SPACS: A Path to Public Ownership
Pitfalls to avoid for Special Purpose Acquisition Corporations.
Over the past few years, the “Special Purpose Acquisition Corporation” — or SPAC — has reemerged as a popular acquisition vehicle. With approximately $6.5 billion raised by SPAC’s over the past 18 months, these corporate structures are increasingly relevant for private companies. Officers and directors should be familiar with the potential strategic options that SPACs can offer.
In addition to a unique source of private capital, SPACs can be a resource of expertise and talent to management and the board. But, as with any potentially transformative transaction, there are pitfalls to avoid, particularly for private companies as they undertake negotiations and adjust to a new corporate structure. Thus, it pays to evaluate SPACs and identify the opportunities while managing the potential risks.
What is a SPAC?
Often known as a “blank check” company, a SPAC raises money through an initial public offering in which shares in the SPAC are sold to the public. SPAC management teams — known as sponsors — are required to complete an acquisition, or other business combination, with the proceeds within two years of the IPO. If sponsors cannot find an appropriate target company and consummate a transaction within that two-year period, they generally must return the principal to the shareholders and dissolve the SPAC.
Although the SPAC usually focuses on a limited range of industries within a specific geography, it generally reserves the right to invest in any industry sector or geographic region that it chooses.
There are a number of unique features of the SPAC which can make it an interesting funding vehicle or exit strategy for owners of private companies. In particular, after a reverse merger into a SPAC, a private company gains immediate status as a publicly traded corporation.
Importantly, a SPAC need not purchase a controlling interest in the target company. This feature allows the SPAC flexibility to raise additional capital and to incur debt to finance acquisitions. As a result, SPACs are able to make investments that are far larger than their IPO proceeds alone would allow. For example, our own $150 million SPAC can finance transactions with companies valued as much as $500 million to $1 billion.
Evolution of the SPAC
When the first SPACs were created in the early 1990s, they were an obscure, somewhat dubious funding vehicle. Since then, however, the quality of the deal sponsors has significantly improved and the average size of the offerings has increased dramatically. Today, SPACs are an accepted institutional investment class. Many are sponsored by leading investment firms, underwritten by leading investment banks, and purchased by well-respected institutional investors.
With these changes, SPACs are now considered respectable merger partners and well-established companies have completed a wide range of successful combinations with them. Just in the last few months, major names in the private equity and investment business, such as The Gores Group, Riverstone Holdings, and WL Ross & Co. have sponsored SPACs. Some of their acquisitions have included Hostess Brands at a $2.3 billion enterprise value; Centennial Resource Production, an independent oil and natural gas company, at a $1.735 billion enterprise value; and Nexeo Solutions Holdings, plastic resins and chemicals distributor, at a $1.6 billion enterprise value. Other SPACs, such as FinTech Holdings, Terrapin 3, and Hennessy Capital II also have recently announced or closed merger transactions.
Opportunities and Advantages
Although SPACs have now entered the mainstream, they are not particularly well-understood outside of the investment community. Today, SPACs offer an efficient alternative to the traditional IPO and a viable alternative to private equity firms, which are typically looking for an exit after a few years. Among the key benefits of merging with a SPAC are:
· Public Listing. They offer a relatively easy path to a public listing, without market or pricing risks. With public equity, companies can offer more attractive compensation packages to key employees and a valuable non-cash currency for financing acquisitions.
· Capital Source. They can provide equity capital for growth or investment without the debt service costs, amortization and covenants inherent in debt capital. They also provide permanent capital, allowing management to focus on long-term value creation, rather than the short-term growth often needed to meet the return hurdles demanded by private equity firms.
· No Unexpected Liabilities. Because the SPAC has not conducted any material business and has a clean balance sheet, the shareholders of the target company typically face no unexpected liabilities after the deal closes.
· Flexible Ownership and Control. There is no need for SPACs to take control of the target or to displace existing management. For example, we have seen SPAC transactions ranging from a 100% acquisition of the target company to the SPAC investors coming in as a partner to provide partial liquidity and/or growth capital to the existing management/ownership.
· Sponsor Expertise. A SPAC sponsor can provide specialized expertise to supplement the skills of the existing management team.
Issues to Consider, Questions to Ask
Along with the unique benefits that come from a transaction with a SPAC, there are also some unique costs and risks that must be taken into account. Most notably, SPAC investors have the right to redeem their equity at the time of the initial business combination if they do not want to continue their ownership through the merger. If the sponsor is unable to attract new investors to replace that capital, then redemptions will decrease the amount of cash available for the transaction and, if too much cash cannot be replaced, make the transaction unworkable.
Thus, the opportunities that SPACs represent come with a number of issues that private company officers and directors need to consider carefully. Most importantly, companies need to get to know the team that makes up a SPAC sponsor. Look for skills and personalities that are complementary to the needs of the company. In particular, seek professionals with extensive capital markets, management and board experience to support the acquired company as it adapts to the public markets. In addition, an experienced sponsor team can provide strategic and operational support to management, helping fill gaps and broadening talent across the organization.
Management is more likely to receive valuable support from sponsors when they sell to those who specialize in the target company’s industry sector. With industry specialization comes expertise in identifying trapped value in companies and helping to execute strategies that will fully realize that value. While SPACs are not required to adopt an industry focus, most are active in a single or a limited number of sectors.
The extent to which sponsors exercise control is a critical question. SPACs that seek 100% equity in the target company, may not be ideal long-term partners. In our experience, the most successful combinations align the interests of existing owners and management teams with the sponsors’ as well as their investors. Indeed, many sponsors, including our own, prefer that companies retain significant ownership.
A Viable Vehicle
Clearly, a merger with a SPAC is not risk fee, but with the right due diligence, companies can avoid costly errors. Although a merger with a SPAC is not the right answer for every company or every situation, a well-negotiated transaction with the right sponsor can deliver multiple advantages. After 25 years of development and maturation, SPACs have proven to be a viable acquisition vehicle, providing a public listing, access to capital, and support from industry and financial market experts. For private companies in the current environment, SPACs represent a strategic opportunity that boards and their management teams would be remiss to ignore.
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