28 March 2021
Are SPACs the new IPOs?
During the last few years, SPACs (or Special Purpose Acquisition Company) have raised record amounts and gained significant popularity as a faster, less complicated liquidity option.
After Anghami, the Abu Dhabi based music streaming company announced that it is listing on the NASDAQ stock exchange in New York by merging with a Special Purpose Acquisition Company and We Work announced that it has agreed to merge with a blank check company instead of the traditional IPO it had initial sought, interest in SPACs, (and questions around why they are suddenly popping-up everywhere) has been up the roof!
What are SPACs?
SPACs are a type of Blank Check Company, often used to gain funds, with the plan to merge with or acquire another business. A Blank Check Company is a publicly traded company that does not have an established business plan. It is usually used to gather funds as a Startup, or more likely, to merge or acquire another business entity.
Why are SPACs suddenly so popular?
There are several reasons SPACs have become so popular right now. The most obvious answer is related to the recent COVID-19 pandemic. Since many companies had to put off their IPO plans, and look for a faster, frictionless alternative, the recent SPAC hype has been attributed to the pandemic, especially since IPO Roadshows, where presentations are made in various locations leading up to an IPO, don’t work as well remotely. All these factors drove a noticeable shift towards one-on-one deals.
Not only are SPACs less costly and complicated, but they also take significantly less time, which makes them more favorable for companies looking to ride a hype wave. This is why SPACs are generally perceived as the right vehicle for a ‘quick IPO’.
How is the SPAC IPO Structured?
The process is almost identical to that of any traditional IPO, which starts with the SPAC sponsor (which is the entity or management team that forms the SPAC) filing for a registration statement with the SEC on Form-1. After the SEC’s comments are cleared, comes a roadshow, followed by a firm commitment to underwriting. The IPO proceeds will be held in a trust account until released to fund the business combination or used to redeem shares sold in the IPO. In many cases, the SPAC will arrange committed debt or equity financing, through a private investment in public equity (“PIPE”), which involves the selling of publicly traded common shares or some form of preferred stock or convertible security to private investors. Following the announcement of the signing, the SPAC will undertake a mandatory shareholder vote or tender offer process, in either case offering the public investors the right to return their public shares to the SPAC in exchange for an amount of cash roughly equal to the IPO price paid. If the business combination is approved by the required shareholders and all other conditions are met, the target business and the SPAC will combine into a publicly traded operating company.
How does a SPAC compare to a traditional IPO process?
Here’s how the two compare at a glance:
|Shorter financial statements||Longer financial statements|
|Financial statements can be prepared within weeks||Financial statements prepared within months|
|Minimal business risk factors||Higher business risk factors|
|Fewer SEC comments||More SEC comments|
|The sponsor, directors, and officers sign a lock-up agreement for 1 year from the pricing of the De-SPAC transaction||The sponsor, directors, and officers sign a lock-up agreement for 180 days from the pricing of the IPO|
Most SPACs are formed as Delaware corporations. Some SPACs however have been formed in other jurisdictions, which frequently include the Cayman Islands or the British Virgin Islands.
The standard set of legal documents signed include:
- Securities Purchase Agreement.
- Warrant Agreements.
- Promissory Note.
- Sponsor Constituent Documents.
- Letter Agreement.
- Registration Rights Agreement.
- Private Placement Warrants Purchase Agreement.
- Administrative Services Agreement.
The key negotiation issues between a SPAC and a target company usually are:
- Valuation: this item is subject to negotiation the most. The valuation must be acceptable to the SPAC shareholders.
- Sponsor Equity. The SPAC sponsor typically starts with a 20% equity in the SPAC (plus its at-risk equity stake) but gets diluted down after the business combination.
- Employee Incentives: mainly to determine if the target company’s stock option plan be assumed by the SPAC
- Deal Certainty: SPACs rarely agree to reimburse the target company if SPAC shareholder approval is not obtained.
- Representations and Warranties: mainly concerning formation, good standing, financial statements, liabilities, intellectual property, and key contracts.
- Registration rights: to determine whether target shareholders receive registered tradable shares or only registration rights.
- Closing conditions: Typical conditions include shareholder approval, no material adverse effect on the target, and any required regulatory approvals.
SPACs are back and growing in popularity. Some have pointed out that they are becoming a ‘crowded trade’ and predict that SPACs will soon be chasing down too few appropriate companies to merge with. Many investors said they do not expect SPACs to be a long-term trend. Their continued growth remains to be determined.