For business owners considering selling their businesses—particularly for larger middle-market businesses that have considered going public as a potential exit—selling to a special purpose acquisition companies (SPAC) can be an elegant and profitable solution, albeit an expensive and complex one.
Privately held businesses must evaluate the significant differences between an IPO, a private sale, and a sale to a SPAC before navigating this new terrain.
How SPAC Deals Work
An SPAC is a publicly traded shell company that does not operate a business. After fundraising through an IPO, the SPAC seeks to acquire a privately held target company (a “de-SPAC transaction”). As part of the IPO, shareholders typically receive a warrant with a strike price of 115% of the purchase price for each share purchased in the IPO.
The parties behind the SPAC are its “sponsor.” The sponsors’ identities and connections have attracted outsized attention and are an important factor for the SPAC’s fundraising prowess. The sponsor generally ends up with 20% of the SPAC as part of the IPO, and a varying number of warrants.
If the SPAC fails to consummate a de-SPAC transaction by the deadline (typically 18 months to 24 months), the SPAC is unwound and the escrowed funds are returned to SPAC shareholders. However, if the SPAC reaches an agreement with a target on a de-SPAC transaction, the SPAC shareholders must approve the de-SPAC transaction. Objecting shareholders can redeem their investment instead of holding stock in the survivor of the de-SPAC transaction.
If too many shareholders ask for their investments to be returned, the SPAC will not have enough capital to complete the de-SPAC transaction. To counter this risk and to allow the SPAC to acquire larger targets, SPAC sponsors frequently seek private investments from institutional investors, including from mutual funds and asset managers.
These investments are called “private investment in public equity” (PIPE investments). Indeed, for SPACs, PIPE investments have become a significantly larger source of funds than the IPO. PIPE investments add certainty to the deal, since PIPE investors are typically brought in once the de-SPAC transaction target is selected and the acquisition price is determined.
SPACs Are Hunting for Deals
With more than 400 SPACs already formed and hunting for deals in the next two years, a lot of new capital is out there. SPAC sponsors make money only if they close a de-SPAC transaction. Without a closing, they bear the organizational expenses and lost time, so sponsors are motivated buyers and proposed acquisition valuations can be impressive.
Further, many SPACs are listed on the NYSE or Nasdaq and have strong ties to PIPE investors. Such connections with well-known institutional PIPE investors and the sponsors’ reputation SPACs may attract better analyst coverage than a middle-market company going public on its own.
To be sure, the target pays a premium for that analyst coverage. But for targets already weighing an onerous IPO, the equity, costs, and fees paid to a SPAC sponsor may be money well spent.
Finally, because de-SPAC transaction typically allows the SPAC to use forecasts and financial projections—which are generally prohibited in an IPO because of the unavailability of regulatory safe harbor—a business that anticipates strong growth in the next five years can attract a tempting higher valuation. This area has drawn particular attention from the SEC recently.
Disadvantages: Expense, Management Changes
That said, there are formidable disadvantages to de-SPAC transactions. To start, a de-SPAC transaction is unusually expensive. Not only does the sponsor frequently end up with more than 20% of the target’s equity as a fee, but PIPE investors can get preferred pricing on their investment. The sponsor, PIPE investors, and IPO investors can also receive warrants, which further dilutes the roll-over equity of the target’s owners.
Additionally, professional fees for the de-SPAC transaction and for on-going operations can be substantially higher than privately held companies are accustomed to paying.
In addition, running a publicly traded company can be shockingly different for the management team, and it demands different skills. The target must typically ramp up management and reporting functions, add personnel for SEC reporting and investor relations, and bolster IT and accounting functions.
Likewise, most private company management teams have limited experience as public company officers. The board of directors must be reinvented, and an audit committee (and, depending on the exchange, possibly nominating and compensation committees) must be added or supplemented. And for a privately held entity that is accustomed to limited disclosure, public company disclosure requirements (and limits) can be jarring.
Fundamentally, it might be difficult for the target’s owners to achieve a significant exit because much of their equity is rolled over and is subject to a post-transaction holding period. Thus, for the target, a de-SPAC transaction may be a better vehicle to raise capital than to sell a business—despite the attractive valuation the target may receive. Indeed, the de-SPAC transaction is closer to an IPO than an M&A exit.
As well, for the target’s ownership group, the volatility of instant public market valuation can be unsettling, because it will represent a significant portion of the consideration that the sellers receive from the de-SPAC transaction.
Stepping back, given the high number of already-formed SPACs pursuing targets, we anticipate that a number of thriving middle-market companies will receive offers for de-SPAC transactions at attractive valuations.
For companies that were already considering an IPO or anticipating robust growth in the future, a de-SPAC transaction might make sense. But for private companies looking for a clean exit, a de-SPAC transaction is likely not the best answer.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Kristen A. Baracy, counsel in the Los Angeles office of Tucker Ellis LLP, has represented both privately held and public companies in connection with offerings of securities, compliance with federal and state securities laws, mergers and acquisitions, and general corporate governance matters.
Joseph Casavecchia, an associate in the Cleveland office of Tucker Ellis LLP, provides support across the firm’s spectrum of transactional practices, including corporate, mergers and acquisitions, and real estate.
Tod Northman is a partner at Tucker Ellis LLP in Cleveland with more than 25 years of experience in corporate organization and governance, business transactions, artificial intelligence technology, contract negotiation and dispute resolution.