Despite a generally weak market for initial public offerings (IPOs), the market for special-purpose acquisition company (SPAC) offerings has continued to be robust . SPACs raised over $3.7 billion in the U.S. markets in 2016 (including the largest SPAC IPO since 2008).
SPACs raise funds through an IPO and, in turn, seek to acquire one or more businesses in the future, resulting in a publicly traded vehicle with capital available to seek business combinations. A SPAC is typically marketed to focus on potential acquisitions in a particular industry or geography, although at the time of the IPO a SPAC will not have identified a particular target. A SPAC normally offers units comprised of shares of common stock and a warrant to purchase common stock with a strike price higher than the offering price of the unit. In recent deals the unit consisted of a share of common stock and a warrant to purchase one-half or one-third of one share of common stock. Typically, 52 days following the pricing of the IPO, holders can separate the units into the underlying common stock and warrants, allowing the warrants and common stock to trade separately. Almost all the funds raised by the SPAC in the IPO are placed in an interest-bearing trust account that cannot be disbursed other than (1) for the closing of an acquisition or (2) to redeem shares that investors have elected to have redeemed upon an acquisition or extension of the life of the SPAC. A SPAC typically has two years beginning on the IPO pricing date to consummate an initial business combination before its formation documents require the SPAC to liquidate and return the funds in the trust account to investors.
In addition to the strong SPAC IPO market, a number of SPAC initial business combinations (often referred to as de-SPACing) took place in 2016 covering a variety of industries, including chemicals, snacks, transportation and media. Notable SPACs that de-SPACed in 2016 include WL Ross Acquisition Corp, Gores Holdings Inc., Hennessey Capital Corp. and Silver Run Acquisition Corp. Two of these are described below: Gores’ acquisition of Hostess Brands Inc. from funds advised by Apollo Global Management, and Silver Run’s acquisition of Centennial Resources Production LLC from funds controlled by and affiliates of NGP Energy Capital Management, L.L.C.
On July 5, 2016, Gores announced it had signed an agreement with Apollo to acquire Hostess, a leading national bakery company with a nearly 100-year history famous for making, among other products, Twinkies. In addition to the approximately $375 million raised in Gores’ IPO and on deposit in the trust account, the transaction included an additional private investment in public equity (PIPE) through a $350 million private placement. At the time of the announcement, the transaction was the year’s largest food and beverage mergers and acquisitions transaction in North America. In the de-SPACing transaction, the sponsor of the SPAC agreed to forfeit 48.67 percent (4,562,500) of its 9,375,000 founder shares by transferring (1) 3,125,000 shares to PIPE investors as a subsidy to their investment, (2) 937,500 shares to Apollo, and (3) 500,000 shares to the new executive chairman of Hostess. The market’s reaction to the transaction was overwhelmingly positive: over 80 percent of the outstanding shares approved the transaction, no shareholders exercised redemption rights, and the shares traded up 33 percent between signing and the end of the year. Upon consummation on Nov. 4, 2016, pre-transaction SPAC investors owned approximately 29 percent of the company. The sponsor and the sellers agreed to a lockup of six months from completion of the transaction.
On July 22, 2016, Silver Run announced an agreement to acquire approximately 89 percent of the outstanding membership interests in Centennial, an oil and natural gas company. The deal was structured with an $810 million PIPE investment from affiliates of the sponsor, Riverstone Holdings, LLC and a $200 million committed PIPE from outside investors to backstop any redemptions. The sponsor was not required to alter its economics in connection with the transaction. The market’s reaction was also overwhelmingly positive: over 99 percent of outstanding shares approved the transaction, no shareholders exercised redemption rights (and thus the $200 million committed PIPE was not drawn), and the shares traded up 102 percent between signing and the end of the year. Upon consummation on Oct. 11, 2016, pre-transaction SPAC investors owned approximately 27 percent of the company.
Deal Structure and Process
Initial Public Offering
A sponsor typically forms the SPAC entity prior to making an initial filing of a registration statement — usually on Form S-1. A SPAC is most often sponsored by either (1) well-known professionals in the specific industry or geography of focus for the SPAC or (2) private equity funds seeking acquisitions outside the focus of their general funds.
The registration statement for a SPAC follows the same form requirements as any other IPO. However, since the SPAC has no operations to describe, the disclosure is relatively simple. The registration statement includes current financial information of the SPAC, including audited financial statements, and a detailed description of the SPAC structure. In addition, although the SPAC will not have identified a target, the registration statement will describe the expertise of the sponsor and generally describe the industry or geography on which the SPAC will focus.
Upon consummation of an IPO, the typical capitalization of a SPAC is as follows:
Twenty percent of the outstanding shares are issued for a nominal amount to the sponsor(s) in what is referred to as the “sponsor promote” or the “founders shares.”
Eighty percent of the outstanding shares are issued to the public in the IPO as part of a unit that also contains a warrant. The proceeds of the IPO, after paying part of the underwriting discount and other expenses, are placed in a trust account. The remaining part of the underwriting discount is only paid upon the consummation of an initial business combination.
The sponsor also purchases warrants to fund the difference between the offering price to the public and the commissions and expenses paid by the SPAC such that there are enough funds in the trust to repurchase shares at the offering price of a unit upon redemption. The proceeds received by the SPAC from the privately placed warrants are referred to as the sponsor’s “at-risk capital” because upon a liquidation, these amounts are paid out to the public shareholders and the warrants purchased would not have any value and would not receive any distributions.
After the IPO, the SPAC is typically listed on the Nasdaq Stock Market and management of the SPAC turns its attention to seeking an existing business to acquire in the SPAC’s initial business combination. Management of the SPAC is typically a group of people affiliated with or on loan from the sponsor who dedicate part of their time to seeking an initial business combination The initial business combination must occur with one or more target businesses that together have an aggregate fair market value of at least 80 percent of the assets held in the trust account (excluding the deferred underwriting commissions and taxes payable on the interest income earned on the trust account) at the time of the definitive transaction agreement.
After signing a definitive agreement for the initial business combination, the SPAC must either (1) seek stockholder approval of the initial business combination at a meeting called for such purpose in connection with which stockholders may seek to have their shares redeemed (regardless of whether they vote for or against the initial business combination) or (2) provide stockholders with the opportunity to sell their public shares to the SPAC by means of a tender offer. Whether through redemption or a tender offer, the price paid for the shares is an amount in cash equal to the holder’s pro rata share of the aggregate amount then on deposit in the trust account, including interest but less taxes payable and amounts permitted to be withdrawn for working capital purposes. Many SPACs restrict holders (together with others they are acting in concert with) from redeeming more than a certain percentage — generally 10 percent to 15 percent — of the outstanding public shares in order to discourage holders from accumulating large blocks of shares. This is often referred to as the “Bulldog provision” (named after an activist investment fund that in 2008 accumulated a large stake in TM Entertainment and Media, a SPAC, and filed a proxy statement to replace the board of directors and force an early liquidation of the SPAC).
The choice to seek stockholder approval of the initial business combination or to conduct a tender offer for its shares is in the discretion of the SPAC, generally in consultation with the counterparties to the business combination. The decision is based on a variety of factors, including whether the transaction otherwise requires approval of the SPAC’s stockholders (such as authorization to amend the formation documents or to issue 20 percent or more of the outstanding shares) and the timing of the transaction. In addition, a business combination is often structured to supplement the trust account (or to backstop any redemptions) through issuance of new equity in the combined company at closing through a PIPE investment. The PIPE, the terms of which may vary widely, may be committed at signing or be marketed to potential PIPE investors between signing and closing. The transactions also often include committed debt financing, either to refinance existing debt of the target company subject to acceleration upon the completion of the transaction or as consideration to purchase the target company. The process from signing to closing typically takes two to five months, depending on the stockholder and regulatory approvals necessary to complete the transaction.
If the SPAC submits the combination to a shareholder vote, it will typically prepare and file a proxy statement with the U.S. Securities and Exchange Commission on Schedule 14A to be mailed to shareholders. The SPAC proxy contains all the information that is typical for a large merger, including the target’s current and historical audited and interim financial statements as well as other detailed disclosure about the target company or companies. Often, targets in initial business combinations are not reporting companies or otherwise regularly preparing financial statements that meet SEC filing requirements. In that case, preparing the information can be a significant impediment to timely filing the proxy statement, which affects the timing of closing the transaction. The proxy will also contain a complete description of the post-transaction company and its management, directors, governance structure and material contracts (including debt financing agreements related to the de-SPACing transaction). If the transaction structure contemplates an entity other than the SPAC as the surviving public company, the proxy could be combined with a prospectus and filed as a registration statement on Form S-4 to register new shares in the surviving company. The proxy is also used to offer the shareholders their redemption rights pursuant to the SPAC’s charter documents.
If the business combination contemplates a tender offer in lieu of a proxy/redemption, the SPAC will prepare a Schedule TO, which includes a similar level of disclosure about the target company or companies and the terms of the transaction as the proxy.
Pursuant to its formation documents, if a SPAC is unable to complete the initial business combination within a set time period (usually 24 months from the IPO closing date), the SPAC will (1) cease all operations except for the purpose of winding up, (2) redeem the then-outstanding public shares for cash at a per-share price equal to the aggregate amount then on deposit in the trust account, including any earned interest, divided by the number of then-outstanding public shares, and (3) as promptly as reasonably possible following such redemption, dissolve and liquidate, subject in each case to the SPAC’s obligations under applicable law, including to provide for claims of creditors. A SPAC can also seek to have the initial time period to seek a business combination extended, so long as it concurrently offers holders of the outstanding public shares the redemption rights they would have upon liquidation. The SPAC’s officers and directors waive their rights to liquidating distributions from the trust account with respect to any shares held by them prior to the IPO, but not with respect to any public shares they acquire in or following the IPO.
Other Key Market Trends
An interesting development in 2016 was the $600 million IPO of CF Corp., the largest U.S. SPAC since 2008. In connection with the IPO, certain institutional and accredited investors entered into forward purchase agreements with CF under which they committed to invest an additional $510 million in the form of equity to finance an initial business combination and were granted some of its founder shares. The additional committed capital available to CF from these forward purchase arrangements provides committed equity financing for the life of the SPAC, allowing increased flexibility to the SPAC in terms of structuring an initial business combination. The capital also may alleviate the pressure to find anchor PIPE investors, which many SPACs face in negotiating an initial business combination. Other developments in the SPAC market include the 2016 IPO of Mediawan SA, the first French listing of a SPAC, targeting the media and entertainment industries in Europe.
SPACs continue to be an attractive vehicle for raising capital and an efficient pathway for privately held businesses to become publicly traded on an expedited timeline compared to a traditional IPO, diverting less of management’s time to the transaction process and allowing management to focus on running the business. Market interest remains strong, both in new SPAC IPOs and in de-SPACing transactions. Already in 2017, four SPAC IPOs have raised over $1.7 billion and at least four more have publicly filed with the SEC since the beginning of the fourth quarter of 2016. In addition, at least three SPACs have announced de-SPACing transactions since the beginning of the year. These trends are expected to continue.
Christian O. Nagler and David A. Curtiss are partners in the New York office of Kirkland & Ellis LLP.
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