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🤿 Sunday Deep Dive: The SPAC
Welcome to another Sunday night edition of FORWARD GC: from beginners’ guides to timely features, explore essays that make legal a little more understandable. Courtesy of Lawtrades—a software company building legal infrastructure for data-driven teams.
SPACs: Almost Everything You Need To Know
You’ve probably been hearing the phrase SPAC lately. They have soared in popularity last year.
But what exactly is a SPAC? And if your company considers merging with a SPAC, how would it affect your work as a GC?
We’re here to explain!
What are SPACs?
A SPAC (Special Purpose Acquisition Company) is a publicly traded shell company, also known as a blank check company. They are started by a “sponsor,” which is usually a group of people with deep business ties. Public figures who have launched SPACs include former Oakland A’s GM Billy Beane and former House Speaker Paul Ryan.
Just like a startup, SPACs raise money. But instead of selling the promise of a new product to investors, SPACs are essentially selling the expertise of their sponsor (their leadership, their experience, their competence etc.)
Then, they use the funding, as well as their IPO, to buy another company, often relying on private equity firms to contribute extra cash for the purchase. SPACs generally target grownup startups -- those that are fairly new but have already attracted considerable investor attention. After the merger, the old stock ticker for the SPAC is replaced by a ticker for the merged company.
Chamath Palihapitiya is known as the SPAC king. His Social Capital Hedosophia Holdings Corp II has merged with Opendoor, Clover Health and Virgin Galactic.
How common are SPACs?
They have been around forever but have become vastly more common the last few years. In 2012, there were 7 SPAC IPOs, according to CB Insights. As of October, there were 141 this year, up from 58 in 2019. SPACs have raised some $40 billion this year, up from about $10 billion each of the last three years.
In the past, SPACs were seen as a tool for B-list companies to go public, often leading to failure. That is no longer the case. There are still risks, however, which we’ll explain further below.
Why would a business want to merge with a SPAC?
Less volatility when going public: Traditional IPOs can lead to uncertainty for employees because a valuation could swing based on the health of the market. Negotiating with a SPAC means setting a concrete valuation.
Less upfront legwork: Companies that merge with SPACs don’t have to make deals with underwriters or prepare the prospectuses required for going public.
What do GCs need to be prepared for?
The first step for any legal department would likely be vetting the SPAC and its sponsor, as well as considering the pros and cons of taking this route to go public. Finding the ideal sponsor will likely depend on what a particular company is seeking. Marcum Bernstein & Pinchuk LLP outlined a few considerations:
Trust: Gauging their level of expertise and how that level of expertise could help your company.
Storytelling reach: Sponsors consisting of well-known VCs or investors may be able to elevate the “story” of your company to a broader audience.
Leadership: Knowing whether sponsors will want to have a governing role in the new company.
A recent panel of attorneys on TechGC noted, “This market is evolving real-time and, while choosing the right sponsor is among the most important early decisions, companies contemplating a business combination with a SPAC should consider a broad range of factors before embarking on this fast-moving journey.”
What about after deciding on a SPAC?
After deciding to go through with a SPAC merger, here are some of the legal processes involved. More than likely, GCs would need outside help.
M&A: Companies usually must produce definitive acquisition agreements and an S-4, not to mention a thorough compilation of financial statements for review.
SEC reviews: Any company merging with a SPAC will still go through the same scrutiny applied to a company seeking a fresh IPO. But the timeline is often shorter.
Preparation for public reporting: As soon as a deal goes through, your formerly private company will be held to public company reporting standards. Directly, GCs will need to ensure compliance with federal securities laws. That also means understanding the risk of potential securities class actions and shareholder lawsuits. GCs may also be counted on to explain new standards for the company’s board, tax planning and financial reporting (for a more extensive list, check out page 7 of this document from Cooley).
Confidentiality: For companies negotiating and making deals with SPACs, more confidentiality is required than, say, negotiating with investors. That’s because of insider trading issues. According to Cooley, “Targets should set up a system of internal controls to ensure proper review of all such public disclosures. Legal counsel should review all press releases and publicity, including product announcements, and should be consulted before interviews are granted or speaking engagements are accepted.”
What are the risks?
Some analysts say SPACs are a new bubble and could lead to financial issues at a grand scale, as well as a surplus of low-grade SPACs. Regardless of the overall merit of SPACs, any company must weigh potential downsides of merging with a SPAC.
Notably, SPAC mergers are expensive. After a merger, the SPAC sponsor typically gets a 1-5% stake in any company it merges with, according to CB Insights.
The quality of any SPAC also varies based on the sponsor. Having trust in a sponsor’s resume is a must.
It’s also important to consider the age of the SPAC. SPACs typically dissolve after two years if they don’t find a company to merge with. A SPAC that is nearing its expiration date may try to rush a pairing with a company, potentially seeking a relationship that isn’t the right fit.
Thanks for reading. Hope you enjoy your Sunday night.