Josh DuClos
Josh DuClos is a partner at Sidley Austin. He concentrates his practice on representing private equity sponsors, public and privately held companies, and their stakeholders and advisors in SPAC mergers, buyouts, investments and divestitures.

As the SPAC market continues to grow and develop, the dynamics between SPACs and their targets are also rapidly changing, as is the list of key issues and complexities arising in de-SPAC transactions. Dealmakers need to stay attuned to the latest developments in deal terms, market trends and the nature of the SPAC ecosystem to ensure they are negotiating in the SPAC market of today.

Differentiating Amongst a Sea of SPACs

In today’s crowded SPAC market, it is becoming increasingly important for SPAC targets to differentiate among SPAC suitors. A year ago, a company may have negotiated with one SPAC. Today, the landscape has changed considerably and given targets a deeper bench of SPACs with whom to negotiate. This trend has given SPACs a more diverse set of potential transaction partners whose equally diverse goals and expectations have to be taken into account when striking deals.

Although the structure and economics may look similar, no two SPACs are created alike, and no two targets will have the same goals in entering into a SPAC transaction. Targets must consider not only basic economic terms, a sponsor’s pedigree and prior execution success, but also the sponsor’s goals and track record with respect to participation in a de-SPACed public company.

Some SPACs and their sponsors could be considered pure transaction vehicles, interested in taking an equity fee for facilitating the financing and/or going public transaction itself. This may be perfect for some targets and a mismatch for others.

Other SPACs have sponsors committed to participating meaningfully in go forward management and operations, even utilizing one or more de-SPACed public companies as cornerstones for a broader roll-up or holding company strategy within a stated vertical. These sponsors may want to hold substantial equity stakes for the long term, and retain meaningful input if not control, in the form of board seats and ongoing shareholder rights. This could be a must have value-add for certain targets, and potential anathema to others.

It is therefore critical that targets ensure there is alignment on the longer-term target and SPAC sponsor goals and not focus exclusively on the short-term valuation metrics. The latter are likely to be achievable with some degree of parity amongst multiple SPACs in today’s heavily SPACed market, but the former is unique to each SPAC.

Bridging Potential Financing Gaps

Third party equity financing has become an important feature of today’s SPAC mergers, but the typical private investment in public equities, or “PIPE” markets that feed these deals has also come under pressure due to the increase in deals and the finite group of investors who participate in SPAC PIPEs. Companies must think about how to creatively structure financing alternatives to ensure they can meet minimum cash needs, and seek flexibility in both cash sources and uses.

This past spring and summer, as the SPAC market began to heat up, securing third party PIPE financing to bridge minimum cash needs and ensure a successful closing was practically no problem at all for a viable deal. The PIPE markets were on fire, and SPAC-related PIPE subscriptions were regularly oversubscribed and often upsized, yielding numerous deals with larger and sometimes record-setting PIPE financings.

The cool autumn weather, however, also ushered in some moderate cooling of the PIPE markets. Many SPAC participants are experiencing a slowdown in PIPE processes, and a tightening to the point of putting downward pressure on proposed target valuations, sponsor and target economics, and deal timing and viability. The “usual suspects” of institutional PIPE participants have become overwhelmed given the sheer volume of deals.

Target companies must think creatively with their SPAC partners to take into account “plan B” financing terms, and by maintaining flexibility and optionality with respect to a transaction’s sources and uses.

On the uses side, shareholder secondary liquidity needs should be reexamined and pressure tested with some downsizing or elimination of immediate secondary components based on minimum cash outcomes, or the potential conversion of secondary components into future deferred consideration. Companies may also look to negotiate the rollover of some or all of their existing debt. These types of arrangements can allow the de-SPACED company flexibility and time to manage its balance sheet needs and pursue alternative financing pre-signing or once public, without preventing the deal itself from being consummated.

Additionally, on the sources side, companies should look at possible financing and investment opportunities from non-traditional PIPE participants, backstop facilities, existing company investors, SPAC sponsor affiliates, existing SPAC investors, as well as potentially debt financing in certain circumstances. Transaction participants should also be judicious and discerning in their engagement of financial advisors that have a proven record of success in arranging SPAC-related financings, rather than just a typical plain vanilla SPAC PIPE.

(Re) Negotiating Sponsor Economics

Sponsor promote economics have come under pressure, both as a result of a competitive SPAC sellers’ market, as well as target companies’ expectations that sponsors will re-align baseline incentives to meet a target’s de-SPAC goals. Targets should seek to intimately understand a sponsor’s economic interests, what they hold in founder shares and warrants, and the baseline terms of those instruments. Other factors include, how much of the “promote” they may have syndicated to third parties, including in connection with anchor IPO sweeteners or SPAC management compensation, and whether they separately invested  above and beyond their “at risk” capital. Targets should then determine based on the competitive landscape, negotiating leverage, and transactional needs, how to utilize some of these sponsor economics to meet their de-SPAC goals.

One increasingly common feature of business combinations with earnouts as part of the purchase price is to include revesting provisions. In this case, a certain amount of sponsor promote is also put at risk of forfeiture in the future if the applicable earnout milestones are not achieved. In an increasing number of business combinations without an earnout, these trading hurdle-based forfeitures are also being required in order to tie sponsor economics more closely to future trading price performance.

Sponsors are increasingly being forced to give up or otherwise subject to forfeiture, some of their founder shares and/or warrants on the front end of a SPAC transaction. This may be in connection with facilitating a PIPE transaction by giving up shares to limit target dilution in response to the need to discount a PIPE purchase price, or a transfer of founder shares to PIPE investors as an equity kicker. It may also be a flat commitment to forfeit founder shares in connection with certain redemption thresholds, both to force SPAC sponsors to commit to take efforts to limit redemptions and preserve the financing they are meant to be bringing to the table in the trust and to limit their pro rata equity stake in the de-SPACed public company.

The most impactful way to limit dilution for target shareholders taking de-SPACed public company equity as consideration in a transaction will be to achieve the optimal target valuation relative to the size of the trust and the size and pricing of third party equity financing. However, thinking creatively about how to renegotiate sponsor economics can both align target and sponsor incentives and limit sponsor rewards to true “success stories” both in terms of low redemptions and future public company trading performance.