SPAC to basics (III): target perspective

Fred Halbhuber

As noted in the first installment of‘SPAC to basics’, use of SPACs as a means of taking a company public has boomed during the COVID-19 pandemic and is expected to remain prevalent in the near future.[1] This third installment of ‘SPAC to basics’ unpacks the advantages and drawbacks of this newly popular investment vehicle for target companies in three sections.First, three oft-cited benefits of SPACs—cost effectiveness, expediency of process and immunity to market volatility—will be considered and, to an extent, critiqued. Second, it will be explained why these benefits made the SPAC-routeto the public markets particularly desirable during the COVID-19 pandemic.Finally, the comparative drawbacks of SPACs for targets will be evaluated against the traditional IPO model.

 

Same end, better means?

Having examined the advantages (and shortcomings) of SPACs for investors, what’s in it for the target company? Four oft-touted benefits for target companies of going public via a SPAC will be examined and critiqued in turn: (i) that SPACs are a cheaper alternative to the traditional IPO process; (ii) that SPACs expedite the traditionally lengthy process of taking the company public; (iii) that SPACs offer greater certainty than a traditional certainty.

 

(i) Cost concerns are one major driver behind SPAC use over traditional IPOs. Often portrayed as a key advantage of SPACs over traditional IPOs,[2] the argument goes that SPAC scan effectively circumvent many costly IPO requirements and accompanying legal and other fees. However, the cost efficiency of SPACs has been doubted as it has become increasingly recognised that professional fees are typically quite similar between SPACs and IPOs of similar sizes.[3] It is also important to consider the dilution factor which is entirely absent in traditional IPOs.

 

(ii) The shorter timeframe for going public via a SPAC—which avoids many of the regulatory hurdles associated with traditional IPOs—has also been an incentive behind the SPAC transition. For example, after Nikola went public through the SPAC VectoIQ Acquisition Corp, Nikola CFO Kim Brady opined that “We thought that by going with a SPAC we might leave some value on the table, but we also knew that it would take much longer to [take the traditional route]”. When considering this factor, and the extent to which it should influence the decision-making of private companies deciding whether to do a traditional IPOor use a SPAC, it is important not to confuse the SPAC IPO with the De-SPAC transaction.[5]Clearly, the target company has little interest in how long it takes for theSPAC itself to go public;[6]relevant for the target company is the time it takes to close the merger following the conclusion of the merger agreement. This process takes significantly longer than the SPAC IPO, with an average closing time of 4.5months.[7]

 

That said, companies are generally nevertheless able to get to the public market faster using a SPAC thantraditional IPOs. This is even more true as the standard time to IPO continues to rise in the US: although the median was around 3.1 years in 1996, it hasincreased to 7.7 years in 2006.[8] Evenso, Vinson & Elkins LLP has commented that “the differences between the minimum time necessary to get to closing [for SPACs and IPOs] are notmeaningful” and that, in practice, companies looking to do IPOs simply begin preparations for financial disclosures earlier than those looking to go publicvia a SPAC.[9] Itis also important to keep in mind that there are only so many SPACs looking for targets of a particular size at any given time; this has become an increasinglyless relevant concern as the SPAC market has boomed in the past year, though it may nevertheless extend the SPAC “timeframe” somewhat since not all targets andSPACs are compatible.[10]

 

(iii) Finally, this articleconsiders the argument that SPACs provide greater certainty than a traditionalIPO. Transaction certainty has been touted as a benefit of SPACs in two (notentirely distinct) ways: first, that the amount raised by the target is not subject to the whims of the market; second, that the target has greater control over the transaction. In a traditional IPO the company going public is at the whim of the market and the amount that the target is able to raise may therefore be influenced by wider market performance around the date of its offering which are largely distinct from the target’s business itself. It has been suggested that SPACs allow the target to avoid market volatility by agreeing on a minimum cash requirement with the SPAC well in advance; therefore, while a high redemption rate may reduce the available capital pool, the burden falls on the sponsor rather than the target to acquire new funds (typically through PIPEs).This arguably also gives the target more agency to decide precisely how much it is hoping to raise and by what date it needs the capital.

 

However, this assumes that the target is in a position to stick to its cash requirement when redemptions are high: if investors clearly are not interested in the target and finding a sufficiently large PIPE investment is proving challenging, the target may be better off waiving its own condition precedent so that it can get the capita lit can; the bad publicity generated for the target by a SPAC deal going belly-up might be too costly to make absolute enforcement of the cash requirement worthwhile.[11]Even where the cash requirement is not waived, the target’s owners may themselves contribute new funds to the SPAC in order to meet cash conditions.This was the case, for example, when Nesco Inc. was taken public by the SPACCapitol Acquisition Corp IV: three weeks prior to closing the target owners agreed to make a $25 million investment through the purchase of 2.5 million shares.[12]Considering these practical restraints on the target’s ability to raise all the capital it had hoped for and to control the transaction, this relative superiority of a SPAC over the traditional IPO route may be doubted.

 

COVID-19 as a stimulant

Use of SPACs has, historically, correlated inversely with use of the traditional IPO process. This relationship is not hard to explain: where it is easy to raise money through traditionalIPOs, firms have taken this route; however, where using a traditional IPO is challenging or undesirable, SPACs quickly become the center of attention. Thus, after emerging in 1992,[13]SPACs largely disappeared in the late 1990s because of the hot IPO market.Following the dot-com bubble, IPOs fell out of favour again and SPACs stepped in to fill the void.[14] Of course, where the markets are particularly cash-strapped, SPACs will not necessarily fair any better than traditional IPOs: although SPACs had recaptured a significant portion of US IPO activity (raising over $21 billion between 2005 and 2008),[15]they came tumbling down with the rest of the market in 2007 (with deal volume tumbling over 70%).[16]

 

COVID-19, and accompanying government restriction, rendered traditional IPOs less desirable. The market volatility brought about by COVID-19[17] made the alternative SPACroute to the public market preferable for its ability to better weather market volatility.[18] The pandemic also sapped capital reserves,[19] leaving many prospective target companies seeking quick access to funds. SPACs offered faster access to new liquidity and therefore remained attractive despite (or rather, because of)the thawing capital markets in April. The spike in liquidity-strapped companies also left the market flush with attractive targets looking for a reliable route onto the exchanges. Therefore, after the IPO market went cold in March 2020, finding a cash-hungry target posed little issue. Taken together, the above factors allowed the market for blank check companies to rebound as never before at the height of the pandemic.

 

Comparative Drawbacks

The SPAC alternative also gives rise to a number of unique challenges which potential target companies must consider before jumping on the SPAC bandwagon. Chief among these is that the target must put their faith in a single company and management team. Therefore, the target’s freedom, in particular when determining how much capital it is looking to raise, is a double-edged sword: it comes at the cost of the greater security offered by traditional IPOs.

 

A poor management team which loses(or perhaps never had[20])the confidence of the SPAC’s shareholders may see redemption rates through the roof that make it impossible for the SPAC to meet the capital the target is looking for. At that point the target is in the unenviable position of having to decide between taking what it can get by going through with the merger regardless or turning their back on this capital entirely and looking for another route onto the public market. Particularly for those firms who hoped to use the SPAC process to raise liquidity quickly, getting stuck with a less-than-competent management team can be quite costly.


[1] Described as an “accelerating…virtuous cycle”: NicholasJasinski, “Why Nikola Decided to Merge With a SPAC. And Why More Such Deals AreComing”, 2 August, 2020, available at:https://www.barrons.com/articles/why-nikola-decided-to-merge-with-a-spac-and-why-more-such-deals-are-coming-51596369610.

[2] “reverse mergers are nearly always cheaper and faster thanIPOs and SPACs have even greater advantages than a traditional reverse merger”:Nate Nead, “Advantages of a SPAC”, Investment Bank, available at:https://investmentbank.com/special-purpose-acquisition-company/#:~:text=Quicker%20%26%20Cheaper%E2%80%93We%20said%20it,than%20a%20traditional%20reverse%20merger.&text=The%20SPAC%20market%20is%20almost,financial%20instability%20or%20macro%20shocks.See also Johannes Kolb and Tereza Tykvová, “IPOs are prohibitively expensivefor small firms”: Kolb and Tykvová, “Special Purpose Acquisition Companies –Are they an Alternative to IPOs?”, 28 April, 2014, available at:http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.438.1410&rep=rep1&type=pdf.See further Shannon Terrell: “Companies use SPACs because they’re typicallyeasier, quicker and less expensive than going the traditional IPO route”:Terrell, “What is a SPAC?”, finder, 3 November, 2020, available at:https://www.finder.com/spacs.

[3] Gerry Spedale and Eric Pacifici, “9 Factors To EvaluateWhen Considering A SPAC”, Gibson Dunn, 11 March, 2019, available at:https://www.gibsondunn.com/wp-content/uploads/2019/03/Spedale-Pacifici-9-Factors-To-Evaluate-When-Considering-A-SPAC-Law360-03-11-2019.pdf.See also Mayer Brown, “SPACs incur significant costs and the process for theoperating company is no cheaper than an IPO”: Mayer Brown, “Special PurposeAcquisition Companies (“SPACs”)”, November 2020, available at:https://www.freewritings.law/wp-content/uploads/sites/24/2020/11/SPAC-Overview-November-2020.pdf.

[4] Nicholas Jasinski, “Why Nikola Decided to Merge With aSPAC. And Why More Such Deals Are Coming”, Barrons, 2 August, 2020, availableat:https://www.barrons.com/articles/why-nikola-decided-to-merge-with-a-spac-and-why-more-such-deals-are-coming-51596369610.

[5] This is frequently done in media coverage, even byfinancial services companies. See, for example, Equiniti: commenting on

[6] For those curious readers, the SPAC IPO can often becompleted in just 8 weeks, the SPAC having little in the way of past financialsto disclose.

[7] Theredemption rate at the point of extension, at around 40%, is very similar tothat at the merger proposal. See Ramey Layne, Brenda Lenahan and Sarah Morgan,“Update on Special Purpose Acquisition Companies”, 17 August, 2020, availableat: https://corpgov.law.harvard.edu/2020/08/17/update-on-special-purpose-acquisition-companies/.

[8] CFA Institute, “Private vs Public Markets - CapitalFormation and Implications for Investors”, 3 December, 2018, available at:https://www.cfainstitute.org/en/about/press-releases/2018/private-vs-public-markets-capital-formation-and-implications-for-investors-CFA-Institute-research.

[9] Ramey Layne, Brenda Lenahan, S. Gregory Cope and Scott D.Rubinsky, “Alternative Routes to Going Public: Initial Public Offering, De-SPACor Direct Listing”, Vinson & Elkins, Fall 2020, available at:https://media.velaw.com/wp-content/uploads/2020/10/09134747/Alternative-Routes-to-Going-Public-Initial-Public-Offering-De-SPAC-or-Direct-Listing.pdf.

[10] SPACs are limited both by an upper and lower threshold. Asto the lower threshold, it will be recalled that a SPAC must merge with atarget or targets with a far value amounting to at least 80% of the trustaccount funds. As to the upper threshold, SPACs cannot take on targets that aretoo large since they will likely not be able to provide sufficient capital tomake the merger desirable.

[11] See for example the Twelve Seas SPAC and its merger withBrooge Holdings.

[12] Klausner and Ohlrogge, “A Sober look at SPACs”.

[13] As a form ofblank check company with new investor protections (see, in particular, theredemption option, as discussed in the second installment in this series: ‘SPACto basics (II): investor perspective’).

[14] Derek K. Heyman, “From Blank Check to SPAC: the Regulator'sResponse to the Market, and the Market's Response to the Regulation”,Entrepreneurial Business Law Journal, vol. 2, no. 1 (2007), 531-552, availableat:https://kb.osu.edu/bitstream/handle/1811/78301/OSBLJ_V2N1_531.pdf?sequence=1&isAllowed=y.

[15] Floyd Wittlin and Kristen Ferris, "Can the SPAC MakeIt Back?", Bloomberg Law Reports—Mergers & Acquisitions, 2010,available at: https://www.morganlewis.com/-/media/files/docs/archive/can-the-spa--make-it-back_5901pdf.ashx.

[16] Phil Wahba, “Cheap acquisitions may be SPACs' last chance”,Reuters, 5 January, 2009, available at:https://in.reuters.com/article/markets-stocks-ipos/rpt-ipo-view-cheap-acquisitions-may-be-spacs-last-chance-idUSN0537042420090105.

[17] The Cboe Volatility Index (VIX) rose by a record 280% in2020; contrast the 108% hike during the Great Recession in 2008: Mark DeCambre,“Chart of Wall Street’s ‘fear’ index in 2020”, Market Watch, 12 March, 2020.

[18] See the comment by Nikola CFO Kim Brady: “Once we hadlocked in the PIPE investors and looked at the market volatility and Covidconcerns in late February, it became clear to us at that point that havingcertainty, a strong valuation, and the ability to get the transaction done byJune was very attractive compared to the IPO path”: Jasinski, “Why NikolaDecided to Merge With a SPAC”.

[19] A record $3.4 trillion in capital was raised in 2020 asfirms sought liquidity to keep their operations afloat: “Companies have raisedmore capital in 2020 than ever before”, TheEconomist, 9 December, 2020.

[20] Where shareholders merely bought at IPO to park theircapital and little no risk with the intent of redeeming and/or selling on themarket once the option presented itself.