The last time I wrote about special purpose acquisition companies (SPACs) in July 2018, I noted that SPACs had been growing in popularity, raising more money in 2017 than in any year since the last financial crisis (see HERE). Not only has the trend continued, but the Covid-19 crisis, while temporarily dampening other aspects of the IPO market, has caused a definite uptick in the SPAC IPO world.
In April, the Wall Street Journal (WSJ) reported that SPACs are booming and that “[S]o far this year, these special-purpose acquisition companies, or SPACs, have raised $6.5 billion, on pace for their biggest year ever, according to Dealogic. In April, 80% of all money raised for U.S. initial public offerings went to blank-check firms, compared with an average of 9% over the past decade.”
I’m not surprised. Within weeks of Covid-19 reaching a global crisis and causing a shutdown of the U.S. economy, instead of my phone not ringing, I was inundated with inquiries relating to SPACs and reverse mergers. The sentiment is that there will be significant buying opportunities as the virus subsides and the economy recovers, including an even further increase in technology and new industries for our new normal.
Similarly, many companies that were planning a traditional IPO have adjusted their focus to a reverse merger. The thought is to go public quietly, make sure governance and processes are buttoned up, and be ready for follow-on offerings, and merger and acquisition opportunities, using stock as currency at the uptick in valuation that comes with the liquidity available to publicly traded companies.
Mid-tier bankers are in on the opportunities. Not all businesses are cash-strapped; in fact, some are enjoying the highest growth in their life cycle. Food-delivery businesses of all sorts, direct-to-consumer household product suppliers, personal protective equipment, including hand sanitizer manufacturers, video meeting and conferencing companies, virtual event planners and organizers and underlying technology providers and of course, e-commerce personalization technology companies, life science and biotech companies, including those that were already deep in viral or immunotherapy research and development, digital currency platforms are all booming. Many of these companies are looking at reverse merger opportunities and small-cap bankers are willing to invest a few million betting on the larger follow-on raise to come.
Those looking to go public via a SPAC or reverse merger have options. At the same time that the SPAC IPO market is booming, unfortunately, many public companies have been hard hit by the crisis and management is considering options, including taking the current business private or discontinuing operations, and finding value for their shareholders by completing a reverse acquisition.
Of course the benefit of a SPAC is that it comes with cash, but that is not a certainty either. A SPAC’s public stockholders can elect to have their shares redeemed for cash in connection with the business combination and as such, the amount of cash available for post-closing operations is uncertain. The target may require a minimum cash closing condition or, perhaps more importantly, that the SPAC have committed acquisition financing. As such, a SPAC can be substantially the same as any reverse merger with a simultaneous PIPE transaction.
Background on SPACs
A special purpose acquisition company (SPAC) is a blank check company formed for the purpose of effecting a merger, share exchange, asset acquisition, or other business combination transaction with an unidentified target. Generally, SPACs are formed by sponsors who believe that their experience and reputation will facilitate a successful business combination and public company. SPACs are often sponsored by investment banks together with a leader in a particular industry (manufacturing, healthcare, consumer goods, etc.) with the specific intended purpose of effecting a transaction in that particular industry. However, a SPAC can be sponsored by an investment bank alone, or individuals without an intended industry focus.
The sponsor of a SPAC contributes 10% of the total post initial public offering (IPO) capital of the company. The sponsor’s 10% capital is used to cover the IPO and ongoing SEC reporting and administration expenses. Although a sponsor will invest 10% of the capital, they typically receive founder’s shares in the SPAC that results in approximately 20% ownership in the post IPO company. Sponsors do not make money unless a successful business combination is completed and the value of their ownership increases enough to justify the time and capital commitment of acting as a sponsor.
When a SPAC completes its IPO, usually 100%, but in no event less than 90%, of the funds raised are held in escrow to be released either upon completion of a business combination transaction, or back to shareholders in the event a transaction is not completed within a set period of time. Upon closing of a business combination, the SPAC investors can elect to continue as shareholders of the combined business or redeem their shares for cash. A SPAC business combination must have a market value of at least 80% of the value of the amount held in escrow at the time of the agreement to enter into the transaction.
A SPAC generally has 24 months to complete a business combination; however, it can get up to one extra year with shareholder approval. If a business combination is not completed within the set period of time, all money held in escrow goes back to the shareholders and the sponsors will lose their investment.
SPAC IPOs are usually structured as unit offerings with both stock and warrants to entice investors to bet on the unknown future opportunity. The number of warrants and exercise price can vary. Although sponsors with a prominent track record can generally attract better valuations and investor deals, with the continuing popularity of SPACs over the years, that has become less important. As an alternative to warrants, some SPAC sponsors agree to over-fund the IPO trust account by some multiple to the investment amount, which over-funded amount would be distributed to the SPAC investors if a business combination is not completed.
The SPAC IPO process is the same as any other IPO process. That is, the SPAC files a registration statement on Form S-1 that is subject to a comment, review, and amend process until the SEC clears comments and declares the registration statement effective. Concurrent with the S-1 process, the SPAC will either have applied for a listing on a national exchange or, following the closing of the offering, will work with a market maker who will file a Form 211 application with FINRA to receive a trading symbol to trade on the OTCQX. The OTCQX is the only tier of OTC Markets that allows for SPAC trading. Also, although both NASDAQ and the NYSE have proposed SPAC eligibility rule changes over the years, as of now, they remain the same as for any other company seeking a listing as part of an IPO.
At the time of its IPO, the SPAC cannot have identified a business combination target; otherwise, it would have to provide disclosure regarding that target in its IPO registration statement. Moreover, most SPACs (or all) will qualify as an emerging growth company (EGC) and will be subject to the same limitations on communications as any other IPO for an EGC. See HERE related to testing the waters and public communications during the IPO process.
When trading commences, investors can trade out of their shares, choosing to attempt to make a short-term profit while the company is looking for a business opportunity. Likewise, buyers of SPAC shares in the secondary market are generally either planning to quickly trade in and out for a short-term profit or betting on the success of the eventual merged entity. If a deal is not closed within the required time period, holders of the outstanding shares at the time of liquidation receive a distribution of the IPO proceeds that have been held in escrow.
Upon entering into an agreement for a business combination, the SPAC will file an 8-K regarding same and then proceed with the process of getting shareholder approval for the transaction. The SPAC must offer each public shareholder the right to redeem their shares and request a vote on whether to approve the transaction. Shareholder approval is solicited in accordance with Section 14 of the Exchange Act, generally using a Schedule 14A, and must include delineated disclosure about the target company, including audited financial statements.
Upon approval of the business combination transaction, the funds in escrow will be released and used to satisfy any redemption requests and to pay for the costs of the transaction. Target companies generally require that a certain amount of cash remain after redemptions, as a precondition to a closing of the transaction, or as talked about above, that a simultaneous PIPE transaction provide the needed cash. The exchanges all require that the newly combined company satisfy their particular continued listing requirements.
SPACs are, by nature, “shell companies” as defined by the federal securities laws. Accordingly, SPACs have all the same limitations as other shell companies, including, but not limited to:
- A SPAC is an ineligible issuer that is not entitled to use a free writing prospectus in its IPO or subsequent offerings within three years of completing a business combination.
- After completing the IPO and until it completes a business combination, the SPAC must identify its shell company status on the cover of its Exchange Act periodic reports.
- A SPAC cannot use a Form S-8 to register any management equity plans until 60 days after completing a business combination.
- A SPAC may not file an S-3 in reliance on Instruction 1.B.6 (the baby shelf rule) until 12 months after it ceases to be a shell and has filed “Form 10” information (i.e., the information that would be required if the company were filing a Form 10 registration statement) with the SEC reflecting its status as an entity that is no longer a shell company. See HERE on S-3 eligibility. Also, recently the SEC has been issuing comment letters where the company is filing an S-3 relying on Instructions 1.B.1 (full shelf) or 1.B.3 (re-sale) following a SPAC deal, suggesting they want those entities to wait 12 months as well. Historically, the SEC would include the SEC filings of the SPAC in the general requirement that the company have a class of securities registered for 12 months prior to use of S-3, but it seems they are changing their view and want the operating business to be public for the full 12 months. I wouldn’t be surprised if we see a rule change aligning all S-3 use with the current shell company requirements in Instruction 1.B.6.
- Holders of SPAC securities may not rely on Rule 144 for resales of their securities after the SPAC completes a business combination until one year after the company has filed current “Form 10” information with the SEC reflecting its status as an entity that is no longer a shell company and so long as the SPAC remains current in its SEC reporting obligations.
Although all forms of going public have pros and cons, in a SPAC deal or other reverse merger, you have a motivated buyer. SPACs are required to liquidate if they do not complete a business combination within the legally specified time period, and the sponsor will lose their investment. In a reverse merger, the current public company must continue to fund SEC reporting requirements, EDGAR fees, transfer agent fees and the usual fees associated with being public, in addition to facing shareholder pressure to either make the current business work, or find an opportunity that has the potential to bring them future value.
For companies that are looking to go public without the traditional IPO, and especially those looking for growth through M&A activity, now is a great time to look at SPACs and reverse merger opportunities.