As financial regulators increase scrutiny on special purpose acquisition companies, SPAC sponsors and their prospective targets need to be aware that the merger following the initial public offering — the de-SPAC — may be subject to the Committee on Foreign Investment in the United States' jurisdiction and may even trigger a mandatory filing, say Kirkland attorneys Ivan Schlager, Nathan Mitchell and Michelle Weinbaum in this article for Law360.
Although special purpose acquisition companies, or SPACs, have been in use for decades, there has been a striking increase in their popularity over the past year, with several hundred transactions completed since 2020.
A SPAC is a shell company that undergoes an initial public offering, followed by acquiring a target company, resulting in that target company being publicly traded — that follow-on acquisition being the de-SPAC transaction.
SPACs offer a number of advantages in quickly bringing private companies to the publicly traded market compared to the traditional IPO. But, as financial regulators increase scrutiny on SPACs, sponsors and potential targets need to be aware of the potential regulatory considerations related to the Committee on Foreign Investment in the United States.
CFIUS is a U.S. government interagency committee charged with (1) reviewing foreign acquisitions of, or investments in, U.S. businesses and (2) identifying and mitigating any risks to national security raised by those transactions. Although a U.S. company's IPO would not typically raise CFIUS considerations, de-SPAC transactions may be subject to CFIUS' jurisdiction and may even trigger a mandatory filing requirement.
Armed with an understanding of the common trigger points for CFIUS, SPAC sponsors and their prospective targets can approach de-SPACing in a way that greatly reduces their regulatory risk. We discuss the primary considerations below, highlighting a few key themes:
- Consider the ownership and governance rights of all prospective foreign investors — including the SPAC sponsors, private investment in public equity investors, and warrant holders.
- Both the SPAC sponsor and prospective target must understand whether the target business raises CFIUS considerations, particularly as they relate to mandatory filings.
- Ongoing CFIUS risk can follow target founders that will roll over their ownership into the SPAC, and, in some cases, rollovers could trigger new filing requirements.
- Because many de-SPAC transactions employ bespoke terms and elements, CFIUS risk must be considered on a transaction-by-transaction basis.
The SPAC formation alone is unlikely to raise CFIUS considerations.
The SPAC transaction itself — i.e., investment into the public shell entity that will acquire a target business — is very unlikely to raise CFIUS concerns.
For background, CFIUS has jurisdiction over a couple types of transactions, including: (1) covered control transactions, whereby a foreign person could obtain control of a U.S. business and (2) covered investment transactions, whereby a foreign person could obtain certain noncontrolling rights with respect to a subset of U.S. businesses defined as technology, infrastructure or data businesses.
The SPAC vehicle itself is a shell company and generally will not be a technology, infrastructure or data business or otherwise raise national security considerations. But SPAC sponsors — even U.S. SPAC sponsors — need to be mindful of how the SPAC is formed and whether the SPAC will be considered a foreign person by U.S. regulators when it de-SPACs.
Non-U.S. SPAC sponsors need to consider their desired post-closing rights.
In de-SPACing, sponsors often gain both voting shares in and one or more positions on the board of the post-closing public company. If any of the sponsors are non-U.S. individuals, entities or funds, their level of ownership and any special governance rights, including certain information rights or involvement in substantive decision-making, can trigger CFIUS jurisdiction over the SPAC.
Some sponsors will want to retain their full equity and board rights despite CFIUS jurisdiction and, accordingly, will need to consider whether to make a filing with CFIUS to seek approval to de-SPAC.
With an average of over 100 days between sign and close for most de-SPACings, seeking CFIUS approval is feasible and in some cases will be prudent. The sponsor should first determine whether a filing is appropriate and make any filing promptly after signing. Importantly, sponsors must keep in mind that they may need to disclose information about CFIUS jurisdiction in risk factors in their U.S. Securities and Exchange Commission filings.
If the de-SPAC involves a sensitive industry such as telecom, defense and aerospace, or artificial intelligence and machine learning, a non-U.S. sponsor may elect to proactively address CFIUS considerations raised by the transaction, such as by forgoing a post-closing board seat.
A sponsor forgoing governance rights may choose to negotiate for an attractive replacement — such as stronger minority investor protections or a more beneficial set of conditions on equity ownership, e.g., the lockup terms. Understanding regulatory risk at the outset allows a sponsor to take CFIUS consideration into account when negotiating with other investors.
Don't forget the PIPE.
Most SPACs raise money not only from the sponsors and public investors, but also from private investment in public equity. PIPE investors agree to restrictions on selling their shares until a period after closing. Investing through the PIPE has become increasingly popular, and many PIPE investors want more than sole economic benefit, also negotiating for board rights on the post-closing company.
As is the case with a non-U.S. sponsor, a non-U.S. PIPE investor can trigger CFIUS jurisdiction based on equity holdings and special governance rights, and the same considerations discussed for sponsors also apply to PIPE investors.
When it comes to the warrant, be mindful of the fine print.
In addition to equity shares, SPAC units involve the sale of warrants — i.e., the right to purchase stock at a certain price and at a certain time after the transaction takes place — often five years, in the case of a SPAC.
Because the purchase of a warrant does not afford an investor with immediate ownership in or rights over the company, CFIUS views this type of transaction differently, as a contingent equity interest. For such interests, CFIUS applies a timing rule to determine whether the purchase of the warrant would be immediately reviewable, or whether it is only subject to CFIUS' jurisdiction if and when exercised.
The timing rule bases the determination of jurisdiction on a totality of the circumstances — looking at several factors including the imminence of conversion, whether the acquiring party controls the conditions for the conversion, and whether the rights can be determined at the time the contingent equity interests are acquired.
With a SPAC warrant, there are factors that weigh both for and against a finding that CFIUS has immediate jurisdiction. For example, at the time that an investor purchases the warrant, there is no certainty that the de-SPACing will be successfully consummated. On the other hand, the interests to be acquired if or when the warrant is exercised are known with some certainty at the time of purchase.
Importantly, the conditions relating to when a warrant can or will be exercised vary from transaction to transaction. Accordingly, it is crucial to read the fine print when a non-U.S. investor is purchasing warrants, particularly when the SPAC's target company is likely to be a technology, infrastructure or data business.
It is essential to understand the potential risk raised by the target and its technology.
Although much of this discussion focuses on the acquirers, understanding the risk posed by the de-SPAC target is equally important.
First, as noted above, CFIUS only has jurisdiction over U.S. businesses. As the SPAC model rises in popularity in Asia and elsewhere, it will become more important to evaluate whether the target contains a U.S. business.
Second, in most cases in which CFIUS has jurisdiction over a de-SPACing involving a U.S. business, a filing for approval remains voluntary.
But in a small subset of transactions involving technology, infrastructure or data businesses, and particularly those that trigger the category based on their underlying technology, the de-SPAC may be subject to a mandatory filing requirement if any foreign person will gain certain new rights in or information from the post-closing company, in combination with any amount of equity — however low — as a result of the de-SPAC.
It is essential that the SPAC sponsors and the target determine whether the target is or includes a technology, infrastructure or data business in order to properly evaluate the potential CFIUS risk. Many technology, infrastructure or data business determinations will rely on an analysis of the export control classifications of the U.S. business's underlying data and technology, regardless of whether any has ever been exported.
This type of analysis can be time-consuming and will often require or benefit from the help of outside experts. Prospective target companies in discussions with a SPAC should undertake this inquiry proactively. Likewise, sponsors should diligence any target business with this threshold consideration in mind.
A founder rollover could trigger CFIUS considerations — and even a filing.
In most acquisitions by a SPAC, existing investors in the target company will roll over some of their ownership into the post-closing public company. When there is existing foreign ownership in a target company, the de-SPAC transaction can raise some important CFIUS considerations.
First, existing foreign ownership that was never reviewed by CFIUS could be subject to what is referred to as a nonnotified CFIUS review. The public nature of de-SPAC transactions, both in media reporting and in filings with the SEC, makes it much more likely that CFIUS will take notice of a transaction, especially one in a sensitive industry, and may seek to review existing foreign investments in the target that were not previously filed with it.
Historically, CFIUS' review of nonnotified transactions lagged. But CFIUS gained resources — and a mandate — under recent legislation that has caused it to begin reviewing nonnotified transactions more quickly and more aggressively. Given this, the parties to a de-SPACing will want to conduct diligence to evaluate the potential CFIUS risk raised by any continuing foreign ownership, even if the de-SPAC transaction is not a covered transaction.
Most importantly, though, existing foreign ownership raises the question of whether de-SPACing will trigger new CFIUS jurisdiction. In the traditional IPO, we tend to think of founder interests in the post-closing public company as being purely a rollover and thus not a covered transaction from CFIUS' perspective.
But depending on the de-SPACing structure, the transaction and any associated rollover could look more like the type of internal corporate reorganization that CFIUS has determined may be a covered transaction, or the de-SPACing rollover may actually result in the existing foreign owners obtaining new rights in a new legal entity — often a different legal entity from the target company — even if these new rights are not substantively different from those the existing foreign owners had in the target before de-SPACing.
In most cases, these rollover transactions in de-SPACing, if technically a CFIUS covered transaction, would be subject only to a voluntary CFIUS filing requirement and would not be expected to raise national security considerations warranting a voluntary filing.
Indeed, in guidance published by CFIUS relating to internal corporate reorganizations: "It is only in exceptional cases that a corporate reorganization would present national security considerations." But, if the target is a technology, infrastructure or data business, and especially for a technology business, the analysis changes.
Under CFIUS' rules, essentially any covered transaction involving a technology business is subject to mandatory filing even, arguably, a de-SPACing that results in the target's founders rolling over their rights into a new legal entity.
Despite the fact that, based on CFIUS' past guidance, such transactions would not necessarily be expected to present national security considerations — in the case of technology, infrastructure or data businesses, parties are not able to forgo a filing based on the transaction's risk profile.
Although arguably not in the spirit of what the CFIUS regulations were designed to pull in for review, a conservative read of the regulations reasonably could suggest that a mandatory filing requirement attaches to any de-SPACing of a technology, infrastructure or data business with a foreign rollover element.
There is a requirement to make any mandatory filing at minimum 30 days before closing, meaning that, for SPACs nearing the end of their period to consummate a de-SPAC transaction, this consideration will become increasingly relevant.
Key CFIUS Takeaways for the De-SPAC
While the SPAC frenzy continues apace, sponsors and prospective targets can manage the CFIUS considerations that arise in a few key ways.
First, all parties need to conduct diligence on the target, its technology and existing investors. Second, the sponsors need to consider risks raised by ownership and rights for any new foreign investment that will survive the de-SPACing.
Most importantly, the parties must determine — based on the specific details of each transaction — whether de-SPACing will trigger any mandatory filing requirements with CFIUS and plan appropriately.
A proactive approach by investors can protect the deal value and timing for the de-SPAC transaction.
Ivan Schlager and Nathan Mitchell are partners, and Michelle Weinbaum is an associate, at Kirkland & Ellis LLP.