In early 2021, the number of Special Purpose Acquisition Company (SPAC) transactions exploded, but by the end of the first quarter, registrations of new SPACs had slowed sharply. This has led many commentators to speculate that the market may be saturated.
SPACs, also known as “blank check companies”, have been around for decades. They are an alternative to traditional initial public offerings (IPOs). The SAVS are created with the aim of raising funds within the framework of an IPO to acquire a private operating company. Over the past year, the use of PSPCs has grown exponentially, in many cases replacing IPOs during the IPO of companies. SPAC’s sponsors range from top athletes to family offices to hedge fund managers. The risks and benefits of SPAC vary at each stage of the transaction and for each type of participant.
The three stages of a PSPC transaction
There are three key stages in a PSPC transaction: training, target identification, and target acquisition (referred to as a “de-PSPC transaction”).
At the formation stage, a sponsor, usually a proven institutional investor or a private equity fund led by a leading investor, forms a company with the intention of going public to raise funds. to the public. At the time of the IPO, the SAVS has no operating business. On the contrary, the SAVS raises funds with the intention of later acquiring an operating business. Investors look to the sponsor to select a business to acquire.
The sponsor makes a nominal capital contribution to the SAVS and receives “founder’s shares”, which are often accompanied by warrants. SPAC then launches an IPO to raise capital from public investors. Units are sold for a fixed amount (usually $ 10.00 each). The units provide investors with one share of the SAVS as well as a warrant allowing investors to purchase a fixed number of additional shares of the SAVS at a fixed price at a future date. The money raised during the IPO is placed in a trust while the sponsor locates a target company to acquire. At the end of the IPO, the founder shares held by the sponsor may represent up to twenty percent of the equity of the SPAC, despite the nominal cash contribution of the sponsor.
Following the IPO, the sponsor identifies a target to acquire. The sponsor will generally have between 18 and 24 months to deploy the capital raised during the IPO. If PSPC does not identify a target within the allotted time, PSPC must liquidate. In the event of liquidation, the limited partner loses its founding shares.
Once the target has been identified, the shareholders of the SAVS will be able to vote if they wish to acquire the target according to the proposed terms and conditions. Investors who do not approve the acquisition of Target can buy back their shares of the SPAC for a pro-rata portion of the funds held in the trust account since the initial IPO, or they can sell their shares on the market. . The announcement of the potential target for PSPC may result in the negotiation of a premium on PSPC shares; however, the reverse is also possible. Sponsors waive the right of repurchase which protects public investors. Investors who approve the acquisition can also sell their shares in the SPAC and keep the warrants. In most SPACs, if the majority of shareholders do not approve the target, the SPAC trust account is closed and the proceeds are returned to shareholders on a pro rata basis.
The last stage of the SPAC transaction is the business combination, known as the “de-SPAC” transaction. At this point, PSPC may need additional funds to acquire the target and will typically use “PIPE” (private investment in public capital) funding to raise additional funds. Once the business combination is complete, Target continues to operate, albeit now as a public company with PSPC investors as major shareholders.
Different risks and rewards for different players
A successful SAVS can result in a windfall for the sponsor, whose initial contribution can translate into a significant equity stake in the resulting public company, entitling the sponsor to a nice return for a small capital contribution. If a PSPC transaction is not completed and PSPC is liquidated, the sponsor loses their initial investment and all expenses incurred in setting up the transaction. This potential loss can create an incentive for the sponsors to complete the de-SPAC transaction regardless of the potential pool of targets available for acquisition, which could potentially lead to lower quality target choices. Public investors must remain alert to the potential financial pressure on sponsors created by this risk.
Public investors in the IPO will make a profit if the share’s value increases after the business combination. There is less profit margin for investors who buy SPAC shares at a premium after the initial IPO, but these investors still have a chance to enjoy a good return on their investment. Of course, all of these scenarios depend on the increase in the price of PSPC shares after the IPO or the initial de-PSPC transaction.
The future of PSPC
The PSPC boom has slowed in recent months, with the number of newly created PSPCs declining sharply since the start of 2021. Commentators have noted that there are only a limited number of profitable private business targets in the market. acquire, and it is not clear how many are still out there.
As a result, PSPC sponsors will likely expand their target search to companies located outside of the United States. PSPC transactions that involve international targets can trigger a host of additional legal barriers to the de-PSPC transaction, including additional tax issues. Cross-border SPACs can involve complex US tax regimes, such as the controlled foreign company rules or the passive foreign investment company rules. With careful tax planning, PSPC sponsors and investors can overcome these dangers, but the cost and complexity of PSPC transactions can increase as more of these transactions are relocated.
The future is also likely to see more PSPC litigation. The recent PSPC boom has led shareholders to file post-SPAC federal securities class actions, as well as a merger opposition litigation in state courts accusing directors of default. fiduciary duties by omitting important information about the targets or the de-PSPC transaction. At the same time, the SEC has issued a series of statements and alerts covering different parts of the life cycle of an SPAC, with warnings to sponsors about their disclosure obligations and additional warnings to investors to carefully consider their investments. investment decisions related to after-sales service.