SPAC to basics (I): structure and timeline
SPACs, or Special Purpose Acquisition Companies, have newly become Wall Street’s darling. With $77.5 billion raised in gross proceeds in 2020 (compared with just $13.6 billion in2019), SPACs have emerged as a hot topic in finance. What is it that has been attracting all this attention?
In brief, a SPAC is a publicly listed company which takes a private company public by merging with it, thereby providing an alternative to the traditional initial public offering (IPO) process. It is necessary to note at the outset, however, that there are relevant differences between US and UK SPACs. This series (‘SPAC to basics’) is concerned primarily with US SPACs. This is for several reasons.First, US SPACs are far more prevalent than their UK counterparts, with 165 SPAC listings in the US in 2020 and not a single listing in the UK over the same period. Second, and as a result, market practice has become more established in the US than in the UK, making the SPAC capital structure easier to generalise. Finally, the redemption option for US shareholders makes the US SPAC fundraising process more straightforward and, for the time being, a more desirable investment vehicle for initial (i.e.pre-merger) investors. Nevertheless, the law surrounding US SPACs remains of great importance both to private UK-based companies looking to be listed on a US exchange as well as to investors hoping to “get in on” the current SPAC craze.
Much has been said about SPACs and their renaissance in recent months: the spike in their use has been called everything from “a bubble that is about to pop” to the “picture of the future”. This series puts aside the hype around the few headline-grabbing SPACs and celebrity involvement and goes back to the drawing board to explore the law surrounding SPACs. The series is split into six parts. The present instalment (I) focuses on the capital structure of a SPAC and the timeline of its operation. The second instalment(II) examines SPAC’s from the perspective of the investor, examining why investors have been drawn to SPACs and evaluating the consequences of current arrangement. The third instalment (III) examines SPACs from the perspective of the target, considering both the advantages and drawbacks of using a SPAC to going public in contrast to the traditional IPO process; it will be explained why SPACs became particularly popular during the COVID-19 pandemic. The fourth instalment (IV) takes the perspective of the sponsor, examining in detail the role of the sponsor at each stage of the SPAC and considering what effect the quality of a sponsor has on SPAC and target performance. The fifth instalment (V) outlines the current calls for reform of SPACs and considers to what extent the traditional IPO process can and should be amended. Finally, the sixth instalment (VI) looks in depth at UK SPACs and whether they have the potential to achieve the same mainstream status currently enjoyed by SPACs in the US.
The lifecycle of a SPAC begins with the sponsor. Typically a private equity company, the sponsor pays a nominal price for founder shares,typically entitling them to 20% of shares post-SPAC IPO, and—at the time of theSPAC IPO—purchases further shares and warrants at fair market value. The funds thus provided by the sponsor cover the SPAC’s IPO costs and the post-IPO SPAC’s operating costs in the two years typically allocated to locate and merge with a suitable target.
Unlike operating company IPOs, a SPAC IPO involves the listing of units rather than of common stock. Each unit typically sells at $10.00 and contains both one share of common stock and a warrant (or, more commonly, a fraction thereof). A warrant grants its holder the right to purchase a common share at a fixed strike price (typically $11.50). Upon closing the SPAC IPO, the capital raised is deposited in a trust account, where it is typically invested in short-term US government securities.
What is the value of common shares in the newly listed SPAC? After a target company has been announced, holders of common shares in the SPAC are given a choice between retaining and redeeming their shares prior to the closing of the merger. Where shares are retained, they will be converted to shares in the target company upon completion of the merger. Where shares are redeemed, the shareholder gives up his share in the SPAC and instead receives corresponding proportional interest in the trust account (typically $10.00 plus the interest accumulated on the treasury bonds). In theory then, common shares in a SPAC should never trade below $10.00 plus interest: any lower price would present an arbitrage opportunity since the holder of the share can always redeem it for a pro rata share of the cash in the trust account prior to the closing of a merger. Of course, if shares are trading above $10.00 plus interest, it is advisable for an investor not to redeem and to instead sell their shares on the public market.
Given this redemption option, how can the target company ensure it raises sufficient capital? The target typically includes a condition precedent to closing in the merger agreement requiring that the SPAC has a minimum cash amount. Where redemption levels are expected to be too high to meet the minimum cash requirement, the SPAC sponsor may step in to provide the requisite cash injection or the SPAC itself may seek new third party investors in a second wave of funding; these private investments in public equity (PIPEs) occur at the timer of the merger to ensure the condition precedent is met. Alternatively the SPAC may enter into separate lock-up agreements with large public SPAC shareholders to prevent them from redeeming or selling their shares before the date of the merger.
The final result is that the private company is listed publicly with at least the minimum cash requirement set out in the merger agreement. SPAC shareholders (including the sponsor) tend to hold a minority stake in the newly public company, though high redemption rates often leave the SPAC sponsor alone holding over 10%.
This section breaks down a ten step timeline for a typical public offering via a SPAC.
(1) Creation of the SPAC
A sponsor creates a holding company and acquires founder shares and founder warrants for nominal consideration. This promote is usually subject to a one year lock-up agreement. The founder assembles a team and funds operating expenses leading up to the IPO.
(2) Preparing for the SPAC IPO (T-8 weeks – T):
As a shell company, SPAC IPOs have no historical financial results to disclose or assets to describe; the IPO process can therefore be completed much more quickly than for traditional operating companies (as quickly as eight weeks).
(3) SPAC IPO (time T):
SPAC investors buy units in the SPAC—each consisting of a common share and a fraction of a warrant—at $10.00 a unit. SPACs increasingly employ Forward PurchaseAgreements (FPAs) at the time of the IPO to obligate the SPAC sponsor or a third party investor to make the necessary PIPE investment at the time of theDe-SPAC (T2). At the time of the IPO the underwriters also typically receive 2%of gross IPO proceeds (contrast the typical 5%-7% of gross IPO proceeds for traditional IPOs).
(4) Splitting of units (T+45 days):
Forty-five days after the IPO, investors in the SPAC acquire the option to split their units and to trade their common shares and warrants independently.
(5) Target search, selection and negotiation (T – T+24 months):
The SPAC has24 months to find and merge with a suitable target, though this may be extended by a general shareholder vote. Once a suitable target has been selected, the SPAC board enters into negotiations with the target for a merger deal: key points of negotiation include valuation of the target and minimum cash conditions(including whether a PIPE will be committed in the event of a high redemption rate). The SPAC’s operating costs during this time is financed by the sponsor’s pre-IPO and IPO investments.
(6) Target announcement (T – T+24 months):
Once an agreement has been reached with the selected target, SPAC shareholders vote on the proposed target: a simple majority of shareholders is required for the target to be approved.Once approved, SPAC shareholders have the option to redeem their shares for a pro rata share of the cash in the trust account ($10.00 plus interest earned from treasury bonds). Typically, well over half of SPAC shares are redeemed.
(7) De-SPAC (time T2):
The SPAC merges with the target. Remaining SPAC shareholders (i.e. those shareholders who did not redeem their shares) acquire shares in the target.PIPE investors (often including the initial sponsor) provide the requisite cash injection to meet the minimum cash requirement in the merger agreement;this funding is provided at the closing of the merger, even if the agreement is concluded earlier. At this point another 3.5% of gross IPO proceeds are deposited in the trust account for the underwriters. Those SPACs which promise investors additional warrants for not redeeming their shares prior to the merger also issue these warrants at the time of De-SPAC.
(8) Super 8-K filing (T2 +4 days)
Within 4days of the De-SPAC, the SPAC is obligated to file a special 8-K form (known asa “Super 8-K”)since the SPAC ceases to be a shell company. The Super 8-K requires the SPAC to file information including, but not limited to: the identity of the persons acquiring control; the date and description of merger; the percentage of voting securities now owned by persons acquiring control; and amount of consideration paid by those acquiring control.
(9) Warrant exercise (T2+30 days; T+12 months):
30 days after the merger (T2) and12 months after the SPAC IPO (T)(cumulative requirements), warrant-holders have the option to exercise their warrants to purchase common shares in the SPAC at a strike price of $11.50.
(10) Warrant expiration (T2+5 years):
Warrants expire five years after the De-SPAC and are rendered worthless; the target company stock can no longer be diluted by the original warranties.
It is hoped that the above outline of the SPAC capital structure and the timeline of a typical public offering via a SPAC have provided a useful insight into this murky territory. In the upcoming second instalment of ‘SPAC to basics’ the arbitrage opportunities hinted at in the present instalment will be unpacked in more detail. This will involve an in-depth look at the shareholder redemption rights at the time of the merger announcement as well as an examination of who bears the costs for the seemingly risk-free returns offered to initial investors.
 SPAC Insider, “SPAC IPO Transactions – Summary by Year”,updated 14 December, 2020, available at: https://spacinsider.com/stats/.
 A number of drawbacks burden SPAC use in the UK.Shareholders in a UK SPAC do not have the generous redemption option (available to their US equivalents) to redeem their shares for a pro rata share of the trust account(see the text to fn.23). Moreover, once a UK SPAC merges with a target(classified as a reverse takeover under the Listing Rules), the SPAC’s shares are suspended pending the publication of an FCA-approved deal prospectus; this locks up investor capital for a protracted period and further limits the ability of disapproving shareholders to avoid the merger. UK SPACs do, however, benefit from the absence of listing requirements like those found in the NASDAQ and NYSE, which mandate that at least 90% of SPAC IPO proceeds be held on trust(see fn.18) and that the fair market value of SPAC mergers amount to at least80% of the trust account (see fn.20). See further as to the differences betweenUS and UK SPACs: Thomas Vita, Fiona Millington and Kevin Connolly, “SPACs: TheLondon alternative”, Norton Rose Fulbright, October 2020, available at:https://www.nortonrosefulbright.com/en/knowledge/publications/94734f5e/spacs-the-london-alternative#:~:text=Key%20differences%20between%20UK%20and%20US%20SPACs,-Whilst%20SPACs%20first&text=In%20the%20US%2C%20shareholder%20approval,proxy%20statement%20with%20the%20SEC.
 From January through October 2020: Nessa Anwar, “SPAC listings hit a record high in 2020”, CNBC, available at:https://www.cnbc.com/2020/11/23/what-are-spacs-2020-saw-record-number-of-shell-companies-listed.html.
 As of 13 October, 2020: Roger Barron and David Prowse,“‘SPAC’ to the Future?”, Paul Hastings, 13 October, 2020, available at:https://www.paulhastings.com/publications-items/details/?id=8ee32570-2334-6428-811c-ff00004cbded.
 Paul Amiss, partner at Winston & Strawn in London, commented that while there is “plenty of sponsor interest” for UK SPACs, “no market for SPACs exists” in the UK: Andrew Singer, “SPAC IPO Surge”, GlobalFinance, 7 December, 2020, available at:https://www.gfmag.com/magazine/december-2020/spac-ipos-surge.
 Gillian Tett, “Bubble warning: even college kids are touting Spacs”, Financial Times, 8October, 2020, available at:https://www.ft.com/content/e64c3e5e-b990-4904-adfe-139e41a5845b.
 John Mason, “SPACs: A Picture Of The Future”, SeekingAlpha, 19 October, 2020, available at:https://seekingalpha.com/article/4379753-spacs-picture-of-future.
 The most prominent among which are Virgin Atlantic (which went public on the NYSE in October), DraftKings (which went public on theNASDAQ in April) and Nikola (which went public on the NASDAQ in June).
 Most notably NBA All-Star Shaquille O’Neal (strategic advisor at Forest Road Acquisition) and former Speaker of the US House ofRepresentatives Paul Ryan (board chairman at Executive Network Partnering).
 Though sponsors also frequently include experienced executives (such as former Facebook executive Chamath Palihapitiya, head of Social Capital Hedosophia Holdings Corp) or other well-informed individuals(such as former Citigroup investment banker Michael Klein, head of ChurchillCapital Corp).
 Typically class B or F common stock, these founder shares typically do not permit the holder to vote on the De-SPAC, to vote to extend the typical twelve month time frame allotted to the SPAC to find a suitable target or to exercise a redemption option for a pro rata share of the trust account (see the text to fn.23): Seward & Kissel LLP, “SPACs Are Back, BackAgain”, 17 August, 2020, available at:https://www.sewkis.com/publications/spacs-are-back-back-again-what-you-should-know/#:~:text=The%20SPAC%20sponsor%20pays%20a,known%20as%20the%20%E2%80%9Cpromote%E2%80%9D.
 The term “operating company IPO” is used in contrast to a“SPAC IPO” since the SPAC itself is not an operating company but rather a shell with which the target (operating) company merges. See Mayer Brown LLP, referring to “target companies” and “operating companies”: “Special PurposeAcquisition Companies (“SPACs”)”, Mayer Brown LLP, available at:https://www.mayerbrown.com/-/media/files/perspectives-events/publications/2020/08/whats-the-deal--spacs.pdf.
 A listing price set by market practice; this price is in part chosen to avoid the classification of the SPAC as a “blank-check company”under securities laws. Note that some prominent SPACs have listed at different prices; for example, Pershing Square Tontine Holdings raised $4 billion in the largest SPAC deal in history, selling 200 million units at $20 each.
 The class of common stock depends on whether the shares are founder or public shares, the former being Class B or F while the latter is general Class A common stock: see fn.11.
 A right to a fraction of share is also sometimes included; a right-holder is typically given the option to acquire a fraction of a share at no additional cost if a target is successfully acquired: Winston & Strawn LLP, “SPAC 101: Transaction Basics and Current Trends”, accessed on 15December, 2020.
 Warrants are distinguished from call options by the fact they are issued by the company itself (rather than by an exchange) and dilute the stock since the company (as issuer) is obligated to issue new stock when a warrant is exercised; warrants also typically have longer maturities than call options.
 15% above the typical listing price.
 Both the NASDAQ (NASDAQ Rule IM-5101-2(b)) and NYSE (NYSEListed Company Manual Section 102.06) require at least 90% of the proceeds from the SPAC’s IPO to be held in a trust account administered by an independent trustee. Note, however, that it is market practice for the full 100% of trust proceeds to be deposited in the trust account.
 To avoid the Investment Company Act of 1944 and ensure sufficient liquidity to De-SPAC and to cover the mandatory $10.00 plus interest per share redemption option. Part of the funds are, for the same reasons, retained as cash reserves.
 Target companies must have a fair market value of no less than 80% of the funds in the SPAC’s trust account (NASDAQ: Nasdaq RuleIM-5101-2(b); NYSE: Section 102.06 NYSE Listed Company Manual). Note, however, that both the NASDAQ and the NYSE requirements are satisfied where the aggregate value of more than one transaction crosses the 80% threshold.
 Both the NASDAQ (NASDAQ Rule IM-5101-2(d)) and the NYSE(Section 102.06 NYSE Listed Company Manual) require that a majority of public shareholders in the SPAC approve the merger. In practice, however, mergers are likely always to be approved since all shareholders retain the option to redeem above par ($10.00 plus interest).
 The expected $10.00 plus interest (“r”) is nearly risk free since, although the trust account may be at risk from third party claims against the SPAC, third parties dealing with the SPAC tend to waive rights to moniesheld in the trust account: SPAC Research, Frequently Asked Questions, available at: https://www.spacresearch.com/faq#trust-account-funds.
 It is worth pointing out that SPAC shares do trade at under$10.00. While this may in part be due to risks of third party claims (seefn.22), such discount trading is more likely attributable to industry-wide liquidity gaps. This was particularly evident this year during the cash-squeeze brought about by the COVID-19 pandemic, which led many large SPAC investors(primarily hedge funds) to sell SPAC shares at a discount to par in an effort to offset other losses. On 23 March, 2020 (after the S&P 500 had fallen more than 34% and reached its lowest point of the year) all 13 of the SPACs that had listed in 2020 by that time were trading under $10 (ranging from $9.25to $9.85): Renaissance Capital, “Blank check IPOs bounce”, Nasdaq, 23 March,2020, available at: https://www.nasdaq.com/articles/blank-check-ipos-bounce%3A-all-13-of-the-years-spacs-trade-below-%2410-redemption-value-2020.
 Admittedly, raising capital immediately is not the only upside of going public; other incentives to going public include making capital more readily available going forward, employing stock options and public stock as a means of compensation and raising public awareness for the company: for further detail see US Securities and Exchange Commission, “Should my company“go public”?”, modified 28 November, 2017, available at:https://www.sec.gov/smallbusiness/goingpublic/companygoingpublic.
 Klausner and Ohlrogge, “A Sober Look at SPACs”, StanfordLaw School, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3720919.
 PIPE injections typically come from large hedge funds andPE firms.
 Indeed, PIPE injections may be several times larger than the capital raised in the SPAC IPO: John Luttig, “SPAC Attack: everything a founder or investor should know”, 17 July, 2020, available at:https://www.rcis.co.za/the-investor-september-2020/. This makes the capital raised in the SPAC IPO is a poor indicator for the size of the final merger.
 SPAC shareholders held a median of 34% equity in target companies following the merger in SPAC mergers between January 2019 and June2020; SPAC sponsors alone held a median of 12%: Klausner and Ohlrogge, “A SoberLook at SPACs”.
 Typically a Delaware or Cayman LLC.
 Typically amounting to 20% of post-SPAC IPO common shares.
 Ramey Layne and Brenda Lenahan, “Special PurposeAcquisition Companies: An Introduction”, Harvard Law School Forum on CorporateGovernance, 6 July, 2018, available at:https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.
 15 of the 46 SPACs coming to IPO in 2018 employed an FPA:SPAC Market Trends, SPAC Research, January 2019.
 Underwriters are usually large investment banks; the five largest underwriters by deal volume for Q2 2020 are, in decreasing order of volume: Credit Suisse, Goldman Sachs, Citigroup, BofA, and Deutsche Bank:Kristi Marvin, “Q2 & First Half 2020 SPAC IPO Underwriting League Tables”,SPAC Insider, 1 July, 2020, available at: https://spacinsider.com/2020/07/01/q2-first-half-2020-underwriting-league-tables/.
 Layne and Lenahan, “Special Purpose Acquisition Companies”.
 NASDAQ rules set the requirement at 36 months (NASDAQ RuleIM-5101-2(b)), though SPAC organisational documents typically require the merger to be completed within 24 months: Debevoise & Plimpton, The Private EquityReport Fall 2017, Volume 17, Number 2, available at:https://privateequityreport.debevoise.com/the-private-equity-report-fall-2017-vol-17-no-2.Note that no equivalent listing standard exists for the NYSE. Note that someSPACs introduce a further requirement (typically at 18 months post-IPO) that the SPAC have concluded a purchase document (typically a letter of intent will suffice). This requirement is not ubiquitous: John Meyer, “Two Years in theLife of a SPAC”, Meyer & Associates, 2006, available at:http://meyeresq.com/publications/two-years-in-the-life-of-a-spac/.
 Richard Harroch, Hari Raman, and Albert Vanderlaan, “10 KeyQuestions And Answers About SPACs”, Forbes, published 11 November, 2020, available at:https://www.forbes.com/sites/allbusiness/2020/11/11/10-key-questions-and-answers-about-spacs/?sh=68955f222f83.
 NASDAQ Rule IM-5101-2(d); NYSE Listed Company ManualSection 102.06
 Median redemption rate for SPACs merged between January2019 and June 2020 was 73%: Klausner and Ohlrogge, “A Sober Look at SPACs”.
 Former SPAC shareholders held a median of 34% of the target company post-merger for SPACs merged between January 2019 and June 2020 was 73%: Klausner and Ohlrogge, “A Sober Look at SPACs”.
 77% of SPACs SPACs merged between January 2019 and June2020 raised additional capital for the merger: Klausner and Ohlrogge, “A SoberLook at SPACs”.
 Sean Donahue, Jeffrey Letalien and Brian Soares, “GoingPublic through a SPAC: Current Issues for SPAC Sponsors and Private Companies”,Morgan Lewis, 2 December, 2020, available at:https://www.morganlewis.com/-/media/files/publication/presentation/webinar/2020/morganlewisgpcaspacpresentation12022020.pdf.
 Note that where no De-SPAC occurs, the 3.5% is not paid tothe underwriters but is instead used (along with the remainder of the trust account) to redeem the common stock.
 See, for example, Ackman’s $4 billion Pershing SquareTontine Holdings Ltd (promising an additional 2/9 warrant/common share if investors do not redeem) and Starboard Value Acquisition Corp (promising an additional 1/6 warrant/share).
 Note that this is an industry term rather than one found in any regulation or legislation.
 “What Is a Reverse Merger Super 8-K? Going Public Lawyer”,Hamilton & Associates, available at:https://www.securitieslawyer101.com/2015/super-8-k-reverse-merger/. Seealso Raluca Dinu, “De-SPAC Process –Shareholder Approval, Founder Vote Requirements, and Redemption Offer”,GigCapital, 27 December, 2019, available at:https://www.gigcapitalglobal.com/de-spac-process-shareholder-approval-founder-vote-requirements-and-redemption-offer/.
 See the text to fn.22 and 23.