This article originally appeared in the ABA Business Law Today on September 12, 2022.
The SPAC IPO Market and the De-SPAC Market Have Slowed Dramatically During 2022.
By all measures, 2022 has not been a banner year for SPACs. With the SEC proposing new rules that threaten to upend the SPAC business, SPAC IPOs have declined from 2021, when more than 600 IPOs raised over $162 billion, to just 74 in 2022, raising only $12.4 billion.[1] July 2022 was, per the Wall Street Journal, “the first month in five years that no new SPACs raised money.”[2] The pace of de-SPAC business combinations has also slowed considerably, with around 290 de-SPACs announced in 2021, compared to only around 90 so far this year.[3] Almost 580 active SPACs are still searching for targets, with approximately 120 SPACs having an investment horizon through the end of 2022. So far in 2022, at least 15 SPACs have already announced that they will withdraw their registration statements or liquidate.[4]
However, M&A Activity Involving De-SPACed Companies is Picking up Significantly, Driven both by De-SPACed Sellers in Search of a Buyer, as well as Strategic Buyers Aiming to Acquire Desirable Companies at Attractive Values.
Many de-SPACed companies are trading below their acquisition levels of $10 per share, in some cases significantly below that level. Of the more than 400 de-SPACed companies that remain publicly traded, around 330 (almost 85%) are trading at or below $10, while almost 95 are trading under $1.[5] Average de-SPAC redemption rates in the latter part of 2021 and in 2022 have been in excess of 80%.[6] As such, many de-SPAC business combinations did not result in sufficient primary proceeds to the companies that went public via a de-SPAC to support projected growth plans.
Given the low valuations at which many de-SPACed companies are trading, raising additional equity financing in the public markets is difficult and may not be an attractive option (if it is even possible at all). PIPE investors, who historically invested in SPACs at $10 per share, currently have little appetite to direct more funds into de-SPACed companies. Many de-SPACed companies are also in “sectors of the future” (like energy transition) and often do not have the steady cash flows and positive EBITDA needed in order to access the traditional bank loan or bond market.
In light of the limited financing options, M&A may be the natural step for de-SPACed companies looking to develop sustainable businesses and generate investor interest. Battery maker Romeo Power, for instance—which de-SPACed in a $1.33 billion deal that closed in late 2020—was recently acquired by electric truck manufacturer Nikola Corporation in an all-stock transaction, implying a consideration of $0.74 per Romeo share. Even de-SPACed companies that are doing well and are generating robust revenues often operate in industries with significant capital needs and may benefit from being part of a company with a larger platform and stronger balance sheet.
M&A Transactions Involving De-SPACed Companies Present Many Unique Issues. Below we Highlight key Considerations in Advising a Client Pursuing a Merger Involving a De-SPACED Company.
The de-SPACed company’s board of directors will need to make important fiduciary decisions. If a de-SPACed company that is trading (significantly) below its IPO price is considering an M&A transaction, especially one where the consideration will be all or mostly cash, the de-SPACed target’s board will need to engage in important fiduciary deliberations. The target’s board may consider, where relevant, questions such as: Is this the right time for the company to sell? What constitutes fair value for the target’s shares? How important is the $10 per share SPAC IPO price as a benchmark? In the current environment, even a bid at a high premium to current trading levels may still be at a steep discount to the de-SPAC acquisition value of the target. It is important for the de-SPAC target board to undertake an informed, thorough, and well-documented (via minutes and presentations by financial and legal advisors) decision-making process when considering a potential transaction. A buyer of a de-SPACed target has an equally strong interest in ensuring that the target conducts a proper process; if a deal is completed, the buyer will inherit any resulting litigation and obligations to indemnify the de-SPACed target’s directors and officers.
Different shareholder groups may have different views as to whether a transaction is desirable. Different shareholder groups may have acquired their shares in the de-SPACed target at different prices. They may thus stand to benefit differently from a potential transaction—especially one at a loss relative to the de-SPAC acquisition value—even if they receive the same consideration. As is well known, SPAC sponsors usually acquire their shares in the SPAC for nominal consideration (typically $25,000 for shares representing 20% of the SPAC’s outstanding shares post-IPO and prior to the de-SPAC), while public investors who purchased on the open market and PIPE investors typically bought their shares at $10 each. It may be useful to study the de-SPACed target’s shareholder base to determine at what price points investors acquired their shares and whether they would likely support a transaction, including at what price, and what mix of consideration may be appropriate in light of the particular facts and circumstances of the de-SPACed company.
Voting power may be concentrated with a few shareholders who may determine whether shareholder approval for a transaction can be obtained. Often, the SPAC sponsor (and its affiliated entities), the anchor PIPE investors, and the legacy target shareholders hold a significant percentage of the de-SPACed target’s shares. In some cases, the legacy target shareholders may also hold high vote stock, which increases their voting power above their economic ownership of the company. Because of this, it is important to determine which shareholders can sway, and potentially decide, the outcome of the shareholder vote and the extent to which they will be supportive not only of a transaction, but also willing to sign up voting agreements in favor of a deal.
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.[7]
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.
[1] SPACInsider, SPAC Statistics as of August 15, 2022.
[2] Wall Street Journal, SPAC Activity in July Reached the Lowest Levels in Five Years, August 17, 2022.
[3] DealPoint Data as of August 17, 2022.
[4] The Deal, List of SPACs to Liquidate after Failed DeSPACs Grows, August 15, 2022.
[5] SPACInsider as of August 15, 2022.
[6] SPACInsider as of August 15, 2022; Freshfields, 2021 De-SPAC Debrief, January 2022.
[7] Freshfields, 2021 De-SPAC Debrief, January 2022.
