Special Purpose Acquisition Company (SPAC) transactions have experienced a meteoric rise in the capital markets. In 2019, there were 59 SPAC Initial Public Offerings (IPOs) with gross proceeds of approximately $14 billion. In 2020, there were 248 SPAC IPOs with gross proceeds of approximately $83 billion - an astronomical 320% increase in the number of SPAC IPOs and 500% year-to-year increase in gross proceeds. Generally, SPACs have maintained a similar structure. However, a recent SPAC, Pershing Square Tontine Holdings, Ltd., in conjunction with fundamental M&A law, might have unleashed market forces that will fundamentally transform the prevailing structure of SPACs.
A SPAC is a publicly-traded blank check company created to take a private company public through a merger. In a SPAC IPO, a SPAC generally offers units, each consisting of one share of common stock and a warrant to purchase a fraction of common stock at a set price. Subject to the terms in the prospectus, the common stock and warrants from the units become separately and freely transferable after the IPO. A SPAC typically has two years to identify a target company and complete the business combination, often referred to as a “de-SPAC” transaction, or liquidate and return the proceeds from the IPO to the shareholders. Additionally, when a SPAC proposes a merger, the shareholders have the option to participate in the merger or redeem their shares at the initial IPO price with accrued interest.
BENEFITS OF SPAC TRANSACTIONS
SPACs have several benefits from a transactional engineering standpoint. Primarily, SPACs provide private companies an avenue to go public with less liability exposure from federal securities laws, and provide flexibility in M&A transactions. In a recently published article, I surmised that “the only significant liability distinction between public and private securities is the heightened pleading standard of scienter-based causes of action” associated with private securities. Stated succinctly, IPO issuers have exposure to the strict liability causes of action in §§ 11 and 12 of the Securities Act. Conversely, plaintiffs in causes of actions stemming from private securities are relegated to § 10(b) of the Exchange Act, which requires a showing of scienter; and scienter has become increasingly difficult to establish since the Supreme Court added a plausibility standard to pleading requirements. In effect, SPACs reduce §§ 11 and 12 liability significantly for private companies looking to go public.
Additionally, M&A lawyers often herald SPACs’ advantages over conventional IPOs and M&A transactions. These advantages include a SPAC’s potential to improve the conventional IPO process by reducing information asymmetry, increasing price and deal certainty, improving efficiency, and providing the potential for flexible deal terms. From a policy perspective, proponents of SPACs argue that SPACs democratize investing and allow non-accredited investors to invest alongside private equity and hedge fund managers in potentially lucrative deals.
DOWNSIDE OF SPAC TRANSACTIONS
Critics of SPACs argue that the investment structure is extremely and unnecessarily dilutive. The dilution stems from the compensation sponsors receive in the form of a sponsor’s “promote” (typically 20% of the post-IPO equity); underwriting fees (typically 5% of the IPO proceeds); and SPAC warrants and rights. Inevitably, the non-redeeming SPAC shareholders and/or the target company shareholders absorb the dilution inherent in conventional SPAC structures. Additionally, because the sponsor’s promote and associated rights partially protect sponsors from the downside of a de-SPAC transaction, traditional SPAC structures have the potential to create a moral hazard problem, and may lead to conflicts of interests between the sponsors and SPAC shareholders. On December 22, 2020, the SEC issued a CF Disclosure Guidance highlighting this issue.
THE PERSHING SQUARE TONTINE SPAC MODEL
The Pershing Square Tontine Holdings, Ltd. (PSTH) SPAC features numerous provisions that set it apart from conventional SPAC structures. Of particular note:
- The PSTH sponsors will not receive the traditional 20% promote of the post-IPO common stock for a nominal price. Instead, the sponsors will purchase Sponsor Warrants at fair market value, with an exercise price of $24.00 per share.
- PSTH Sponsor Warrants are generally not transferable or exercisable until three years after a de-SPAC transaction.
- PSTH Sponsor Warrants are not exercisable until the common stock value is at least 20% higher than the IPO price.
- The fractional warrants associated with the PSTH SPAC units are considerably lower than conventional SPAC warrants. The terms of the warrants are engineered to reward non-redeeming shareholders and minimize gains for short-term investors.
PSTH’s structure mitigates several of the structural concerns of SPACs, which might give the PSTH structure a competitive advantage over conventional SPACs in the capital market, and perhaps more importantly, in the market for suitable acquisition targets. The PSTH model is less dilutive than conventional SPAC models; additionally, the warrant structure of the PSTH model aligns the downside for sponsors with its common stock shareholders and target companies’ shareholders.
As it relates to the capital market, the PSTH model might be more attractive to some investors and less so to others. Investors who are inclined to divest their shares before the consummations of the de-SPAC transaction will be less attracted to the redemption and warrant rights of the PSTH model. However, the PSTH model might be able to offset the loss of capital from short-term investors with that from traditional institutional investors. To the extent the PSTH model transforms the compensation to SPAC sponsors to align sponsors’ interest with that of SPAC shareholders and create a fee structure that resembles conventional hedge funds and private equity funds, SPACs that use the PSTH model might become more attractive to institutional investors. Additionally, the PSTH model might help assuage regulators' and policymakers' concerns as retail investors participate in investment activities traditionally relegated to accredited investors through SPACs, while the debate over the proper balance between investor protection and democratizing finance unfolds.
Of particular note, fundamental M&A law might give the PSTH model a competitive advantage when bidding for a suitable acquisition target. Under Delaware law and many other jurisdictions, a target company's board has a fiduciary duty to “seek the best transaction for shareholders reasonably available” if the company decides to merge. The PSTH model has embedded structural advantages that will help sponsors structure deals that are deemed best transactions in bids for target companies. As stated above, conventional SPAC models are fundamentally dilutive. To the extent that a target company has to bear part of the dilution cost, or the PSTH structure helps create a superior bid for a target company, the target company's board will have a fiduciary duty to accept the bid from the PSTH structure.
CONCLUSION
As SPACs continue to evolve and gain prominence as part of the toolkit for private companies to obtain liquidity, competition for capital and attractive companies to take public will intensify. Additionally, capital from SPAC IPOs allocated for deals will start to accumulate. Contemporaneously, M&A fiduciary laws and market forces will start to affect the evolution of SPAC transactions. As SPACs with a similar structure to the PSTH model start to win competitive bids for attractive target companies because their structure helps create the best transaction, market forces will pressure market participants to adapt. The composition of SPAC investors might also evolve with a change of SPACs’ structure. Specifically, as short-term investors begin to exit the market, institutional investors looking to capitalize on the transactional and regulatory benefits of SPACs over IPOs and conventional M&A transactions might increase their SPAC investment allocation.