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Blank-Check Sponsors Get Creative In Crowded Market

Kirkland partner Christian Nagler is quoted in this article regarding increased competition among special purpose acquisition companies (SPACs) amid the current blank-check initial public offering (IPO) boom.

As blank-check initial public offerings boom across the landscape, more issuers are introducing novel terms designed to appeal to investors and acquisition targets in hopes of standing out in an increasingly crowded market.

Blank-check IPOs, in which management teams form shell companies and raise money to acquire private businesses and take them public, have exploded to record levels in 2020. According to research firm Pitchbook, 104 blank-check IPOs have been filed through Sept. 23. Those IPOs have raised more than $35 billion so far, more than all of 2018 and 2019 combined.

Also called special purpose acquisition companies, or SPACs, blank-check companies generally have a set period of 24 months to land a merger. The year's boom in blank-check IPOs means that a bevy of acquirers are now hunting for targets and looking for an edge over their peers.

"It's a more competitive space," Kirkland & Ellis LLP partner Christian Nagler said. "We are starting to see people consider different structures."

The surge in blank-check offerings, which offer acquired companies an alternate path to public markets from traditional IPOs, coincides with widespread economic uncertainty since the coronavirus pandemic began. Companies may prefer going public through a SPAC because deal terms can be more certain. The target company negotiates directly with its acquirers rather than take its chances on a volatile IPO market, where valuations can sink on down days.

For the most part, blank-check IPOs contain predictable terms. SPACs raise money by selling units, which include common shares plus warrants, enabling shareholders to buy more shares at a fixed price. The warrants serve as additional compensation to investors, who are tying up their money in a blind pool while the blank-check company searches for an acquisition target.

Business executives who found SPACs typically get a hefty payday that entitles them to 20% of the post-merger company's shares. That aspect of the deal, called the "promote," is intended to compensate the SPAC founders for their work in landing an acquisition.

While these traditional structures remain in place for most blank-check IPOs, some issuers have begun to veer from well-worn paths in order to better entice investors or the target companies they acquire. Attorneys say competition is fueling experimentation.

"You're going to start to see differentiation in a marketplace where, for the longest time, SPACs basically copied one another," Goodwin Procter LLP partner Jocelyn Arel said. "This is the beginning of innovation, and it shows the maturation of SPACs."

Some SPACs, particularly life sciences-focused vehicles, have reduced or eliminated warrants, which can appeal to target companies who worry that shareholder warrants will dilute their stock. Other SPAC sponsors have shown willingness to negotiate their paydays in order to demonstrate to shareholders that they are committed to investors' success as well as their own.

Davis Polk & Wardwell LLP partner Derek Dostal said it's healthy that SPACs are exploring new structures, rather than sticking to one-size-fits-all designs. He noted that SPAC sponsors may need more ways besides their investment theses to stand apart from competitors.

"Fundamentally, people are looking at their structure and trying to build a better mousetrap," Dostal said. "There are a lot of smart people focused on the structure, trying to refine it, improve it, and tailor it to their particular situation."

The most conspicuous SPAC to depart from precedent was a record-breaking $4 billion IPO by Pershing Square Tontine Holdings Ltd., backed by billionaire investor Bill Ackman. Pershing Square's July IPO broke ranks from competitors in many respects, including ditching the traditional 20% promote and introducing distinct warrant features.

Attorneys say replicas of Ackman's SPAC are unlikely, given that the size of Pershing Square's offering dwarfs a typical blank-check IPO. But Sidley Austin LLP partner Josh DuClos said that market participants studied the deal, possibly looking for signs about what structures work.

"A lot of folks will get ideas from it," DuClos said. "Either directly borrowing from that, or using it as market permission to be more creative."

More blank-check firms are now including provisions meant to encourage long-term investors whose interests are more aligned with the company that the SPAC ultimately acquires.

For instance, Ackman's SPAC granted investors one-ninth of a warrant per unit and the promise of an additional two-ninths of a warrant if they do not sell their shares when a merger is announced, providing investors an incentive to commit for the long haul. The result would mean that only long-term investors would earn one-third of a warrant, a more typical figure in SPACs.

Starboard Value Acquisition Corp. has since raised a $360 million IPO this month that sold investors one-sixth of a warrant, plus a right to receive another one-sixth if they do not redeem their shares when a merger is announced. Investors have the right to redeem if they are unhappy with the deal or want to exit after a quick profit.

Hedge fund-backed Starboard Value said in regulatory filings that it crafted that structure to give investors an incentive not to redeem their shares in connection with a merger announcement.

Ackman's SPAC also ditched the typical promote where the founder receives 20% of the post-merger company's shares. Instead, Pershing Square agreed to buy up to 5.95% of the acquired company's equity if the resulting company's shares rise 20% above the IPO price.

No SPAC since Pershing Square has enacted similar terms regarding founder shares, though some companies have experimented in smaller ways. Fintech-focused Ribbit Leap Ltd. raised $350 million this month in a deal where the founders accepted 10% of the potentially merged company's shares with rights to additional shares if certain performance goals are met.

Executive Network Partnering Corp., a blank-check company backed by former U.S. House Speaker Paul Ryan that recently raised $360 million, granted sponsors 5% of shares plus the ability to acquire another 15% after the merger if the company's stock rises at least 10% from the IPO price.

Under a typical setup, SPAC founders get 20% of the acquired company's shares for a nominal fee — usually $25,000 — which can position them to make big profits even if the acquired company's stock drops. But more SPAC sponsors appear willing to negotiate these benefits, either upfront or before a merger is consummated, in order to seal a deal.

"Anything a SPAC can do to distinguish itself and make itself more attractive also improves its ability to compete for deals," WilmerHale partner Glenn Pollner said.

Some SPACs are also enacting terms to appeal to companies they acquire. Four blank-check companies, all focused in life sciences and related industries, went public this summer with no warrants. Shareholders benefit from warrants, which typically allow the holder to buy a common share for $11.50 each, because they can provide access to more shares at a low starting point.

But warrants also dilute the acquired company's stock, making them less popular with the company's management. Attorneys say the absence of warrants may not deter life sciences investors, who tend to be devoted followers of biotechnology and medical technology firms, an industry filled with early-stage companies that carry risks but offer higher growth potential.

Attorneys also say the arrival of no-warrant IPOs confirms that the SPAC universe is expanding. Blank-check sponsors have historically targeted industries with more modest growth prospects, like energy or industrials, while high-growth sectors tend to favor traditional IPOs.

"It certainly suggests that there are new investors coming into the SPAC space, who may not view warrants as being an important part of the investment equation," Pollner said. "It remains to be seen how that plays out, whether no-warrant deals get more traction, not only in life sciences but more broadly across sectors for SPACs."

Arel expects more innovation in SPACs in general, given the arrival of new market players to the scene, including Silicon Valley venture capital veterans focused on startup technology firms.

Social Capital Hedosophia, a partnership between Silicon Valley venture capital firm Social Capital and London investment firm Hedosophia, has formed six IPOs, including five this year. Social Capital's first two vehicles have already completed acquisitions, including aerospace company Virgin Galactic and online marketplace Opendoor, while four more are searching.

"You are seeing not only the hedge funds and private equity, but now you're seeing traditional Silicon Valley and VC players coming into this space," Arel said. "Each of them philosophically is different in terms of their investment approach."

Social Capital's three most recent-blank check IPOs, filed on Sept. 18, anticipate raising a combined $2 billion. Each IPO offered investors one-fourth of a warrant per unit, less than the one-third or one-half of a warrant structures common in many blank-check IPOs.

Looking ahead, DuClos said market participants will have better insight on which if any of novel SPAC structures gain traction within two years as acquisition deadlines for most of the recent blank-check sponsors expire. He said the quality of SPAC sponsors remains the key predictor of success, as the market gravitates toward management teams with proven pedigrees.

White & Case LLP partner Joel Rubinstein said he expects many blank-check teams will continue to use traditional structures, which can accommodate the needs of most parties. But he noted that growing the SPAC market is also proving flexible enough to allow for new ideas.

"Innovation in the product is definitely healthy," Rubinstein said. "It is important that people continue to think and evolve. And I think that's what's giving SPACs a lot of staying power."