public companies
SEC Scrutiny – Forward-Looking Statements
Statement by Acting Director of the Division of Corporation Finance in April 2021 hints that the safe harbor protections for forward-looking statements may not be available for a de-SPAC transaction’s financial projections
Even if safe harbor rules continue to apply to SPACs, they only apply to private litigation and don’t provide protection from SEC action for false or misleading statements
SEC Scrutiny – Warrant Accounting
Warrants covered under FASB ASC Topics 480, Distinguishing Liabilities form Equity, and 815, Derivatives and Hedging, requiring companies to assess
classification of warrants
Warrants categorized as liabilities must be accounted for at fair value, introducing volatility into earnings
SEC has indicated that some SPACs haven’t properly accounted for their warrants, leading to an increasing number of financial restatements
