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ANALYSIS: SPAC Deal Terms & IPO Market Are Changing Fast

Aug. 6, 2020, 8:18 AM

The red-hot SPAC market has been making deal terms easier for SPAC sponsors—and life harder for the traditional IPO market. Bloomberg Law has conducted a review of various SPAC offering documents filed with the Securities and Exchange Commission as well as news reports and market data. Our review found that terms that were standard equipment for SPACs only months ago, such as a unit price of $10 and units consisting of both common shares and warrants, now are optional.

The recent success of the $4 billion Pershing Square Tontine SPAC offering broke not only the record for the largest SPAC IPO in history, but also many longstanding SPAC deal term conventions. Those changes are likely to reverberate and inspire emulators for years to come.

The (Deal) Terms, They Are A-Changin’

Strong investor appetite for SPAC IPOs is allowing their sponsors to offer less of a premium compared to traditional IPOs. As observed in the June 8 SPAC Research newsletter, institutional investors are increasingly being joined by retail investors who may not fully understand the complexities of what they are buying. However, the market is hot, and some ordinary investors and day traders appear willing to risk trying to ride that momentum.

To entice investors to hand over their money for some unknown future acquisition two or three years down the line, SPACs have had to offer more. Rather than merely purchasing shares of common stock, SPAC IPO investors buy “units” that consist of one share of the company’s common stock and up to one whole warrant to purchase one share of common stock.

As recently as 2018, SPACs were typically offering investors one common share plus one-half to one full warrant. Sometimes, SPACs offered an additional inducement, such as a larger fractional warrant if a business combination was not consummated within a specified period of time.

Fast-forward to mid-2020, and the fractional size of warrants offered in units has dropped considerably. The record-busting Pershing Square Tontine SPAC IPO only offered one-ninth of a redeemable warrant to unit buyers. GS Acquisition Holdings Corp II, a recently completed SPAC IPO sponsored by Goldman Sachs, reduced the fractional warrants offered with its units from one-third to one-fourth of a warrant before the IPO priced.

Most significantly in the recent history of SPAC IPOs, Therapeutics Acquisition closed its IPO on July 10 after completely eliminating its planned one-third redeemable warrant, upsizing its offering, and, with underwriters maxing out their over-allotment option. The strength of the SPAC market appears unprecedented.

SPAC IPOs have long been closely associated with offering a combination of shares and warrants bundled as units. The Therapeutics Acquisition IPO has become the first SPAC to complete its IPO by selling only common shares—no warrants. Without warrants, SPAC IPOs move an important step closer to level with traditional IPOs.

Bill Ackman’s SPAC Goes Big, Breaks Mold

Breaking the rules and breaking records, Bill Ackman’s hedge fund took his Pershing Square Tontine Holdings SPAC public in mid-July for a record-shattering $4 billion plus. His goal for the SPAC—to acquire a mature unicorn target—is a lofty one, so he built his SPAC to have a war chest commensurate with the challenge.

The basic offering is for each public unit purchased, the subscriber gets one share, one-ninth of a warrant to purchase one share of common stock, and a contingent right to receive additional warrants. It gets more complicated from there, but here are some of Pershing Square Tontine’s less-than-typical offering terms:

No Industry Sector Identified. A SPAC typically tells prospective investors the type of business it seeks, such as technology or biotech. The sector generally matches the expertise of management. Here, the SPAC simply says that it is seeking a private firm with the right growth profile. Pre-IPO, if a SPAC had already chosen the target for its business combination, that would trigger significant SEC disclosure obligations any SPAC would be eager to avoid.

Unit Price Doubled. The $10 unit price has been a constant across SPAC offerings regardless of the sector targeted or capital-raising ambitions. Even Churchill Capital Corp III, the previous record SPAC capital-raiser at $1B, priced its offering at $10 a unit. Pershing Square blows up this convention by doubling the price to $20 per unit. All the normal trigger prices are similarly doubled as to warrants and the crescent term, explained below.

Sponsors’ Profits Tied to Public Investors’ Fortunes. Sponsors won’t make money unless public unit investors make money.

No Founder Shares. Usually, founders get a 20% stake in the company, causing significant dilution for other shareholders. Pershing Square will instead purchase warrants at fair market value.

20% Voting Power. Despite forgoing the usual Founder Shares, Pershing Square will nevertheless be able to exercise 20% voting power by virtue of holding 100 shares of Class B common shares. Publicly traded shares are Class A.

Three-Year Wait to Exercise Sponsor Warrants. Pershing Square may only exercise its warrants three years after a business combination at a 20% premium. This feature helps ensure the alignment of sponsor and investor interests since the value of the merged company must increase substantially for those sponsor-held warrants to be “in-the-money” (i.e., the cost to exercise the warrants is below the traded stock price).

Minority Stake in Target. Bill Ackman has said the SPAC will seek a roughly 20%-30% minority stake in a target that is a private company valued at least $10 billion (a mature unicorn). This is unusual, as SPACs typically take either a majority stake or a more significant minority stake in a target.

Two Forward Purchase Agreements and a Director Forward Purchase Agreement. The agreement with independent outside directors to purchase $6M worth of units is unusual. Forward purchase agreements that are entered into before the IPO are designed to reduce the uncertainty that a SPAC might have insufficient assets to complete a deal with a target should too many SPAC shareholders redeem their shares. These forward purchase agreements are between the SPAC and its founders. They address the risk that redemptions could blow up the business combination by obligating the founders to purchase additional units if additional capital is required to complete the deal. Pershing Square Tontine has two forward purchases that raise the total potential capital by $3 billion over and above the $4 billion raised by the IPO.

Non-Detachable Warrants (Redeemers Punished). Warrants are usually detachable from common shares, an important benefit to investors who redeem their shares prior to the business combination. Here, the offered warrants are non-detachable. Redeemers lose not only their shares but also two-thirds of the warrants received.

Tontine Structure (Survivors Rewarded). Non-redeeming investors will be rewarded by sharing in warrants forfeited by redeeming investors.

Crescent Term. The offering includes a Crescent Term, so named after the SPAC that originated it, Crescent Acquisition Corp. This provision adjusts the warrants’ exercise price if the SPAC’s issuing equity in the de-SPACing business combination falls materially below the per-unit-at-IPO offering price.

Conclusion

SPACs are moving toward cleaner deal terms similar to those in traditional IPOs. These two IPO types are also converging on average deal size, share price performance after going public, and the quality of their professional representation throughout the IPO process. Investors have taken note.

The doubled unit price by Pershing Square Tontine may create something of a race for SPACs to get bigger to capture bigger, more attractive targets such as mature unicorns that have stayed private. Larger offerings get investor attention, as do large business combinations with well-known private startup companies.

This was likewise the case when the Powerball multistate lottery doubled its ticket price from $1 to $2 to more quickly increase its jackpots. The eye-popping jackpots are what really drives its ticket sales. Competitor MegaMillions found it had little choice but to follow suit with the price increase or be left behind. It may not be long before SPAC offerings with $20 unit prices become the norm, as well.

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