Is there space in the stack for a SPAC?

Special purpose acquisition companies (SPACs) have been around for a while and although they may have “historically been viewed as a bit shady” (Axios correspondent Felix Salmon), 2020 seemed to have been (at least for them) a good year, with SPACs (particularly in the US) being increasingly used as a means for established private companies to access capital markets and go public.

So, what are SPACs?

Simply put a SPAC is a company that is formed to raise investment capital through an initial public offering (IPO) in order for them to acquire an existing operating company. Often referred to as “blank cheque” companies, a SPAC is created to raise funds through an IPO, with the capital then being held in a trust until a predetermined period elapses or the desired acquisition is made. If the acquisition is not made within a certain period (usually two years), the SPAC has to return the funds to the investors.

The re-invention of the SPAC?

Over the past 12 months, SPACs seem to have re-found favour as sponsors have identified them as an option in their investment armoury. According to Dealogic, 256 SPACs were listed last year, compared to just 73 in 2019, while a recent New York Times article has reported that in the US $42.7 billion was raised by SPACs during January and the first half of February 2021 alone, with many sports personalities, celebrities and well-known investors becoming involved.

Despite the hype surrounding them, SPACs are relatively straightforward structures to create and to understand, with the sponsor merely needing to create a company, undertake the requisite filings that go with the incorporation of a public company and then find investors to buy units in the company. Investors generally acquire a unit that represents one share in the company, along with a warrant that gives them the ability to buy more shares in the future. The attraction for the sponsor is that they usually retain a 20% stake in the SPAC, which can be considered “founder shares.”

The funds raised are put in to trust and are then able to be used only for an acquisition. The SPAC, having now gone public, trades like any other publicly traded company. Retail investors can purchase shares on the open market, even though the actual acquisition is not known (although the sponsor will generally give an indication of the market they are looking to target for an acquisition).

The position closer to home?

While the US market has boomed over recent months, the London market appears to be somewhat lagging. However, in a post-Brexit UK investment publicity drive, the UK Government has shown its eagerness to promote London as a SPAC investment centre with a review of the UK’s listing regime by Lord Hill specifically recommending changes in relation to SPACs to encourage their use.

Currently, trading in a SPAC’s shares is suspended once a target has been found in order to protect investors from price fluctuations. Lord Hill’s report recommends that this should no longer apply and that instead, stakeholders should be given increased rights to find out more about the proposed transaction, sanction the acquisition and redeem their shares. In addition, the report suggests the introduction of dual-class share ownership for a minimum of five years. This would potentially allow SPAC founders to retain a greater level of control for a certain period.

Given that the changes are unlikely to be introduced until much later this year, whether they are enough to increase SPAC activity in the UK will be interesting to see and may well depend largely on the media publicity surrounding SPACs.

The benefits of a SPAC?

The key benefit of a SPAC is that it is already public at the point of its acquisition. Provided that the sponsor finds a target company for it to acquire within the relevant time frame, the mechanism simplifies the process for a private company to go public with only an acquisition being required, rather than a listing.

From the point of view of the private company, not only is the process considered to be an easier way to go public, but it allows access to capital markets and the acquisition creates more certainty as to what funds will come in to the company and shareholders, as opposed to their being at the mercy and vagaries of the underwriters and market makers while trying to get the IPO away.

Shareholders in the SPAC are presented with the terms of the acquisition of the target company and then vote on the acquisition. If the shareholders don’t like the terms they have the power to vote against the acquisition, but if it proceeds they have the option to sell their shares while being able to keep their warrants, so can still benefit from an upside.

Some corporates are also looking at SPACs as a way to buy businesses they might not otherwise be able to afford from their own resources, i.e. by creating their own SPACs to look at possible acquisitions.

Advocates of SPACs claim that they make it easier for private companies to go public, with some describing them as “venture at scale” and some consider them to be an essential tool and option for private companies wanting to buck the trend of staying private for longer and raising money from alternative sources, such as sovereign wealth funds.

And the downside?

Critics of SPACs point to the fact that during 2020, SPACs gave poor returns on investments (although whether this is a trend or just short term will remain to be seen) and that sponsors are in it for their own ends without any regard or fairness for the public investors. According to figures by JP Morgan Chase, while sponsors have achieved an average return of 648% over the past two years, post-acquisition investors earned considerably less than that, with returns of just 44% (albeit some commentators may say that a 44% return in the current market given interest rates, for example, is still an attractive return). Others raise concerns that the business model incentivises doing something – anything – with other people’s money as opposed to making a true strategic assessment of opportunities, particularly if the clock is ticking before funds have to be returned.

Equally, the growth in the SPAC market could be its own challenge – with around 250 SPACs created over the past year, could this lead to parties chasing deals, overcrowding the market and overpaying for companies?

There is also a concern that some companies that would not be suitable for an IPO, or that would benefit from the rigour of an IPO process, could end up becoming public companies via the SPAC route when they would otherwise not persuade the market to take them on? (It will be interesting, for example, to see the fallout from the allegations surrounding one of the high-profile SPAC investments, Nikola Corporation, and whether that dampens SPAC enthusiasm).

Is increased “fairness” the answer?

Could the increased publicity surrounding SPACs and the competition element pave the way for some SPACs to offer “fairer” options for their public investors? A number seem to be taking this step, including:

• Tying up sponsor shares for a certain period
• Smaller sponsor stake
• Correlating the sponsor stake with performance post-acquisition

It may be that in order for SPACs to continue to garner investor support and flourish as an investment tool, changes to their structure along these lines are inevitable and the market will, as it usually does, find its own balance in time.

Conclusion

Possibly the way to look at SPACs is the way one should look at most investment vehicles. None are perfect, some will suit certain types of investment and companies better than others and some will be more suited to professional investors rather than retail investors. On this basis, perhaps, for the right investment, there is space in the capital stack for SPACS to be a useful investment vehicle and option for some companies.

Stuart Hatcher is a Partner, Tasneem-Zohura Alom is an Associate and Lianne Baker is a Knowledge Development Lawyer in the Corporate team.

Disclaimer

This note reflects our opinion and views as of 17 March 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.