Over the past year, Bradley’s corporate and securities attorneys have fielded numerous questions about special purpose acquisition companies, or SPACs, and how they are impacting the M&A market in the United States. While SPACs have been around for years, their recent surge in popularity has established SPAC IPOs as a popular alternative to a traditional merger or IPO. SPAC IPOs made up about 50% of the IPO market in 2020, and the trend has only accelerated in 2021, [1] prompting the SEC to open an inquiry into the SPAC IPO’s surge in popularity.

Given this interest in SPACs, we are providing this update for anyone who hasn’t tracked their development or is interested in pursuing a SPAC transaction.

What is a SPAC?

A SPAC is a special purpose entity formed to raise capital through an IPO that will be used to acquire one or more target companies. SPACs are formed by sponsors, often individuals or institutions with experience in private equity, who will identify one or more businesses to target for an acquisition after the IPO. Because the IPO occurs before the SPAC acquires a target company, SPACs market to investors based on the sponsors’ track records, investing experience, and credibility within the target industry.

The proceeds of the SPAC IPO are placed in a trust account until the SPAC completes a business acquisition. Prior to closing the business acquisition, the SPAC’s investors vote on the transaction and have the option to redeem their shares for a portion of the trust account.  

SPACs must complete the initial business acquisition within a relatively short period of time, often 24 months, or else the SPAC is required to liquidate and return the proceeds raised in the IPO to its investors. SPACs are attractive to investors because they offer the upside of potentially investing in a high-growth target company with downside protection since shares may be redeemed at the time of the closing if the investor does not approve of the deal.

When and How Do SPACs Look for Target Companies?

A SPAC can only identify specific acquisition target companies and enter discussions with targets after the IPO. This requires investors to invest in a blind pool in the IPO, but the SPAC sponsor team will often identify and describe industries, sectors, or geographic locations in which the SPAC intends to focus its search for a business acquisition target. This information is publicly available in the SPAC prospectus filed with the SEC in connection with the IPO.

How is a SPAC Acquisition Different From a Traditional Merger or Acquisition?

From a target business’s perspective, a SPAC acquisition is largely the same as a traditional merger or acquisition with respect to the acquisition transaction. The SPAC typically needs shareholder approval for the acquisition and will file a proxy statement containing proposals seeking shareholder approval. The proxy statement will include a description of the proposed acquisition and governance matters. It will also include financial information of the target company, including historical financial statements and pro forma financial statements showing the effect of the acquisition.

If the SPAC’s shareholders approve the acquisition and all regulatory matters are cleared, the acquisition process proceeds as a traditional merger or acquisition would. However, at this point, the transaction differs from a traditional M&A transaction: after the closing, the target business is a publicly-traded company by virtue of the combination with the SPAC. This means that the combined business must have the appropriate management, governance and financial reporting processes in place to operate as a public company.

Why Choose a SPAC IPO Over a Traditional IPO?

Many SPAC acquisition targets are high-growth privately-held companies that would also be good IPO candidates. But a SPAC IPO usually takes less time than a traditional IPO. Traditional IPOs generally require four to six months, while a SPAC IPO may require three to five months after signing a letter of intent. Additionally, in the SPAC transaction, the valuation of the business is negotiated with the SPAC sponsors instead of relying on investment banks to secure investor support for pricing, which can be uncertain and difficult to predict in times of market instability. Furthermore, while similar to the disclosures required in a traditional IPO, the disclosures required in a SPAC IPO are on the whole less burdensome and allow for the inclusion of projections.

There are also downsides to be aware of in a SPAC transaction. First, there may be limited trading liquidity in the SPAC for the period following the closing of the business combination. This may impact not only investors in the SPAC but also owners of the target business that roll equity into the SPAC at closing. Additionally, certain limitations on the ability of a SPAC to take advantage of automatically effective registrations of securities for three years after the business combination closes may impact the SPAC’s ability to access capital markets post-closing quickly. SPACs also must comply with stock exchange listing requirements upon the closing of the business combination.

SPACs and the SEC

While SPACs continue to rise in popularity, Reuters recently reported that the SEC has opened an inquiry into the SPAC IPO process and how underwriters are managing some of the risks involved. The SEC sent letters to Wall Street banks seeking information on their SPAC dealings on a voluntary basis. There are suggestions that, while this information-seeking probe is voluntary at the moment, it may be a precursor to a formal investigation.

This inquiry was brought about by the surge in popularity of SPAC IPOs. This month, the SEC warned investors against buying into SPACs based on celebrity endorsements, and indicated that it would be closely watching SPAC disclosures and structural issues. Additional concerns the SEC may have regarding SPACs and the SPAC IPO process include the depth of due diligence SPACs perform before acquiring assets, whether payouts to the SPAC and its sponsors are fully disclosed to investors, and the heightened risk of insider trading in the period between when a SPAC goes public and when it announces its acquisition target.

Although this inquiry does not necessarily signal a decrease in SPAC popularity, it will be interesting to see how the SEC’s attention impacts the market.

Conclusion

As SPACs continue to rise in popularity, your company could be a target for a SPAC acquisition. Understanding the benefits and challenges of a SPAC transaction can make a difference in securing a positive outcome.

[1] As of March 24, about 300 SPACs have gone public this year.