Rehabilitating its image from shady to superlative, Special Purpose Acquisition Companies, or SPACs, have become a force in the initial public offering (IPO) market.
Speaking at the industry’s SPAC Conference 2020 in New York on Feb. 6, Mitch Nussbaum, a partner with the law firm Loeb & Loeb LLP, said SPAC IPOs are gradually ranking with traditional IPOs, as more issuers are selecting SPACs as their chosen path of going public. Doug Ellenoff, name partner of Ellenoff Grossman & Schole LLP, the leading SPAC-advising law firm per Bloomberg 2019 League Tables, declared that SPACs no longer have a bad name. He touted the prodigious pipeline of new SPACs, the features that make SPACs an attractive capital-raising vehicle, and the strong performance of technology and healthcare SPACs.
Bloomberg Law’s IPO statistics bear out those statements. Last year, SPAC IPOs raised $13.6 billion on 59 deals. That represents 23.6% of the 250 IPOs priced in 2019, and 19.4% of the $69.9 billion raised on U.S. exchanges. These investment funds have enjoyed spectacular growth in both deal count and deal value since 2012’s paltry results of $521 million raised on 10 deals.
Overall, SPAC IPOs have underperformed traditional IPOs in recent years, but large SPAC deals, as well as those in technology and healthcare, have fully tracked traditional IPO performance, according to Nussbaum.
Limited Required Disclosure to SEC
SPACs are a type of blank check or shell company. They have no active business operations but rather are looking for a business combination with a suitable target company. Money raised from investors in the IPO is held in trust until the SPAC merges with a target. At that time, an investor may stay in the deal or redeem units held for cash.
The disclosure that SPACs provide to the SEC on Form S-1 is very limited because these companies do not yet have an active business. SPACs offer investors the opportunity to invest with, and benefit from, experienced industry professionals with a history of finding attractive targets and executing those business combinations. This limited disclosure reduces SEC staff review significantly, so SPACs have the chance to go public more quickly than traditional IPOs.
An IPO With Flexible Benefits
The appeal of SPACs lies in their combinination of the benefits of an IPO and the flexibility of M&A, all at a reduced cost and in a faster timeframe. Completing the IPO before acquiring a target business also increases certainty because “you know you have sufficient capital to get the deal done,” explained Joel Rubenstein, Chair of law firm Winston & Strawn LLP’s Capital Markets Practice and a SPAC Conference panelist.
A conference panel of WithumSmith+Brown partners, a public accounting firm with a 40.7% SPAC audit adviser market share since 2012 (per Bloomberg), advised that only about two weeks of financials are needed for a SPAC IPO.
The quick going-public timeframe can be a double-edged sword, however. Some sponsors rush their SPAC to complete its IPO before they are truly ready. Going public starts the typical 24-month clock for a SPAC to find a suitable target company and complete the acquisition. Given all the private money searching for deals these days, the competition is fierce and the quality of the deals SPAC sponsors may entertain typically deteriorates as the deadline approaches. Many SPACs are forced to seek an extension beyond the 24 months disclosed in their SEC registration statement.
Tightened Nasdaq Listing Requirements Tripping Up SPACs
Further complicating life for SPAC sponsors, Nasdaq, the most popular exchange for SPACs, revised its listing requirements effective August 2019. These new criteria have proved tricky for some SPACs to meet and sometimes appear as a last-minute issue to resolve. SPAC Conference speaker Mike McCrory of I-Bankers Securities warned that more companies are receiving notice that they are not meeting listing requirements. Typically, an issuer’s underwriter syndicate will take care of this at the IPO stage, but the company will also need to prove its compliance later when they de-SPAC—that is, when they complete the merger with their target.
Nasdaq-listed companies must have at least 450 unrestricted round lot shareholders (holders of 100 shares or more) and at least half of the minimum required number of round lot holders must each hold unrestricted securities with a minimum value of $2,500. Nasdaq’s FAQ-Listings ID number 1416 advises that many SPACs at the de-SPACing stage “have difficulty verifying the number of round lot shareholders in a timely manner given the challenges involved in determining shareholder numbers generally and the additional complications that result from the ability of SPAC shareholders to redeem their holdings for cash at the time of the business combination.” Noncompliance can lead Nasdaq to initiate delisting the combined entity.
SPACs Quality Up, Opening Previously Closed Sector Opportunities
SPACs’ increase in size and credibility in the market has created opportunities in sectors previously believed unavailable to them, as a certain deal size is sometimes necessary to make the numbers work. Health sciences, REITs (real estate investment trusts), and broker-dealer SPACs are now practicable and increasingly being done.
Nussbaum cited the merger of SPAC Health Sciences Acquisitions Corporation (HSAC) with Immunovant Sciences Ltd in December 2019 as an example of a SPAC deal that would likely not have happened in years past. HSAC was one of the first institutional-backed SPACs for health sciences. The combined company has performed very well since the merger. HSAC went public in May 2019 with units priced at the standard SPAC price of $10 and completed the merger with the biotech company on Dec. 19. The stock hit a closing price high of $17.13 on Jan. 16, per Bloomberg data, an increase of 71.3%. A de-SPACing deal’s value can be measured in the bump its stock price receives over its IPO price after the deal’s announcement, and in the dearth of shareholder redemptions for cash at the time of the deal. HSAC reportedly received zero redemptions.
Success stories like the Immunovant acquisition have given rise to serial SPAC sponsors who are able to build on their past deals to finally attract fundamental and sector investors. Improvement in SPAC quality—from being largely limited to entrepreneur and promoter involvement to the participation of fundamental and institutional investors who once shunned them—is leading to higher-quality deals and a cycle of success.
Legal Issues Noted at SPAC Conference 2020
-Going offshore. Only some offshore jurisdictions are SPAC-friendly. Most of the first-tier jurisdictions have legal systems based on common law. Even in jurisdictions following British common law, there can be issues (e.g., redomestication is either difficult or impossible). Michael Killourhy, a partner with international law firm Ogier, counseled that the British Virgin Islands follows large parts of Delaware corporation law and allows redomestication. However, the U.K. Channel Islands’ capital rules can make redemptions more difficult. Advantageous tax treatment is the number one reason to go offshore.
-Litigation. There is very little litigation against SPACs at this time, but that’s likely to change should the market sour.
-RWI. Although M&A risk is different from SPAC risk at the IPO stage, SPACs’ use of M&A reps and warranties insurance is increasing in the de-SPACing phase. Due diligence is still required.
-Crossing the wall. So-called wall crossings offer a way for SPACs to speak to potential investors such as private equity and hedge funds while avoiding a Regulation FD (fair disclosure) violation. These are limited-duration confidentiality agreements that allow potential investors to “cross over the wall” for non-public discussions. At the end of the confidentiality period, investors typically disclose the deal (if there is one) and are thereby cleansed; and—typically—if there is no deal, then there is nothing to be publicly disclosed, according to Carol Anne Huff, a partner with the law firm Arnold & Porter.
-Communications. Traditional IPOs are subject to the SEC’s stringent communications rules, called “gun jumping.” SPACs receive treatment under more lenient business combination rules. Nevertheless, a SPAC must make sure legal counsel and the target are comfortable with any disclosure language. This also holds true for investor presentations. Later proxy disclosures must be consistent with those investor presentations.
Conclusion
These are heady times for SPACs, but golden ages never last. It’s uncertain beyond repricing what repercussions a sustained downturn might bring. Could monies held in trust be reachable in bankruptcy? If the securities plaintiffs bar, currently focused on traditional IPOs, moves against SPACs, what novel legal theories might they bring? More litigation would lead to more court decisions; how might those decisions affect the industry? These are questions the SPAC industry cannot yet answer.
(The analysis article has been adjusted in paragraph 18 to indicate that public disclosure is generally not required if there is no deal.)
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