What are key considerations in a SPAC deal?

What is a SPAC?

What is a SPAC? A special purpose acquisition company (or blank check company), which is formed for the purpose of acquiring or merging with an operating business by a specific date, typically 24 months after the SPAC’s IPO. SPACs have been in the news lately. According to spacinsider.com, in 2020 there were 248 SPACs that became public, raising over $83 billion in proceeds. By contrast, in 2016, less than $3.5 billion in total SPAC IPO proceeds were raised from 13 SPAC IPOs. Notable companies that have merged with or been acquired by SPACs (and hence are now publicly traded) include DraftKings, Utz Brands, Fisker, and Virgin Galactic, to name a few.

Why do I need to be aware of SPACs?

As of the first quarter of 2021, over 300 SPACs have gone public raising over $90 billion dollars. This is more than all of 2020 (both in terms of number of SPAC IPOs and proceeds raised), which itself was hailed as the year of the SPAC. As of the time of this writing, there are over 430 SPACs actively looking for private company targets. If your company is considering selling itself, it may receive some interest from one or more SPACs. If you are on the hunt for an acquisition target, you may face competition for targets from motivated SPACs, who have strong incentive to get a deal done.

What are some of the key considerations in negotiating a SPAC transaction?

SPACs have been around since the 1990s but, as alluded to above, the number of SPAC megers with private companies (also referred to as a “de-SPAC transaction”) has exploded in the last two years. In addition, SPACs had a reputation for involving unscrupulous financial players. In recent years, however, major institutional investors have formed their own SPACs or otherwise have joined the frenzy. All this is to say that we don’t have a long history of data from which to pull trends, as we may be able to do with traditional private target M&A transactions.

Nonetheless, when negotiating a SPAC transaction, there are some key issues to think through.

Valuation/Earnout

Unlike a traditional underwritten IPO (which may come with pricing and market risks), in a de-SPAC transaction, the valuation of the target company is fixed in the merger agreement. Valuation tools and metrics used in traditional M&A transactions can used in the SPAC context.

To the extent the parties disagree on valuation, they can also rely on familiar tools to bridge the gap, such as an earnout. In 2020, the percentage of deals containing an earnout for the target stockholders was slightly more than half.

While an earnout is a familiar tool in an M&A practitioner’s tool box, in a de-SPAC transaction, the parties have another lever to pull. The parties may also bridge any gap between valuation by negotiating whether or not (and to what extent) the SPAC sponsor’s (also called the “founder”) shares may vest, with shares being forfeited if milestones tied to stock price are not attained.

Of all the de-SPAC transactions that closed in 2020, 59% of them required the sponsor to subject its shares to vesting or forfeiture. Of those deals that imposed vesting requirements, over 80% of deals had vesting periods of 5 years or less, with almost 20% of deals imposing vesting requirements that are tied to stock price. And of those deals that resulted in sponsor forfeiture, almost half required forfeiture of both founder shares and warrants.

Mix of Consideration/Purchase Price Adjustment

In a de-SPAC transaction, the merger consideration will almost always consist of some stock consideration. In 2020, only 2% of closed de-SPAC transactions were cash-only. The number of deals that were stock only vs. a mix of stock and cash were roughly equal. In 2020, of the deals where the merger consideration comprised stock and cash, the percentage of cash, on average, was around 20%.

Perhaps due to the competitive nature of a large number of SPAC seeking targets in 2020, almost three quarters of closed deals had no post-closing purchase price adjustment mechanism and no escrow. Of the minority of deals with an escrow, however, the most common use of the escrow was to secure indemnity obligations, followed by an escrow for purposes of purchase price adjustment.

Indemnification

Given the large number of SPACs competing for deals, it is no surprise that only 30% of closed de-SPAC transactions in 2020 had seller indemnification provisions and only 30% had a termination fee. In 2021, it will not be a surprise if these percentages trend downward.

Cash

In a de-SPAC transaction, each stockholder has the option to redeem its shares at the closing of the business combination for a pro rata portion of the cash held in the trust account. As a result, the amount of cash at the closing will be unknown and, for obvious reasons, target companies are reluctant to close without a condition that the SPAC have a minimum amount of cash available at closing. In 2020, approximately 80% of deals had a closing minimum cash condition.

SPACs typically raise capital through PIPEs to ensure that the minimum cash closing will be satisfied at closing. If PIPE proceeds are not enough to make up the difference, a renegotiation may occur and target companies should be prepared for this possibility. One potential way to minimize the risk is to get commitments from PIPE financiers at the signing of the business combination agreement. In 2020, of the deals that required additional financing, over half were PIPE-only financings.

Post-Closing Board Composition

Most post-closing boards of directors of the combined business entity will be staggered. In 2020, approximately 70% of post-closing boards were staggered, with the average size of the board being around 7 to 9 directors. In just over half of post-closing boards, SPAC sponsors designated one or two directors.

How long does a typical SPAC transaction take?

Commencing with the closing of the IPO, a SPAC can hold substantive discussions with a target. If a SPAC needs more time than is set forth in its organizational documents, it can seek a shareholder vote to amend its organizational documents to extend the deadline. With each vote to extend the deadline, the SPAC’s organizational documents typically also provide that the SPAC must offer shareholders the right to redeem their shares for a pro rata portion of the cash held in the trust account. Typically, it takes around 4–5 months from the signing of the definitive documents to closing. From the closing of the SPAC’s IPO to the closing of the business combination, the average time frame is approximately 16 months.

What considerations should a target company keep in mind if it will go public via a SPAC transaction?

A target company must have two to three years of financial statements, audited in compliance with the rules of the Public Company Accounting Oversight Board (PCAOB). As a result, even if a target company has audited financial statements, additional audit procedures may be required before financial statements are ready to be filed with the SEC. A PCAOB audit will often be a gating items and thus early discussions regarding financial statement and audit readiness will take place.

In addition, a target company should analyze whether it has people, procedures and IT systems required to handle the regular demands (which include speed and accuracy)of public reporting, including necessary internal controls and procedures.

A target company must also ensure it has the necessary corporate governance policies, procedures, and practices that meet public company compliance requirements, including those of the applicable stock exchange.

Target company stockholders should balance the potential upside of continuing to own a significant portion of the operating business against the cost and distraction of operating a public company and the need for immediate liquidity after closing.

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