Editor’s note: Jim Verdonik and Benji Jones, Co-Founders of Innovate Capital Law discuss Special Purpose Acquisition Companies (SPACs) -the hottest trend in capital raising. This is the fourth part of the series. (Links to the previous three stories are embedded in this story.)
JIM: In our prior SPAC discussions, we discussed the explosive 600% growth of SPACS during 2020, how to determine whether doing a SPAC deal is right for your business and how to chooses the best SPAC for your business
BENJI: Now, let’s assume you and a SPAC think a deal makes sense. Let’s talk about SPAC deal terms and the process of how we close a SPAC deal. The four biggest deal issues are
- How much is paid at the merger closing to buy out existing owners
- How much cash remains in the post-merger company to operate and grow the business (it’s no fun being a public company that is low on cash),
- How much equity of existing target company owners is rolled over into publicly traded equity
- When is each player allowed to resell stock after the merger
Most of the negotiation is usually around these four issues.
JIM: To understand how the negotiation works, we need to understand all the players and what their motivations and leverage are.
What’s a SPAC? And why are they the hottest deals going on Wall Street?
BENJI: SPAC sponsors/founders buy 20% of the SPAC’s shares for nominal consideration as compensation for starting the SPAC. These sponsors control the SPAC’s Board of Directors.
Public shareholders of the SPAC who purchased in the IPO or in the trading market own 80% of the shares that they bought for $10 per share and warrants to purchase more shares for $11.50 per share. (It’s almost always $10 per share and $11.50 exercise price for warrants.) The public shareholders must approve the merger and also have the right to have their shares redeemed for $10 per share if they don’t like the merger deal. So, the deal has to please these public shareholders.
This is complicated by the fact that the funds the SPAC holds in trust to redeem shares from the public for $10 per share is usually less than the amount required to redeem all the shares. Underwriting and other fees and expenses of operating the SPAC may have reduced the trust fund by 20% or 30%. So, SPACS have to avoid massive redemptions or raise more money to fund redemptions.
JIM: Then, in many SPAC deals there are PIPES investors. PIPES stands for Private Investments in Public Equity. PIPES investors add extra money to the SPAC that comes in when the merger closes. The SPAC is negotiating with PIPES investors while the SPAC is negotiating merger terms with the target private company. So, the merger negotiation is often a three-way negotiation, because the PIPES investors have leverage that affects the merger terms.
BENJI: Then, of course, there’s the target company. Its negotiating position is affected by different constituencies. Management team members may have one goal. Investors who own different classes of stock with different claims to the cash and stock received in the merger may have other goals. SPACs require major shareholders and the management team to agree to vote to approve the merger at the time the merger agreement is signed and not to sell to others. That’s because the SPAC doesn’t want to publicly announce a deal and then not be able to close, because target company shareholders won’t approve the deal.
What’s a SPAC, part 2: Is going public this way really a good idea for your firm?
JIM: A successful SPAC merger has to satisfy all these groups: SPAC sponsors, public stockholders, public warrant holders, PIPES investors, the target’s management team and different classes of target company investors. PIPES investors are the last money in the deal. Being the first to cash out of the deal is important to them. So, the PIPES investors get registration rights and require lockup agreements from the other players to ensure that they get the first opportunity to sell shares into the public market.
BENJI: I thought SPACS were supposed to be easier and less expensive than IPOs. That sounds complex and expensive.
JIM: It is complex and expensive, but for the right companies it can work. The beauty of the SPAC is that the negotiation occurs before the SPAC publicly announces the deal. Price and other terms are set when the merger agreement is signed. If negotiations break down and no merger agreement results, it’s not a public event like filing with the SEC for an IPO and then not being able to sell the deal. Of course, since SPACs are public companies, they are affected by changing market conditions. So, there is no iron clad guaranty that one of the groups won’t later try to renegotiate the deal.
BENJI: I’ve never seen a deal with an iron clad guaranty. Who pays expenses if the deal falls apart?
JIM: The target company pays its own expenses and the SPAC pays its expenses. So, if the deal falls apart, the target company may have wasted a lot of money.
Now, let’s talk about the time and money required to do a SPAC deal. I’ll begin by saying that virtually all the SPAC merger time schedules you see on the Internet are misleading.
BENJI: Really? Internet Information wrong? How unusual!
JIM: Virtually all the schedules do two things. First, they don’t include the three to six months it often takes for a SPAC and the target company to get to know one another to determine if a deal makes sense and to prepare the target company to successfully do the deal and be a public company. Then, most schedules assume that nothing will go wrong or slow things down after the merger transaction work intensifies.
BENJI: Is that because most of the time schedules posted on the Internet are posted by service providers who want you to hire them to do your SPAC deal? Who wants to hire the service provider that says it will take a longer time?
JIM: I won’t speculate about motives, but the schedules are unrealistic. Just add three to six months to the schedules you often see to get a realistic picture of when you should start planning a SPAC transaction. Preparing for the SPAC transaction or an IPO takes both management time and money. So, you need to know how long it’s likely to take until you receive money and how much money you will spend on transaction expenses and preparing yourself to operate a public company.
BENJI: What does a SPAC merger transaction cost for the target company?
JIM: You should be prepared to spend at least $200,000 on accounting and legal fees for the last several months of the merger transaction.
BENJI: What you spend before that time during the preparation period usually depends on how much preparation the target company previously did. Does its accountants have the qualifications required to audit financial statements to be filed with the SEC? Does it have SEC compliant audited financial statements? Does it have a good data room? Are there transactions that need to be cleaned up? How much will be needed to improve information technology systems to bring them up to public company standards?
JIM: Let’s break the last several months of the process into stages to explain how the sausage is made.
BENJI: The first step is usually a non-binding term sheet or letter of intent that spells out the structure and big picture deal terms. Let’s start counting from that date. During the next four to six weeks while the potential deal is still a secret, the SPAC completes the due diligence it started during the preparation period, the merger agreement is negotiated and target company shareholders sign voting agreements. Roadshows may also occur to sell the deal to PIPES investors to raise more money than is in the SPACs trust fund. Selling the deal to PIPES investors is often the biggest reason for delay. So far, the deal is confidential.
JIM: After the merger agreement is signed, the “de-SPACing” process begins – the process of transforming the SPAC into a business with real operations. At that point (4 to 6 weeks after a letter of intent), the SPAC announces the deal with a press release and files a Form 8-K with the SEC and the SPAC soon files a proxy statement and registration statement with the SEC.
BENJI: While we wait for the SEC reviewers to sign off on the deal (and hope that plaintiffs’ lawyers don’t commence litigation seeking a better deal for the SPACs public shareholders), we are working on a new listing application for the de-SPACed shares to trade on NASDAQ or NYSE. Let’s budget another 7 weeks so we are 15 weeks into the process when official shareholders meeting notices are sent.
JIM: About four weeks later, the SPAC’s public shareholders approve the merger and the closing occurs about 17 weeks into the process. The new team then files a Super 8-K with the SEC and the de-SPACed company’s shares begin trading under a new listing.
BENJI: Then we file the registration statement for reselling the PIPEs investors’ shares. That registration statement usually becomes effective within several weeks, because the SEC staff recently reviewed the merger related documents. For about 180 days after the deSPACing process is completed, sponsor and target company shareholders are locked up and can’t trade. In some SPAC deals lockups are longer or may be subject to market price milestones that shorten or lengthen the lock-up period. Because the SPAC was a public shell company, shareholders can’t use Rule 144 to resell shares for one year after the Super 8-K was filed.
Considering a SPAC? Here’s advice on how to pick right one for your business
JIM: What can businesses do to keep the deal on schedule or even get deals done faster?
BENJI: Getting as much done in the preparation period as possible is the best thing you can do. Choosing the right SPAC that can sell the deal to the public shareholders and to PIPES investors. Also, don’t take you eye off of running your business while you are doing the deal. Adverse changes before you close can delay the closing.
JIM: There you have it: The Good, the Bad and the Ugly of SPAC deals
Jim Verdonik and Benji Jones, Co-Founders of Innovate Capital Law
