Episode #21: SPAC Trends, Advantages and Obstacles (Davina Kaile)

Joel Simon: Let’s jump right in! Your securities transaction experience runs the gamut from IPOs to follow-on equity offerings, PIPEs and debt. But today we’re going to focus on a transaction category that has taken the market by storm—SPACs. Can you tell us what a SPAC is and why it’s all the rage now?

Kaile: In its simplest terms a SPAC is a Special Purpose Acquisition Company, or as we tend to call it these days, a special purpose IPO company. But, it is in essence a shell company, so it’s an entity that is formed to raise capital in an IPO, and the purpose is to use the proceeds from the IPO to acquire one or more unspecified businesses or assets that will be identified after the public offering. The shell company is usually formed by a group of sponsors and investors, typically with a very strong reputation, experience and success in identifying, acquiring and operating a business. It used to be the case that they were often focused on a specific business sector—for example, clean energy or hospitality, etc.—but these days more and more you’re seeing SPACs being formed without necessarily being focused on a specific industry sector. After the IPO, the proceeds from the IPO are put into a trust account, and those funds cannot be released until the closing of a business combination, or what we call a D SPAC transaction, or, if they don’t close the business deal, they have to unwind the SPAC and give the cash back to the public stockholders. From a timing perspective, SPACs usually have up to two years to complete a business combination, otherwise they have to return the funds. The other unusual aspect about a SPAC is that the public SPAC investors, typically, whether or not they vote in favor of a business combination can still opt to redeem their stock and get cash back when the deal closes. So, think about a SPAC really in terms of three phases, there’s the SPAC formation—going public—and then there’s this period of time where the SPAC is a public company and looking for a target, and then the third phase where they actually identify a target, negotiate the merger and merge the companies together and the private target essentially steps into the shoes of the SPAC and becomes the public company on a going-forward basis.

Simon: And the reasons for its new popularity?

Kaile: In terms of why it’s all the rage, it’s sort of interesting. There are a lot of reasons, but I think one of the main ones is there have been a lot of SPACs around for a couple of years that are coming up on their deadlines to use their funds or give the money back, and also, there are a lot of companies that are looking for access to the public capital markets now, and because of market volatility and economic conditions a traditional IPO window may not be open, or the company might not be a suitable traditional IPO candidate, so the SPAC vehicle is now becoming increasingly attractive as offering them an alternative to access the public markets.

Simon: I worked on a SPAC many years ago, and what I remember most about it is that it wasn’t thought to have much of a future due to its speculative nature and disclosure risks (or should I say, risk of lack of disclosure!). What’s different this time around?

Kaile: I do remember back in the day we would see a lot of SPAC IPOs, and frankly sort of dismiss them because SPACs definitely used to be viewed more as an alternative of last resort for companies that wanted to go public, but now they’re definitely being viewed as at least a viable, realistic alternative to an IPO, and, for lack of a better term, there’s less stigma attached to them. Beyond the reasons I mentioned—sort of right place, right time, SPACs needing to find targets coming up against deadlines, and companies increasingly need or want to access the public capital markets—there are a couple other reasons why SPACs are no longer sort of a negative four-letter word. You’re definitely seeing a lot more high-profile and successful SPAC transactions, and those high-profile deals pique investor interest and add to the legitimacy of a SPAC deal. Also adding to the legitimacy of SPAC deals—you see SPAC transactions “moving up-market,” and by up-market I mean you’re starting to see the bulge bracket, high-profile investment banks and very experienced, well known, well regarded sponsors and founders becoming involved in SPAC transactions. Whereas historically, you might have seen not so much the bulge bracket firms leading SPAC IPOs. Also, there’s a lot of market volatility, and, as I noted, the IPO window is a little bit hazy for companies, so the SPAC offers a good alternative.

Simon: Interesting.

Kaile: Another thought is that companies and the industry have always been looking for an alternative to the traditional IPO, so we’ve seen the rise of direct listings, and now you’re seeing SPAC deals. People just sometimes view the IPO process as a bit burdensome and expensive. The other issue that relates to my last point ironically—I actually personally view it as a misconception—but some private target companies looking to go public tend to view the SPAC process as being faster and cheaper than a traditional IPO process. Just from personal experience, I actually counsel companies that while that can sometimes be the case, it is often not the case. So even though that might be helping to fuel the SPAC trend, I don’t know that that’s actually a true, underlying reason that you actually unwind these SPAC deals and look at how much time it takes and how much the cost is for the target company.

Simon: So, in addition to time and expense factors, if a company is comparing the IPO—the more traditional IPO that is—to a SPAC IPO route, what are some other factors that a company should be looking at in deciding between the two options?

Kaile: First and foremost is looking at the profile of the target company itself, and specifically whether it is a viable traditional IPO candidate, because, if it is, in many cases the traditional IPO route might actually work better for it. But there are obviously a lot of great companies with a lot of potential that might just be in what I’ll characterize as an emerging industry, or a non-traditional industry, and for that reason the traditional IPO market and traditional IPO investors may be less familiar and less comfortable with a company in that sector, or with that profile. For that company maybe a traditional IPO route isn’t the best alternative, and they could look toward the SPAC alternative, or other alternatives. Other factors are market volatility and IPO windows, so if there’s tremendous volatility, or the IPO window is definitely closed, and a company feels that this is the time that they really need to get out and access public markets, then they would definitely want to consider a SPAC alternative. The third reason, and probably one of the more important ones, is valuation certainty. Again, for companies up and to the right on the scale—traditional IPO candidates—a traditional IPO option probably works best for them because there will be high demand for their stock, and they will price the deal very well, and will very likely trade up after the IPO. But for many other companies that valuation uncertainty, and waiting to see how the roadshow works out, etc., is a bit of an obstacle for them, so going IPO through a SPAC route is a little bit better in that it provides them more valuation certainty because they will have negotiated a price with the SPAC, they’re not waiting for the book bill to process and an IPO roadshow to determine the price of their stock. Another factor which companies don’t always focus on, but which as a lawyer I always have to flag for them: Is the company “public company ready”? Whether you go IPO through the SPAC or you go IPO through the traditional route, that private target company has to be ready to be a public company on day one of closing of the business combination or day one of closing the IPO, and getting “IPO ready” or “public company ready” is a very time-intensive process. It requires a lot of work in the background, and a lot of companies take a year or two to get fully ready, so even if a SPAC process is even faster than an IPO—and, again, it often isn’t—the target company might not be ready in that timeframe, so they have to factor that in. Again, I want to reiterate: the time and cost factor between the two alternatives is not as disparate as many people might think.

Simon: Perhaps you could close us out with a brief mention of any particular obstacles to pursuing a SPAC strategy?

Kaile: Obviously, some of this will touch a little on what I mentioned in terms of time and cost with IPO and public company readiness, but in terms of obstacles, and, again, speaking from a lawyer’s perspective, companies that are considering a SPAC process should really look at a SPAC as three deals at once. First, you’re doing a merger into a public entity. Second, in almost all cases you are also doing a capital raise into what we call a pipe financing, which is a private equity in public securities. That is to ensure that there is enough cash at the closing of the business combination for the company to continue to operate because, remember, in a regular IPO, the company is actually raising cash proceeds. In a SPAC route, they are merging into a public company and making it public, so unless they do an additional financing they aren’t actually raising capital. Finally, the third part of the deal is you actually are doing an IPO, you’re just doing it in a different way. And that, again, dovetails into what I mentioned about really needing to be ready to be a public company and doing all of the work that you would do in an IPO. It just overlaps or in a slightly different manner when you’re doing it through a SPAC. So it’s three deals at one time, and, as a result, can be very expensive and time consuming. They should also consider deal uncertainty, and, again, there’s deal uncertainty with a traditional IPO and a SPAC, it’s just a different kind of uncertainty. For an IPO, it is going on the roadshow and having a successful roadshow, then with the SPAC process it’s uncertainty around closings. So if you need a shareholder vote and the SPAC shareholders vote it down, or if an excessive number of SPAC shareholders elect to redeem their shares for cash, you’re scrambling to make sure there’s enough cash in the till for the company on a post-business combination basis. Also, with a SPAC merger, unlike a regular merger, the target has much more limited recourse in case the deal falls through—there’s usually no reverse break-up fee, for example. So if they’re negotiating a merger with a SPAC and they’re spending a lot of money and the deal breaks, the target is a little bit left holding the bag and has spent a lot of outlay of cash, etc., and there’s not much recourse to recoup those losses. Depending on the deal structure, remember that a SPAC has shareholders—the founders usually have a significant percentage and have structured the deal so that they’ll maintain a significant percentage in the business combination—so you’ll have to negotiate around the potential dilution of the sponsor’s shares and their sponsor’s percentage ownership post the SPAC transaction. Again, it’s the same amount of work as an IPO from a target company perspective, so while the SPAC route is definitely a great alternative for a lot of companies, I always caution them by saying you’re still doing the same amount of work, it’s still the same disclosures, so definitely take a step back and think about your suitability as a traditional IPO target, how ready you are, if you’re ready to cope with potential deal uncertainty of a certain type, and don’t be so focused on thinking it’s the quick, cheap way to go IPO because that isn’t necessarily the case. Having said that, again, for companies that can’t go, or aren’t suitable candidates, the SPAC route is definitely a very good and viable alternative.

Simon: Davina, you’ve really shed some light on a previously mysterious securities product. Thank you so much for that. It’s been great chatting with you today.

Kaile: My pleasure, and, again, thanks so much for having me on.