Special purpose acquisition companies (SPACs) have become an increasingly popular route to the public markets, and they show no sign of slowing down. In 2020, SPACs netted record-breaking IPO proceeds of over $50 billion, and the more than 60 completed and announced SPAC mergers dwarfed the 21 and 22 seen in 2018 and 2019, respectively, based on public filings and assumed transaction sizes. If this trend continues, active and filed SPACs could result in more than 200 new public companies worth over $300 billion.
Numbers of this magnitude demonstrate that SPACs have been gaining favor with both private companies that want to go public and prospective investors. Board directors need to understand the ins and outs of this strategic option if they’re serving a private company exploring this path. But they also should be prepared if they’re approached to join the board of a SPAC itself.
But first, the basics
Sometimes referred to as “blank check companies,” SPACs are investment vehicles that raise capital from investors via an IPO to use at a later date in an acquisition of a target that is still undetermined as of the listing. Investors in SPACs are essentially backing sponsors with the belief that they’ll be able to effectively deploy the capital in an attractive asset that will provide a good return.
Functionally, SPACs serve as a temporary cashbox used to identify a merger target and facilitate its access to public markets. Proceeds from a SPAC listing are typically set aside in an escrow account until a target is identified, at which time investors have the ability to either approve the transaction or receive their money back plus pro rata interest in the trust account if they participated in the IPO; sponsors typically have between 18 to 24 months to identify a suitable investment.
That defined time frame is one reason why SPACs have attracted interest from a wide range of players, including hedge funds, private equity (PE) and retail investors. Another factor is the typical $10 share price, which avoids the seemingly inevitable IPO “pop.” More importantly, players appreciate the ability to generate returns and liquid currency in the form of stock faster than the normal holding period of PE or hedge funds. In addition, PE investors are able to generate gains via founder shares, and retail investors have the chance to invest earlier in companies that previously would have followed the private equity path.
This greater certainty around price and execution appeals to private companies as well. For them, taking the SPAC route offers all the benefits of the public markets with enhanced flexibility and versatility, including access to greater amounts of capital and the ability to offer more cash to existing shareholders.
Companies that become public via this route leverage a SPAC’s ability to include projections of future earnings to help market the deal, a practice that is constrained in the traditional IPO process. Since the SPAC is already a public entity, it avails itself of safe harbor provisions. Upon completion of the merger, the acquired company becomes public.
Operating company considerations
For private companies considering a capital market transaction, management teams and board directors should thoughtfully explore multiple opportunities, including SPACs. Similar to an IPO, the SPAC alternative requires a company to be prepared. Having your house in order — from strategy and structure to operations and reporting — will make the company a more attractive acquisition target.
In terms of strategy and structure, the company should have defined deal goals, such as whether it wants to work with a SPAC that will hold a minority stake or one that controls the company moving forward. The company will need to have a strategy for deploying the new funds that come in. If the company will be the principal entity acquired, it must have an independent audit under PCAOB standards, so incremental audit procedures may need to be factored into the timeline. If the transaction involves multiple operating companies, additional considerations apply, but the requirements are generally less onerous for any company that is not the predecessor entity.
Operationally, a company should look toward organizational improvements that can help it act as a public company. For instance, focusing on how long it takes to close books on a monthly basis can be beneficial, as can determining whether any processes can leverage automation or be restructured completely. It’s also a good time to make sure people are deployed in efficient roles within the organization to take on the additional responsibilities of a public company. On the reporting side, proxy materials will need to be developed: typically three years of financial statements, management discussion and analysis, and pro forma statements for the latest fiscal year and year-to-date interim period. The level of effort is essentially the same as in a traditional IPO, but on a condensed timeline and with certain merger characteristics.
When it comes to the sale itself, companies that wish to be acquired should keep in mind several considerations. For example, a SPAC needs to have a minimum amount of cash on hand to complete the transaction, but if shareholder redemptions are greater than expected, that condition might not be met. Such a situation could either jeopardize the sale or reduce the amount of capital available to the company once it has gone public. Working with a serial SPAC sponsor can allow private companies to better gauge potential risk associated with redemptions because they can see the redemption level of past transactions.
Another deal condition that could come to bear is the existence of super-voting shares. While these are primarily reserved for transactions that involve a current owner with outsized voting shares or founder-led organizations, there are legal structuring and valuation issues that should be considered.
For private companies, SPACs offer benefits, concerns
How does a special purpose acquisition company (SPAC) differ from an IPO?
A SPAC can be used to access the public markets faster than the typical IPO timeline. In practice, it is most similar to a complex merger and acquisition.
What are the capital benefits of a SPAC?
A SPAC can provide significant cash proceeds to private company sellers, as well as capital to deleverage the operating company or to pursue accretive mergers and acquisitions to build the company.
What could be a potential capital risk?
Redemptions in excess of thresholds set out in the merger agreement could result in an abandoned deal.
How can a SPAC benefit private company management?
An experienced SPAC sponsor with past success in operating growth businesses and public companies can unlock managerial experience, extensive networks or additional capital.
What risks should management be aware of?
A high burden of performance to protect valuation through lock-up periods.
How flexible are SPAC deals?
Due to the negotiation aspect of these transactions, many potential terms could be incorporated.
What can be an issue for target companies?
Due to competition in the market for deals, the timeline to find and complete a transaction or dissolve is challenging for SPACs to meet, putting pressure on the target company to move through the de-SPAC process quickly. In addition, the valuation desired may be challenged.
What are some compliance concerns?
Private companies need to ramp up activity to begin complying with public company infrastructure, often with limited resources.
As SPACs grow in popularity and number, there will be an increasing demand for directors to fill their boards and help develop strategy. Potential directors should understand the goals of the sponsor group and the sponsors’ fund-raising capability.
As they consider joining a SPAC board, potential directors need to gauge their expected level of involvement. For example, some sponsor groups will hold the primary responsibility for selecting potential operating companies to acquire, while others will expect the SPAC board to participate in filtering these targets. This can require frequent communications with the sponsor group to better understand what type of operating company is an appropriate target.
It’s important to remember that a SPAC director’s involvement may be short-lived, as most SPACs have an average shelf life of under two years. Following a merger with an operating company, the SPAC’s board will be reshuffled, with some directors replaced on the newly combined board. Other scenarios entail working with either a serial SPAC sponsor or an entity that is launching multiple SPACs. A director could sit on the board of each SPAC that launches in the case of a serial sponsor or choose the SPAC that’s the best fit if a sponsor is running multiple SPACs simultaneously.
A final consideration is whether the directors and officers (D&O) insurance being carried is in line with expectations. While insurance amounts have grown significantly over the past year, from around $1 million per deal to over $10 million, that increase is not universal. Directors who are accustomed to a certain level of D&O insurance should make sure they are comfortable with what the SPAC they are considering joining is carrying.
Board members should be talking with their management team to determine whether they are considering SPACs as a potential path to the public markets. Companies will need to get themselves transaction-ready while remaining flexible for potential capital opportunities. Once in the SPAC process, everything is negotiable and the timing will be quick, but it’s important to remember that there will be a public company upon the deal’s completion.
There’s little question that SPACs are here to stay for the foreseeable future. They offer an alternative form of capital that can be structured in many ways to offer liquidity so companies can grow. The past year has been very dynamic, and that pattern is likely to continue over the next several years.
Karim Anani and Alex Zuluaga are Americas Financial Accounting Advisory Services Transactions Leaders and SPAC Co-Leaders, Ernst & Young LLP.
Source: Private Company Director – SPACs: What Directors Should Know and Why