Special purpose acquisition companies (SPACs), often called “blank check companies” have been on the rise for a few years and have really taken off in 2020. To find out why, Mergers & Acquisitions turns to Ari Edelman, who recently joined Reed Smith as a partner in the global corporate group in the New York office. Edelman, who specializes in SPACs, was previously a partner at Ellenoff Grossman & Schole LLP.
Why is the SPAC market hot right now?
Between 2014 and 2019, I worked on about 35 SPAC IPO closings, with the market activity picking up substantially during that period. In May 2020, after the onset of Covid-19, we closed a SPAC IPO that felt like it might be our last one for a long time to come. Yet, since that time, the market has exploded.
One aspect fueling this explosion is the availability of cash in the IPO market. With interest rates where they currently are and other investment opportunities less attractive in the current environment, investors are putting their cash in a product that guarantees their money back plus up-side in the form of warrants. Similarly, investors are investing much more heavily in SPACs as they close their business combinations because public market valuations are currently generally strong.
The second aspect is the maturation of the SPAC product and the string of successful acquisitions that SPACs have made, particularly in the past 12 months. Pioneer SPAC sponsors such as Chinh Chu, Michael Klein and Alec Gores set the stage for such evolution. Previously, other than well-known sponsors, SPACs were generally not an attractive buyer, in large part because nobody knew how much money the SPAC would ultimately bring to the table. Today, SPACs and target companies are teaming up with leading investment banks to line up the necessary capital, leading to numerous very successful results.
Is this a “bubble?”
Yes, we are in a bubble in the sense that at some point the SPAC IPO activity will not be as robust as it is today. Eventually, the cash that investors are investing in SPACs will be invested elsewhere, as the overall economy gets back on its feet. In addition, some SPAC sponsors will not come back with a successful business combination and this will impede some of the market activity. Nevertheless, the SPAC product has evolved to a point where it should continue to be a viable option, for the long-haul, for sponsors and target companies that know best how to make it successful.
Why should a private company merge with a SPAC rather than go public through an IPO?
For many companies, going public by merging with a SPAC is as good an option as an IPO, and in some cases a better – or the only – option.
Historically, the perception was that SPAC targets lacked the marketability of an IPO-ready company, for one reason or another. That is no longer the case. Currently, many of the companies merging with SPACs are marketable through an IPO based on their industry, size and the amount of capital they are raising in their go-public transaction.
The basics of dealmaking are simple: ABC – Always Be Closing. SPACs are currently offering more certainty to closing. The SPAC, the target company and the anchor investors all commit to the deal, and lock in the terms, from the outset. If additional capital is needed, in the current market investors have generally been keeping their capital invested in deals rather than redeeming their shares. Given these favorable market dynamics, the biggest hurdle to closing the deal – i.e., availability of cash – is cleared.
SPACs also provide a lot of flexibility in terms of how to structure deals, whether it be in the form of an earn-out or other equity incentives tied to stock market or operating performance. Sellers also generally take some cash off the table in the SPAC transaction and roll over the balance of their holdings into the public equity, which provides them with both liquidity and up-sideopportunity as these companies grow in the public markets.
In some instances, it is the SPAC team that adds value to the transaction. On the capital raising side, some SPAC sponsors have the track record and network to raise funds that a target company would not otherwise have attracted. In addition, on the operating side, some SPACs bolster the target company’s management team with one or more individuals with deep industry experience that helps the company grow in ways that were not otherwise possible.
What are SPAC sponsors typically paid and what is the SEC currently investigating?
In exchange for putting up the SPAC’s risk capital and investing countless hours to close the SPAC IPO and business combination, a SPAC sponsor holds equity in the public company.
The percentage of the sponsor’s holdings overall depends on the size of the target, how many public shareholders stay in the deal, how much additional capital is raised and how well the sponsor negotiates its economics with the target company. By way of example, if the sponsor holds 20% of the SPAC’s equity, all public shareholders stay in the deal, and the sellers acquire a 70% interest in the SPAC, then the sponsor would own approximately 6% of the post-closing entity. If the SPAC raised a private investment in public equity (PIPE), or the sponsor agreed to forfeit some of its shares to get the deal done, the sponsor’s interest would be less. A sponsor’s founder shares are typically locked up for up to 12 months, and where the stock price will be at that time is anybody’s guess.
Last month, SEC Chairman Jay Clayton stated that the SEC is focused on making sure that sponsor economics are adequately disclosed to the public. In fact, in connection with its IPO, a SPAC must file a registration statement, which is reviewed by the SEC. Similarly, before a SPAC can close its business combination, the SPAC must file a registration statement or proxy statement, which is also reviewed by the SEC. Included in each filing is a description of the sponsor’s economics. What will come of the SEC’s investigation remains to be seen.
In what ways are private equity firms getting more involved in SPACs?
PE firms are more commonly sponsoring SPACs and selling their portfolio companies to SPACs. In terms of sponsoring, for some firms, the SPAC opens up a new avenue for them to invest in target companies that were not otherwise available, because of size or otherwise. For others, the SPAC is simply an alternative way of raising capital. Either way, we advise our PE clients to be mindful of how their limited partners will react to the SPAC and involve the LPs in the SPAC to the extent possible and appropriate. In terms of selling to a SPAC, SPACs with formidable sponsors are attractive buyers, and PE firms now recognize that selling certain of their assets to a SPAC will create significant value for the PE firm and their LPs.