On January 27 and 28, 2021, over 300 participants joined Morrison & Foerster’s webinars on “SPAC 101 — Is 2021 the Year of SPACs in Asia?” where Partners Mitchell S. Presser, Justin R. Salon, and Ruomu Li led an in-depth discussion on the growing significance of SPACs and their relevance to the Asian market. Upon popular demand, we would like to provide brief answers to the below questions often asked by our clients regarding SPACs.
- Question 1: Since a de-SPAC transaction is subject to the approval by the SPAC shareholders, does it mean de-SPAC transactions lack deal certainty in general?
- Answer: No. The notion that a de-SPAC transaction runs the risk of not receiving approval by the SPAC’s shareholders is more theoretical than practical. In practice, shareholders have strong incentives to vote in favor of the de-SPAC transaction because even if a shareholder votes for the de-SPAC transaction, such shareholder can still redeem his or her shares and hold onto the warrants, which will only have value if the de-SPAC transaction closes. As a result, the SPAC shareholders are incentivized to approve the de-SPAC transaction for the upside gains upon exercise of the warrants, whether or not they choose to redeem.
- Question 2: Will the SPAC sponsor own 20% of the equities in the combined entity upon the closing of a de-SPAC transaction?
- Answer: SPAC sponsor promote, while often starting at 20% of the SPAC’s total shares outstanding prior to the de-SPAC transaction, will usually end up being much less than 20% upon the closing of a de-SPAC transaction due to dilution. It is because the consideration for a de-SPAC transaction consists of primarily newly issued shares of the SPAC (some deals may have a cash component) and the valuation of the target company is often four to five times the valuation of the SPAC.
Assuming the SPAC sponsor receives 5 million shares at $0.005/share for $25,000 at the formation of the SPAC, the SPAC then raises $200 million in its IPO by issuing 20 million shares to the public shareholders at $10/share, immediately after the IPO, the sponsor holds 20% and the public shareholders collectively hold 80%.
Assuming the target company is valued at $1 billion and the shareholders of the target receive an aggregate of 100 million shares at $10/share upon the closing of the de-SPAC transaction, and further assuming there are no PIPE and no warrant exercises to keep the math simple, the target shareholders will collectively own 80% of the combined entity post‑closing, the SPAC sponsor will be diluted to 4%, and the public shareholders (assuming no redemptions) will be diluted to 16%.
However, note that the SPAC sponsor and public shareholders may exercise their warrants after the closing of the de-SPAC transaction to mitigate the dilution, but that would not significantly increase their shareholding percentages given the valuation of the target. (Note: the warrants typically have an exercise price of $11.50 per share, so they would only be exercised if the stock trades up more than 15% from the base price of the transaction.)
- Question 3: Can the SPAC sponsor enter into a non-binding LOI with a target company before the SPAC launches its IPO in order to secure a successful de-SPAC transaction?
- Answer: No. Under the SEC’s rules, a SPAC may not identify a specific target company prior to the closing of its IPO, and the SEC requires the SPAC to disclose in its prospectus that the SPAC does not have any specific target company under consideration, and that neither the SPAC, nor anyone acting on behalf of the SPAC, has engaged in any substantive discussions with a potential target company. In fact, if a non-binding LOI is entered into before the SPAC’s IPO, the SEC may even suggest that it is the target company that should conduct an IPO, not the SPAC, which would defeat the entire purpose of using a SPAC as an investment vehicle and an alternative to a traditional IPO for the target company.
- Question 4: Will the investors in the target company be subject to lock-ups after the closing of the de-SPAC transaction?
- Answer: Yes. Founders of the target company, as well as shareholders holding 5% or more of the target shares, will usually be subject to lock-ups. The lock-up period for target company shareholders typically is between six months and one year from the closing of the de-SPAC transaction.
- Question 5: What are the most important considerations for a target company when it comes to choose a SPAC for a de-SPAC transaction?
- Answer: We have seen good target companies being approached by multiple SPACs. It is mainly due to the large number of SPACs currently on the market seeking good target companies, as well as the SPACs’ limited time horizons to find targets. For a target company, focus should be given to whether a SPAC and its sponsor can maximize its value. Does the SPAC sponsor have the ability to successfully solicit PIPE investors for the de‑SPAC transaction? Can the SPAC sponsor provide valuable input on the business strategies of the target going forward? Will the SPAC be able to introduce any new business relationships to the target through its resources? Does the SPAC sponsor have industry expertise and experience to enhance the target company’s growth? The main question is whether the SPAC sponsor will be a value added partner. Target companies can often benefit from strong, supportive SPAC sponsors.
- Question 6: Is it possible for a SPAC to merge with more than one target companies at the same time?
- Answer: Yes, it is possible, but not very common. Generally, the SPAC market prefers simplicity and one SPAC one target is the norm. That being said, we have seen a few deals where a SPAC closes two acquisitions at the same time. If the two target companies can create synergy, it may significantly increase the value of the combined entity.