Special Purpose Acquisition Companies ("SPACs") played a critical role in U.S. capital market growth in 2020. There were 248 SPACs launched, raising an aggregate of $83 billion in proceeds. The beginning of 2021 witnessed an acceleration of SPAC activity. In January and February alone, roughly $60 billion was raised by 189 SPACs.
Although SPACs have been in existence for over 30 years, it is only fairly recently that SPACs have come to be viewed as a legitimate alternative to a traditional U.S. IPO. The explosion of SPACs in 2020 was driven by the highly favorable economic return to SPAC IPO sponsors, the initial market challenges caused by the pandemic, and the execution, liquidity, and pricing certainty offered by SPACs to both target companies and investors. With over 300 SPACs currently searching for targets to de-SPAC within a limited timetable, many SPACs are exploring opportunities outside the U.S., including in Greater China and Southeast Asia, where there are an abundance of PE and VC backed emerging companies with compelling growth and value creation prospects. In addition, recently a number of Asia-based sponsors have listed SPACs in the United States.
In this article, we will discuss what a SPAC is, how to raise a SPAC, and how de-SPAC transactions work.
Raising a SPAC
What is a SPAC?
SPAC stands for "special purpose acquisition company." A SPAC is a shell company formed for the specific purpose of raising capital through an initial public offering for use in the acquisition of control of one or more target companies (a "de-SPAC transaction"). A SPAC does not have operations or operating assets.
Formation of a SPAC
Forming a SPAC has become quick and easy. Most SPACs formed by U.S.-based sponsors are incorporated in Delaware because Delaware has been recognized as a business favorable jurisdiction in the United States. SPACs formed by Asia-based sponsors are often incorporated in offshore tax havens such as the Cayman Islands. There currently are approximately 143 SPACs incorporated in the Cayman Islands searching for target companies with which to de-SPAC. Note that a SPAC can always reincorporate into a different jurisdiction before a de-SPAC transaction, subject to tax considerations.
The SPAC sponsor typically receives shares of common stock for nominal cost at the time of the formation of the SPAC, which would typically represent 20% of the post-IPO outstanding common stock of the SPAC. In this article, we will use a SPAC named MoFo Acquisition Co. and sponsored by MoFo Sponsor Co. as an example.
Below is the structure chart of MoFo Acquisition Co. upon its formation where the sponsor, MoFo Sponsor Co., invests $25,000 for 5,000,000 shares of common stock at $0.005 per share.
Once formed, a SPAC will go through the typical IPO process of filing a registration statement with the U.S. Securities and Exchange Commission ("SEC"), clearing SEC comments, and undertaking a road show followed by a firm commitment underwriting. A SPAC IPO can be completed in a couple of months because, as a shell company with no operations to describe, the SPAC's IPO registration statement is straightforward and relatively easy to prepare. Units of a SPAC (comprised of one share of Class A common stock and a fraction of a redeemable warrant) start trading right after its IPO.
SPAC Trust Account
An important feature of a SPAC is that the proceeds from its IPO will be held in a trust account and cannot be used for any purpose other than (i) funding a de-SPAC transaction or (ii) redeeming the shares sold to the public shareholders in the IPO (as described below). The funds in the trust account are typically invested in short-term U.S. government securities or held as cash. It is therefore important that when a SPAC enters into a contract with a third party (e.g., a confidentiality agreement with a potential target for a de-SPAC transaction), the contract will include waiver language to ensure that the counterparty has no claim or recourse against the trust account assets.
In a SPAC IPO, units will be sold to public investors. Each unit, which is offered to the market at $10 per unit, consists of one share of Class A common stock and, typically, a fraction of a warrant (e.g., 1/2, 1/3, or 1/4 of a warrant) to purchase one share of Class A common stock in the future at $11.50 per share, representing a 115% premium to the $10 IPO price. Generally, within 52 days after the closing of the IPO, the units become separable such that the public can trade the shares separately from the warrants.
Two Classes of Stock
SPACs typically issue two classes of stock. The common stock included in the units sold to the public investors at the IPO is "Class A" common stock and the common stock purchased by the sponsor at the formation of the SPAC is "Class B" or "Class F" common stock. Class B/F common stock will typically convert into Class A common stock at the time of the de-SPAC transaction on a 1:1 basis. Class A and Class B/F common stock typically vote together as a single class. The rights of these two classes of stock are generally similar except that shares of Class B/F common stock are not subject to redemption, are subject to transfer restrictions pursuant to lock-up agreements, are subject to registration rights, and, often, only holders of shares of Class B/F common stock have the right to appoint and remove directors before the closing of a de-SPAC transaction.
Warrants Issued to Public Shareholders
Only whole warrants are exercisable. If one SPAC unit consists of 1/3 of a warrant, a holder needs to hold three units (or three fractional warrants) in order to purchase an additional share of Class A common stock. The exercise price of the warrants is typically 115% of the unit price (i.e., $11.50 per warrant). The warrants typically become exercisable on the later of (i) 30 days after the closing of the de-SPAC transaction and (ii) 12 months after the IPO. The warrants usually expire five years after the closing of the de-SPAC transaction.
Private Warrants Issued to Sponsor (i.e., Sponsor's At Risk Capital)
As described above, all IPO proceeds from the sale of units to the public will be held in a trust account. So how does a SPAC pay costs and expenses in connection with its IPO, such as underwriting commissions, legal counsels' fees, and D&O insurance premiums? These costs are funded by the SPAC sponsor with what is referred to as the "at-risk capital" by purchasing warrants in a private placement that closes concurrently with the SPAC IPO. The sponsor warrants are "at-risk" because, in the event that the SPAC does not consummate an initial business combination within its investment period, the warrants will expire and be worthless, and the money invested to purchase them will typically have been spent.
Terms of the public warrants and private sponsor warrants are generally similar, including the exercise price. The key difference is that the public warrants are included in the units sold in the IPO while the sponsor needs to pay for the warrants (typically between $1.00 and $2.00 per warrant). Unlike the public warrants included in the units, the private sponsor warrants (including the shares issuable upon exercise of the sponsor warrants) are subject to transfer restrictions and generally are not subject to redemption. The sponsor warrants typically are not freely tradeable.
Below is the post-IPO capitalization structure of MoFo Acquisition Co. assuming a $200 million IPO raise and $6,650,000 of at-risk capital invested by the sponsor at $1.50 per private warrant. There are 20,000,000 units issued to public shareholders, consisting of 20,000,000 shares of Class A common stock and 6,666,666 warrants (i.e., each unit consists of one share of Class A common stock and 1/3 of a warrant). There are 4,433,333 warrants issued to the sponsor at $1.50 per warrant. Immediately after the IPO, the public shareholders collectively hold 80% of the outstanding shares in MoFo Acquisition Co. and the sponsor holds 20%.
The underwriting commissions for a SPAC IPO is typically 5.5% of the total IPO proceeds, with 2% to be paid at the closing of the IPO and 3.5% to be paid at the closing of the de-SPAC transaction. If no de-SPAC transaction occurs, the deferred 3.5% will never be paid to the underwriter. The amount of the sponsor's at-risk capital is typically calculated as the sum of 2% of the total IPO proceeds, which will be used to pay the upfront underwriting commissions, plus an additional $2 million to $3 million to cover the other offering expenses and the expenses of the SPAC to be incurred during the investment period to identify and pursue one or more target companies before the closing of the de-SPAC transaction. The average amount of the sponsor's at-risk capital is approximately 3.2% of total IPO proceeds.
A SPAC generally has a deadline of 18 to 24 months after its IPO to complete the de-SPAC transaction. In the event that no such transaction is completed within such timeframe, the SPAC may seek its shareholders' approval to extend the deadline or the SPAC will be liquidated, in which case 100% of the funds in the trust account will be returned to the public shareholders on a pro rata basis.
No Specific Acquisition Target at the Time of IPO
A SPAC typically will (although it is not required to) identify in its IPO prospectus certain specific industries or geographic areas in which it will pursue a target to de-SPAC after its IPO. However, SPACs cannot identify the acquisition target prior to the closing of the IPO. The SEC often requires disclosure in the IPO prospectus that the SPAC currently does not have any specific target under consideration, and that neither the SPAC, nor anyone acting on the SPAC's behalf, has engaged in any substantive discussions regarding a possible target. If a SPAC had a specific target under consideration at the time of its IPO, detailed information regarding the target would need to be included in the prospectus, which could significantly delay the IPO process.
De-SPAC is a Public Merger
A typical de-SPAC transaction is structured as a merger. At the closing of the de-SPAC transaction, the target is merged with a wholly owned subsidiary of the SPAC, and the target shareholders receive newly issued SPAC shares in exchange for their shares in the target company. Some deals may have a cash component of the consideration, which can be used to cash out certain existing investors in the target.
The de-SPAC transaction typically requires approval from the SPAC shareholders. Shareholder approval is also required for other proposals in connection with the de-SPAC transaction, such as approval of the issuance of shares in the PIPE (private investment in public equity) transaction that will close concurrently with the de-SPAC merger, approval of a post-closing public company equity incentive plan, and charter amendments to remove provisions unique to SPACs.
The need to obtain shareholder approval for a public deal has long been considered as one of the major obstacles to closing. However, the notion that a de-SPAC transaction runs the risk of not receiving approval by the SPAC's shareholders is now more theoretical than practical. In practice, shareholders have strong incentives to vote in favor of the de-SPAC transaction because even if a shareholder votes for the de-SPAC transaction, the shareholder can still require that that the SPAC redeem its shares and hold onto the warrants (as described below), which will only have value if the de-SPAC transaction closes. As a result, the SPAC shareholders are incentivized to approve the de-SPAC transaction for the value of the warrants, whether or not they choose to redeem.
Before the closing of the de-SPAC transaction, a SPAC is required to offer its public shareholders the right to require that their shares be redeemed at a redemption price of approximately $10 per share plus accrued interest (i.e., an amount equivalent to the IPO price plus interest earned in the trust account). The redemption offer does not apply to warrants. The public shareholders likely will require their shares to be redeemed when the market reacts negatively to the announcement of the de-SPAC transaction (i.e., the SPAC shares trade below the redemption value). The shareholders can exercise their redemption rights whether they vote for, against, or abstain from voting with respect to the de-SPAC transaction. The sponsor, directors, and officers of a SPAC typically waive their redemption rights with respect to their shares, including any public shares they may purchase in connection with the de-SPAC transaction, effectively agreeing to stay invested in the SPAC through the closing of the de-SPAC transaction.
Because of the redemption rights of shareholders, the actual amount of cash that will stay in the trust account at the closing of the de-SPAC transaction (and be released to the company as available funds) is unknown when the definitive merger agreement is signed, which could mean that the combined entity might be without sufficient cash to fund its operations after the closing. Such risks can be mitigated to a significant extent through alternative financings, such as a PIPE investment in the SPAC by institutional investors or forward purchase arrangements provided by the sponsor (or its affiliates), which typically close concurrently with the de-SPAC transaction.
In order to mitigate the liquidity risk associated with shareholder redemptions and to provide additional cash to fund the post-closing operations of the combined entity, many SPACs will issue new shares to institutional investors in a PIPE transaction that is contingent upon and closes concurrently with the closing of the de-SPAC transaction.
Forward Purchase Arrangement
The sponsor (or its affiliates) or other institutional investors may also enter into forward purchase arrangements with the SPAC to commit to purchase newly issued shares of the SPAC to provide additional funding concurrent with the closing of the de-SPAC transaction.
The SPAC sponsor, as well as the founder and major shareholders of the target, typically are subject to lock-ups for a period of six months to one year after the closing of the de-SPAC transaction. PIPE investors, which are more focused on liquidity, typically are not subject to a lock-up.
Valuation of Target
Under the NYSE and NASDAQ listing rules, the target of a de-SPAC transaction must have an aggregate fair market value of at least 80% of the assets held in the trust account at the time of signing of the definitive agreement. In recent deals, the valuation of the target is typically three to five times the value of the assets held in the SPAC trust account (and many times even more).
We use a hypothetical de-SPAC transaction between MoFo Acquisition Co. and a target company, MoFo Target Co., to illustrate the consideration waterfall.
The tables below set forth the pre-closing capitalization of MoFo Acquisition Co. (SPAC). Recall that MoFo Sponsor Co. holds 20% of the SPAC's shares and 4,433,333 warrants purchased with at-risk capital of $6,650,000. The public shareholders hold 80% of the shares and 6,666,666 warrants in a $200 million IPO raise.
|SPAC (MoFo Acquisition Co.) Capitalization|
|Shares||% Share Ownership||Warrants||Warrant Ownership|
|SPAC Public Shareholders||20,000,000||80.0%||6,666,666||60.06%|
|SPAC Sponsor (MoFo Sponsor Co.)||5,000,000||20.0%||4,433,333||39.94%|
Assuming the target, MoFo Target Co., has 13,000,000 shares issued and outstanding on a fully diluted basis at a valuation of $1 billion, then the shareholders of MoFo Target Co. will receive an aggregate of 100,000,000 shares of Class A common stock at $10 per share upon the closing of the de-SPAC transaction (assuming no cash is used as consideration), and, further assuming there is a PIPE of $150 million, the PIPE investors will receive 15,000,000 shares of Class A common stock at $10 per share at the closing. Upon the closing and assuming no redemptions by the SPAC shareholders, the target shareholders will collectively own 71.43% of the combined entity, the SPAC sponsor will be diluted to 3.57% and the public shareholders will be diluted to 14.29% before exercise of any warrants, and 6.24% and 17.65%, respectively, upon exercise of the warrants in full, as set forth in the pro forma cap table below.
|Pro Forma Ownership of Combined Entity|
|Shares||% Ownership||Shares (Post-Warrant Exercise)||% Ownership (Post-Warrant Exercise)|
|Target (MoFo Target Co.) Equityholders||100,000,000||71.43%||100,000,000||66.18%|
|SPAC Public Shareholders||20,000,000||14.29%||26,666,666||17.65%|
|SPAC Sponsor (MoFo Sponsor Co.)||5,000,000||3.57%||9,433,333||6.24%|
Note that the SPAC sponsor and public shareholders may exercise their warrants after the closing of the de-SPAC transaction to mitigate the dilution, but as shown in the pro forma cap table above, that would not significantly increase their shareholding percentages given the valuation of the target. Also note that the warrants typically have an exercise price of $11.50 per share, so they would only be exercised if the stock trades up more than 15% from the base price of the transaction of $10 per share.
Post-Closing Board and Management
The initial members of the board and management team of the post-closing combined company are normally determined during the negotiations between the SPAC and the target before the closing. The combined entity will need to comply with the relevant stock exchange listing rules and other corporate governance requirements for public companies in general (e.g., the majority of the board should be comprised of independent directors and the audit committee of the board should be comprised of independent directors only).
In connection with solicitation of SPAC shareholders' approval of a de-SPAC transaction, a SPAC is required to distribute a proxy statement to its shareholders that contains the following information:
- Audited financial statements of the target for the past two or three years, and the unaudited financial statements of the target for the interim period;
- Pro forma financial information of the combined public entity after closing of the de-SPAC transaction;
- Management discussion and analysis and other information concerning the target (e.g., business description);
- Risk factors with respect to the target and the de-SPAC transaction;
- Beneficial ownership in the combined public entity after closing of the de-SPAC transaction (including shareholders owning 5% or more of the shares of the SPAC, executive officers, and directors);
- Information on executive compensation;
- Information on related party transactions; and
- Background of the de-SPAC transaction.
SEC rules also require that a SPAC file a special Form 8-K ("Super 8-K") within four business days after the closing of the de-SPAC transaction. The "Super 8-K" must include all of the information that would have been required if the target were filing an initial registration statement on Form 10 and will include substantially all the information from the proxy statement and certain other updated information. For example, the pro forma financial information and other related disclosures will need to be updated to reflect the actual redemptions by the shareholders.
Shares of a SPAC issued to the public can be traded right away. Shares issued to the target company shareholders are also typically registered and freely tradeable, but many of the larger shareholders will be expected to sign lockups, as discussed above. Shares issuable upon exercise of the warrants are not registered at the time of the IPO; however, a SPAC typically will undertake to use efforts to register these shares shortly after the completion of the de-SPAC transaction. A SPAC will typically provide its sponsor and PIPE investors registration rights.
Timeline of a Typical De-SPAC Transaction
The table below sets forth an illustrative timeline of a typical de-SPAC transaction.
|1. Signing of NDA||Post-IPO|
|2. Signing of LOI (letter of intent)||After signing of NDA|
|3. Due diligence review on the potential target||After signing of LOI; before signing of definitive agreement|
|4. Negotiation of definitive agreement|
|5. Financing arrangement(debt and/or equity, including PIPE)|
|6. Signing of definitive agreement||Upon completion of due diligence|
|7. Announcing the deal||Immediately after signing|
|8. Initial rollout and investor presentation|
|9. Submission of first draft of proxy statement to SEC||Within 2-4 weeks after signing of definitive agreement|
|10. SEC review of draft proxy statement||5 to 10 weeks after signing of definitive agreement|
|11. Shareholders' meeting of SPAC||3 to 5 weeks post-effectiveness|
|12. Regulatory approval and pre-closing restructuring||Prior to closing
Note: not every de-SPAC transaction involves this step
|13. Closing||Upon satisfaction of all closing conditions|
|14. Filing of "Super" 8-K||Within 4 business days after the closing|
SPAC vs. Traditional IPO
For all private companies, going public is a major milestone in the company's history. However, the traditional IPO process can be a huge obstacle given the time, expenses, and uncertainties involved. Listing through a de-SPAC transaction can provide a more certain and may provide a quicker path to the public markets. The chart below sets forth the comparative advantages of listing through a de-SPAC transaction and a traditional IPO.
|Access to additional capital||✔||✔|
|Public currency for M&A||✔||✔|
|Public currency for management/employee compensation||✔||✔|
|Use of projections in marketing materials||✔|
|IPO process requirements including delivery of audit and SEC review process||✔||✔|
|Transparent price discovery mechanism (with prospect of price renegotiation)||✔|
|Additional cost in form of sponsor promote||✔|
|Flexibility in structuring economics||✔|
|Closing risk due to shareholder voting and redemption rights||✔|
|Speed in execution/closing||✔|
|Post-closing compliance with public company requirements||✔||✔|
- Flexibility of deal terms. In a de-SPAC transaction, the SPAC and the target company may structure the deal in a variety of ways in terms of capital structure, financings, and economic terms.
- High deal certainty. A SPAC is already a public company. Therefore, the target company becomes a public company immediately upon the closing of the de-SPAC transaction. It largely reduces the risks and uncertainties in the traditional IPO process.
- More effective pricing mechanism. In contrast to a traditional IPO where pricing is only determined at the very end of the IPO process, pricing in a de-SPAC transaction is determined upon the signing of the definitive merger agreement. The market participants can validate the price (or, alternatively, express their dissatisfaction with the transaction or price) by trading up or down the SPAC's common stock after the announcement. Investment in a de-SPAC transaction by PIPE investors, which are usually sophisticated institutional investors, can also validate the valuation of the target. A successful PIPE would also provide funds available for the post-closing operations of the target company, and it significantly reduces the uncertainty of the capital raise of a de-SPAC transaction created by potential redemptions of the public shareholders of the SPAC.
Traditional IPOs tend to be more suitable for established companies of a larger scale and with a strong market reputation, in which the shareholders are confident in the ability to successfully complete the IPO process and are not seeking the level of certainty provided by a de-SPAC Transaction.
- Additional time to meet obligations of public company. As a traditional IPO takes longer, which may provide additional time for companies to implement internal controls, policies, and procedures necessary to satisfy post-listing compliance requirements (or become "public company ready") as listed companies.
- No dilution by sponsor shares. As shown in the pro forma capitalization of the hypothetical de-SPAC transaction between MoFo Acquisition Co. and MoFo Target Co., the sponsor, MoFo Sponsor Co., takes 3.57% of the combined entity (or 6.24% upon exercise of warrants) with very little upfront cost, which dilutes the target shareholders. De-SPAC Transactions typically incur significantly higher overall fee levels as well.
In this article, we endeavored to provide a practical overview of the life cycle of SPACs and key features of de-SPAC transactions. While the typical documentation and commercial issues for public mergers would also apply to de-SPAC transactions, such as valuation and allocation of consideration among the target company shareholders, there are many issues unique to SPACs and target companies in de-SPAC transactions, such as commitment and size of PIPE financing and post-closing board composition of the combined entity; thus, careful planning is required to achieve a successful de-SPAC. When de-SPAC targets are incorporated in Asian jurisdictions, planning is especially important as the typical structure used for a de-SPAC often is not permitted under applicable regulations and/or would result in significant tax liabilities.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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