By James Inness and Anna Ngo
Special purpose acquisition companies, or SPACs, are companies that are incorporated for the purpose of making one or more strategic acquisitions. SPACs are also referred to as “blank check” companies or “cash shells”, which seek to raise capital by listing shares on a stock exchange. Each SPAC has its own investment criteria and focus, such as a specific industry. Alternatively, it may operate under the banner of a more generic acquisition mandate, which guides its potential acquisition strategy.
At the time of IPO, the SPAC is empty – it has no business operations or tangible assets. However, it will have an experienced management team, which usually includes the sponsors or founders, and an investment criteria, which the management team will seek to meet by identifying attractive targets for acquisition by, or merger with, the SPAC within 18-24 months from IPO. A failure to execute an acquisition within the timeframe will generally lead to the liquidation of the SPAC and a return of investment to the public shareholders.
Why SPACS are back
SPACs were a common feature in the equity capital markets prior to the global financial crisis, and have recently experienced a resurgence in popularity. As with many trends in equity capital markets, the swell in favour of SPACs began in the US before finding its way into the UK. With increasing popularity in the oil and gas and technology sectors following the relaxation of certain regulatory conditions in the US, 2017 saw 34 SPACs being listed in the US, the highest number since 2007, raising a total of $9.9 billion. In the UK, 15 SPACs listed on the London Stock Exchange (“LSE”) in 2017, compared with none in 2016 and one in 2015, raising a total of $2.15 billion in the past three years.
The increased popularity of SPACs sits against the backdrop of improved market conditions for fundraises in the equity capital markets. Low interest rates and high market valuations in the equity capital markets, along with the perceived ease of exit either through the ‘money-back’ feature following a failed or ‘no deal’ situation (see below), or via the freely transferable and liquid shares in the market in the event of a successful acquisition, have made SPACs an attractive investment opportunity for investors. In addition, private equity firms are increasingly acting as SPAC sponsors as an alternative route to raise public capital beyond the traditional private equity fund investment model, which has increased the attractiveness of such SPACs to both potential investors and targets for the SPACs looking to the benefit from the expertise of a private equity firm.
A closer look at SPACS
Prior to the IPO, the founders or sponsors will invest a nominal amount of capital in order to incorporate the SPAC. Upon IPO, public investors will typically receive “units” comprised of shares and warrants, representing the right to acquire additional shares, in the SPAC. The founders or sponsors will typically retain a 20% equity investment in the SPAC, usually through one or more separate classes of shares, which may include preferred equity, along with warrants, and in return, they undertake to provide management services to the SPAC to assist with the identification and acquisition of a potential target company. The economic interests of the founders or sponsors may be structured so that they benefit from a lower subscription price for their shares, a right to a dividend under the preferred shares (which may be payable in cash or through the issue of further shares), as well as a lower exercise price in respect of any warrants.
The cash proceeds of the IPO are typically ring-fenced in a trust account that can only be used for the purpose of an acquisition under the terms of the SPAC, except that the SPAC may utilise a limited portion of the IPO proceeds to pay for the day-to-day expenses of operating the SPAC, such as office overheads. All other costs, such as the IPO expenses, are funded by the sponsors’ or founders’ original investment in the SPAC or the interest arising from the ring-fenced IPO proceeds.
An application to liquidate the SPAC will be made in the event an acquisition is not made within the specified timeframe, provided no further extensions are granted by the SPAC investors, so that funds are returned to the public shareholders (“money-back” feature). In comparison, the founders or sponsors may have limited rights on liquidation.
The expense downside and the risk of not having any investment upside with respect to their significant holdings in the SPAC generally means that the founders or sponsors are strongly incentivised to complete a transaction within the specified timeframe.
Listing a SPAC in the UK
As a cash shell, a SPAC does not meet the eligibility requirements of a premium listing on the Main Market of the LSE as it will neither have an independent business nor a financial track record required to meet the requirements of Chapter 6 of the Listing Rules (“Listing Rules”) of the Financial Conduct Authority (“FCA”). In addition, it will not meet the requirements of being a premium listed closed-ended investment fund under Chapter 15 of the Listing Rules as it will not normally have a policy of investment with the objective of spreading investment risk.
SPACs can, instead, seek (i) a quotation on the LSE’s AIM market, or (ii) a Main Market standard listing on the LSE under Chapter 14 of the Listing Rules. Both an AIM quotation and a standard listing benefit from lighter regulation than a premium listing on the Main Market.
AIM has traditionally been the ‘natural home’ for smaller, start-up companies with a limited financial track record seeking to list. However, after a number of high-profile cases of AIM-quoted SPACs running into difficulties in 2015, the LSE, as the regulator of AIM, tightened the conditions on eligibility for admission to AIM under the AIM rules (“AIM Rules”). A SPAC can now only list if it raises a minimum of £6 million on or before the IPO. In addition, a SPAC is required to substantially implement its investment policy (i.e. deploy its capital) within 18 months of being admitted to AIM or seek further shareholder approval for its investment policy at its next annual general meeting and on an annual basis thereafter until such time as its investing policy has been substantially implemented. There is also an ongoing requirement for AIM companies to appoint a Nomad (Nominated Adviser) at all times. All of this means founders and sponsors are increasingly looking to explore alternative listing avenues.
A Main Market listing on the LSE through a standard listing has become an increasingly attractive option for SPACs, particularly those attracted by the prestige of a Main Market listing. A SPAC seeking a standard listing must have at least £700,000 of capital, but is not required to appoint a financial advisor, sponsor or Nomad or be subject to any specific corporate governance rules. Nevertheless, the SPAC will need to prepare an initial listing prospectus, and will be subject to the ongoing requirement to have at least 25 per cent. of its shares held in public hands.
The acquisition by a SPAC of a target will qualify as a ‘reverse takeover’ under both the AIM Rules and the Listing Rules. An announcement (or leak) of a proposed transaction will generally lead to the suspension of a SPAC’s listing on both AIM (unless the target company is also listed on AIM or the Main Market) and the Main Market (save where the target is also a standard listed company). Upon the receipt of shareholder approval in respect of an AIM quotation, or the completion of the transaction in respect of a Main Market listing, the SPAC’s listing will be cancelled, and the enlarged entity will need to re-apply for admission to listing and trading on AIM or the Main Market. The process for re-admission will require the preparation of an AIM admission document or listing prospectus, as applicable.
SPAC for good?
With the increased involvement of private equity firms, the rationale for using SPACs in certain sectors, such as oil and gas, continuing low interest rates, and the inherent investor protection mechanism, we expect the demand for SPACs is expected to remain strong and their resurgence will be a continuing trend in the global market, which we expect to continue in the London and European markets.
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