A court ruling Wednesday bolstered research that argues the true worth of blank-check company mergers is often far below the typical $10-a-share valuation.
The Delaware Chancery Court ruling found that the GigCapital3 Inc. special purpose acquisition company must face claims that public shareholders were denied crucial information, including how much money shares were worth in the purchase of an electric vehicle manufacturer.
The GigCapital3 SPAC shareholders couldn’t make an informed decision on whether to cash out shares or participate in its purchase of Lightning eMotors, court Vice Chancellor Lori Will ruled.
The ruling adds to legal problems facing SPACs and their sponsors, who earn huge payouts when blank-check companies complete mergers.
Stanford Law Professor Michael Klausner developed a financial model that argues the true value of SPAC shares are much lower than $10-a-share. He brought the court case in August 2021 against GigCapital3 alongside lawyers from Grant & Eisenhofer. The suit was a rare move for a self-described “obscure academic.”
In the Gig3 case, the sponsor’s initial $25,000 investment had an implied market value at the time of the merger worth $39 million—a 155,900% return, Klausner argued. Sponsors only earn those returns when a deal is completed.
Will’s ruling accepted Klausner’s calculations. Part of the information GigCapital3 shareholders didn’t receive was that the shares the SPAC used to purchase Lightning eMotors were worth around $5.25 per share—not $10, according to Will.
“If Gig3 had less than $6 per share to contribute to the merger, the proxy’s statement that Gig3 shares were worth $10 each was false—or at least materially misleading,” she wrote. “Moreover, Gig3 stockholders could not logically expect to receive $10 per share of value in exchange.”
When a SPAC announces a merger, shareholders have the option to cash out their shares at the original value plus some interest or let their shares be converted into ownership of the new company.
The defendants in the Gig3 case argued that shareholder approval of the merger—which was 98% in favor of the deal—meant it should not be subject to Delaware’s “entire fairness” review. That is the strictest level of review, and courts judge the process and results of the transaction to determine if they were fair to the corporation and its shareholders.
Will ruled that the entire fairness burden of review would be applied, finding that the economic incentives of the SPAC structure rendered the vote “of no real consequence.”
“Public stockholders had no reason to vote against a bad deal because they could redeem,” Will wrote. “Moreover, redeeming stockholders remained incentivized to vote in favor of a deal—regardless of its merits—to preserve the value of the warrants included in SPAC IPO units.”
Michael Barry, a Grant & Eisenhofer principal who represented the plaintiffs, said the decision reaffirms that SPAC sponsors need to fully disclose the actual economics of the transaction they’re proposing.
“Professor Klausner’s research is very important and was acknowledged as such,” Barry said in an interview.
John Reed, a DLA Piper partner who represented GigCapital 3, did not immediately respond to a request for comment.
The case is now set for discovery and headed for a trial. The suit seeks to claw back millions for shareholders who stayed invested through the merger.
Klausner’s research paper, “A Sober Look at SPACs,” has been downloaded nearly 40,000 times since it was first published in 2020. It has been used to bring at least two other lawsuits against SPACs in Delaware.
But his research argued that the problem of diluted SPAC shares is almost endemic to the business model. For SPACs that merged between September and November last year, he estimates the net cash per share was worth around $6.40.
Klausner said the case is the first to recognize that “the basic structure of SPACs” dilutes the value of shares.
The effect of the ruling, he said, is that SPACs should disclose the amount of cash they hold per share. The U.S. Securities and Exchanges Commission noted Klausner’s research on dilution in its rules proposal last year, which has already been part of a severe decline in the number of new SPACs.
“Hopefully, the SEC will see what Vice Chancellor Will saw in the SPAC structure,” Klausner said.