Special purpose acquisition companies (SPACs) have been trending for the past few years. SPACs are companies formed for the purpose of going public under an initial public offering (IPO), with only money in its bank account without any business operations. Because it doesn’t have any business operations, it doesn’t have any audited financial statements or complicated disclosures in its business operations which would lead the Securities and Exchange Commission to have many questions during the IPO process. As such, the approval of a SPAC’s IPO can normally take as little as 8 weeks, unlike a regular business which would take six to eight months to go public. The SPAC is also known as a blank check company or a shell company.
Once a SPAC goes public, its management team starts looking for target profitable private companies who want to be publicly-traded companies. In that case, the private company can merge with the SPAC and become a publicly-traded company fast. The SPAC’s risk is relatively minimal compared to the reward because the money of the investors is placed in a interest-bearing trust account until a target company is acquired. If no acquisition is made within 2 years, the investors are entitled to a pro-rata share of the trust account.
A pro-rata share of the trust account is not normally the price one purchased the share in the open market. For example, if the SPAC share is $10 in the IPO, but one purchases the shares after the IPO in the open market at $12/share, the pro-rata share associated in the trust account is $10 per share, and not $12/share. If one bought 100 shares of the SPAC in the open market at $12/share and a business combination did not take place within 2 years, the buyer’s pro-rate share in the trust account is pegged at $10/share or $1000, and not $12/share or $1200. The SPAC IPO prospectus will give details about the terms of the trust account, and other circumstances in which cash may be released from the trust account.
Once a company is incorporated, the founders, normally called the sponsors, generally purchase equity in the SPAC at terms more favorable than investors in the IPO or subsequent investors in the open market. For example, SPAC sponsors may be able to purchase 25% of the equity offered to the public at a nominal amount of $25,000.00. Founder shares also have anti-dilution provisions which prevent their percentage ownership of the SPAC to be diluted or decreased.
The SPAC’s founders or sponsors are usually a team of institutional investors, Wall Street professionals from the world of private equity or hedge funds, or high-profile CEOs. Because the SPAC does not have any operating history, what a person is investing in a SPAC is the business background of the SPAC management and its sponsors.
The SPAC’s capital structure is composed of units, public shares, founder shares, public warrants, and founder warrants. A unit is a combination of a share and a fraction of a warrant. Only whole warrants are exercisable. A warrant is an option to purchase the SPAC’s stock at a future time (normally after the initial business combination which is the merger with the target company) at a pre-determined price (normally the warrant strike price, $11.50). Public warrants have to be cash settled (meaning, paid for in cash), while founder warrants can be net settled (meaning, the founder does not have to pay in cash but will be issued a number of shares equal to the difference between the trading price and the warrant strike price). The founder warrants are not registered at the time of IPO but subject to a registration rights agreement after the initial business combination. The warrants usually dilute any equity retained by the seller of the target business.
Public shares and founder shares, on the other hand, are similar except for the anti-dilution provisions enjoyed by founder shares. Because of this unique capital structure, the interests of the sponsors and other initial investors may be different from the interests of investors who purchased in the public market, and these sponsors will benefit more from completing an initial business combination, even if its terms are generally less favorable.
SPACs may also require additional financing to fund an initial business combination. The sponsors normally provide the additional financing in the form of convertible debt, which could dilute the public investor’s interest in the SPAC. As a result, the sponsors’ interests diverge once more from the interests of the public investors.
Once a SPAC goes public, its shares and warrants become publicly traded. The units (which are a combination of shares and a fraction of a warrant) can be separated for public trading, but only whole warrants are exercisable. It is important to remember that even if a SPAC becomes a publicly-traded company, the SPAC still does not have any operating history or assets aside from the money gathered from the IPO. Its stock price may trade higher than the initial price of $10, but it is still a shell company or a blank check company. What a person is investing in is the reputation of the sponsors and management team to acquire a profitable private company that can lead to a favorable exit strategy for the investors.
The concessions given to founder shares and warrants incentivize the sponsors to complete an initial business combination, even if such terms are not favorable. For this reason, although some high-profile SPACs have performed reasonably well, most SPAC mergers completed between 2015 to 2020 showed below-average post-market return for investors from an IPO.
Generally, corporations are formed because of their limited liability. The stockholders’ and officers’ personal assets are not liable for corporate debts. However, in cases where an officer does something illegal or grossly negligent, or is complicit in misleading the public, lying to the government, stealing corporate resources, or defrauding investors out of their money, the veil of corporate fiction may be pierced and the sponsors may face criminal or civil penalties, including jail time.
Should you feel need assistance regarding your investment in a SPAC, we, at the Law Offices of Albert Goodwin, are here for you. We have offices in New York City, Brooklyn, NY and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].
This article is for general purpose and educational purposes only and is not meant to provide legal, financial or tax advise. Please contact your attorney, accountant and financial advisor if you want specific advise about your situation.