De-SPAC directors may be nominated by certain shareholders and may face actual or perceived conflicts. Many de-SPACed companies are parties to shareholder agreements that may give certain significant shareholders director designation rights. As a result, directors of de-SPACed companies may be affiliated with certain shareholders, and it may be important to evaluate whether in the context of a particular transaction any directors may have actual or perceived conflicts of interest given their relationships with certain shareholders. This highlights the need for some de-SPACed targets to assess process issues, potentially including, given the facts and circumstances of the proposed transaction, the need for, or benefits of, creating a special committee or seeking a “majority of the minority” vote. As noted above, a buyer of a de-SPACed target has a shared interest in ensuring that the target conducts a proper process. If a transaction is evaluated by the courts under the “entire fairness” standard of review, for example, any shareholder litigation challenging the deal will be difficult to dismiss on the pleadings. Therefore, if there are procedural measures that can be employed to lend a transaction “business judgment rule” review, a buyer may want to consider those measures.
De-SPACed companies may have very complex capitalization structures. De-SPACed companies often have multiple classes of stock (including potentially high vote and low vote stock). In addition, it is not uncommon for founders and other legacy target shareholders to be entitled to “earnout shares,” which are issued if and when the de-SPACed target’s stock price reaches or exceeds certain levels. In 2021, over 40% of the closed de-SPAC deals contained an earnout provision. On the flip side, a portion of the SPAC sponsor’s shares may be subject to “vesting” or “forfeiture back” provisions, under which the sponsor will lose some of its shares unless the de-SPACed company’s stock price trades above specified levels by specified deadlines. Sponsor equity was subject to such vesting and/or forfeiture in over half of the de-SPAC deals that closed in 2021.
As such, determining the fully diluted capitalization of a de-SPACed company may be particularly challenging, and the treatment of earnout, vesting, and forfeiture provisions needs to be carefully reviewed in light of the contemplated amount and mix of deal consideration. This task may be time-consuming especially where the relevant provisions have drafting ambiguities and do not lend themselves to straightforward answers.
De-SPACed companies may have multiple types of warrants that need to be accounted for. As part of a de-SPAC transaction, de-SPACed companies typically inherit “public warrants,” which were issued to the public investors in the SPAC IPO, and “private placement warrants,” which were issued to the SPAC sponsor, as well as potentially PIPE investors, in putting together the financing for the deal. The terms of the public warrants and private placement warrants are usually identical, except that the de-SPACed company may redeem the public warrants if its stock price reaches or exceeds certain levels, whereas the private placement warrants are not redeemable.
Both public and private placement warrants may contain provisions that provide that in the case of a merger or other business combination transaction, the warrants become exercisable for the merger consideration. This means that the buyer cannot unilaterally take them out (subject to the redemption provisions of the public warrants based on the deal price) and—if some warrant holders do not exercise their warrants right away—may have ongoing obligations to pay the merger consideration for the life of the warrants.
As a separate matter, in a deal that involves less than a specified percentage (usually 70%) of listed stock as the deal consideration, the warrants often provide that the exercise price will be adjusted if the warrant is exercised within a specified period of time after the closing of the deal (usually 30 days) such that the warrant holder will be entitled to receive upon exercise, on a net basis, the Black-Scholes value of the warrant (calculated as of immediately prior to closing, based on certain assumptions specified in the warrant agreement). This creates an added complication in that a buyer may not know the exact amount of consideration to be paid for the de-SPACed warrants at the time of signing. Buyers should, therefore, consider whether the warrant agreement terms may be amended and whether it would be feasible or desirable for the buyer to enter into agreements with the warrant holders that lock in the treatment of their warrants at the time of signing.
Finally, de-SPACed companies may have inherited legacy target warrants (for example, if the target had issued warrants to VC funds or debt or service providers pre-SPAC IPO), which may have bespoke provisions and may further complicate cleaning up the company’s capital structure post-acquisition.
Some de-SPACed companies are organized as “Up-Cs” for tax purposes. Some de-SPACed companies are structured as umbrella partnership C corporations (“Up-Cs”), where the target business is organized as a flowthrough for tax purposes, either as an LLC or a limited partnership (“opco”), and the publicly listed de-SPACed company’s sole asset is its equity in opco. In such a structure, the public shareholders hold one class of shares in the public company (which carry both economic and voting rights) while other shareholders, typically the legacy target founders and initial investors, hold both a different class of shares in the public company (which carry voting but no economic rights) and units in opco (which carry their economic interests). As such, acquiring a de-SPACed company that is organized as an Up-C is even more challenging from a corporate perspective; the transaction needs to account for both the treatment of shares and opco units. Further, many Up-Cs often have a tax receivable agreement (“TRA”) in place. TRAs may, among other things, require a payout to TRA beneficiaries upon a change of control of the de-SPACed company, and these payments can be significant. Therefore, having a TRA in place raises additional structuring considerations, including whether certain shareholders are potentially receiving differential consideration.
De-SPACed companies may be subject to, or at risk of, litigation or investigation. Finally, it is not uncommon for de-SPACed companies to be subject to fiduciary duty litigation in connection with the de-SPAC process, and/or securities litigation or investigations regarding issues with the de-SPAC merger or subsequent SEC disclosures. (This is especially common when the de-SPACed company misses earnings targets shortly after going public with the de-SPAC). Any potential buyer of a de-SPACed company should carefully conduct diligence regarding these potential exposures and the extent to which they may be extinguished by virtue of the acquisition.
Mergers involving de-SPACed companies present several unique features. It is important—even more so than in other contexts—to engage and consult with counsel early, as several threshold matters will need to be addressed to ensure that the transaction is structured in the appropriate manner, that the valuation accounts for the fully diluted capital of the de-SPACed target, and that the board process is appropriately structured to meet applicable fiduciary standards.