A Quick Introduction to SPACs

By Gabriel J. Kurcab, Attorney at Law, Katz Teller

The last two years have brought big challenges and big opportunities to businesses—and to mergers & acquisitions. With Wall Street and Main Street adjusting to the (not-quite-post) Covid landscape, the economy has seen inflation, supply and demand shocks, and all-time highs on public equity indices. And in that uncertain climate, Special Purchase Acquisition Companies (SPACs), which are publicly traded companies created for the purpose of acquiring or merging with an existing company, have been enjoying time in the spotlight.

SPACs have existed for decades. But in different economic climates, they failed to capture the imagination of investors and the attention of business owners. We can’t cover in this column the many reasons SPACs have flourished in the last two years—and different theories abound. Some say it’s the low interest rate environment, stimulating a raw hunger for new investment opportunities. Others point at the simplicity of a SPAC transaction compared to the complexity of the initial public offering (IPO) process that, although once the standard path to riches for fast-growing private companies, has been conspicuously avoided by plenty of companies in recent years.

Whatever the true justification for the growth in SPACs—and despite the fact that the market for many SPACs has shown signs of softening—SPACs (much like a certain virus) appear to be here to stay. As such, the structure and process are worth understanding. SPACs can usually offer top-dollar for their targets, but as we will see, the headline valuation must be kept in perspective in light of some of the unique risks for sellers in a SPAC deal.

To create a SPAC, a sponsor forms a new corporation without assets or operations and takes the corporation public in an IPO. The IPO process is comparatively easy for a SPAC because the SPAC doesn’t own anything or do anything. The investors in the IPO are not retail investors, but hedge funds and other professional investors. The money raised by the SPAC in its IPO is placed into an escrow account while the sponsor looks for a private company that would be a good acquisition target. Like many creatures in the animal kingdom, a SPAC has a short lifespan if it can’t find a target (at the end of 2 or so years, any SPAC who fails to find an acquisition target disbands, and the funds raised are returned to its investors). If, however, the SPAC does find a good acquisition target, it negotiates with that target a transaction in which the SPAC will acquire the target (typically in return for stock in the SPAC). Once the transaction is papered, and the SEC approves the related disclosures, the SPAC goes to its investors and holds a vote to determine if the investors want to complete the transaction. If they do, it goes forward. If they don’t, they get their money back. But if enough investors bolt, and no alternative financing is located, the process is at an end, and the SPAC, if it has time left, moves on to find another target.

This process— so different from an ordinary sale to a public company or private equity buyer—creates unique risks for a private business owner. For one, since the purchase price is almost always only in stock (and stock that typically can’t be sold for at least 6 months after the sale), the sellers, after the closing, still bear the economic risk that their business falls in value. This risk is not academic—many SPACs today trade for significantly less than their closing day price, representing a real and material decrease in the value received by the sellers. For another, it takes 6-9 months for a sponsor to negotiate a deal and take it to a shareholder vote—and the seller has no assurance that the process will lead to a favorable outcome (and the dismal performance of many SPACs seems to be making investors much more cautious and more likely to pull their funds if offered less-attractive targets). Operating covenants will bind the seller’s hands during that interim period, and the seller’s legal and professional fees, if the deal does not close, usually remain the seller’s responsibility. The flip side, however, is that a SPAC sale creates a good opportunity to expand a business—the cash initially raised by the SPAC investors is typically used to fund a robust balance sheet—and the often-generous valuation of the seller will swell if the stock price moves upwards after the closing.

So how should we assess a SPAC exit? Not all bad, not all good. Just trivia for many business owners, and an exciting prospect for others. Each situation is different, and your professional advisors should help you make the right decision. Time will tell how influential SPACs will be in the coming years, but at least as evidence of the endless innovation of Wall Street and its relentless hunt for yield, they have already left their mark.

For more information, contact Gabriel J. Kurcab at 513-977-3485 or gkurcab@katzteller.com.

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