The possible impact of the M&A law on the development of SPAC transactions
The transactions of the Special Purpose Acquisition Company (SPAC) have seen a rapid surge in the capital markets. In 2019 there were 59 SPAC Initial Public Offerings (IPOs) with gross proceeds of around $ 14 billion. In 2020 there were 248 SPAC IPOs with gross proceeds of approximately $ 83 billion – An astronomical 320% increase in the number of SPAC IPOs and an increase in gross revenue of 500% year on year. In general, SPACs have maintained a similar structure. However, a new SPAC, Pershing Square Tontine Holdings, Ltd., coupled with the fundamental M&A law, could have unleashed market forces that will fundamentally change the prevailing structure of SPACs.
A SPAC is a publicly traded blank check company that was formed to bring a private company public through a merger. In a SPAC IPO, a SPAC generally offers shares each consisting of a common share and a warrant to buy a fraction of the common stock at a fixed price. Subject to the provisions in the prospectus, the common shares and warrants of the shares will be separately and freely transferable after the IPO. A SPAC typically has two years to identify a target company and complete the business combination, often referred to as a “De-SPAC” transaction, or to liquidate the proceeds from the IPO and return it to shareholders. If a SPAC proposes a merger, shareholders will also have the option to participate in the merger or to redeem their shares at the initial IPO price with accrued interest.
Benefits of SPAC transactions
SPACs offer several advantages from a transaction development perspective. First and foremost, SPACs offer private companies the option of going public with a lower liability risk under federal securities laws and offer flexibility in M&A transactions. In a recent article, I hypothesized that “the only major distinction of liability between public and private securities is the increased standard of pleading for scientifically based cause” associated with private securities. In short, IPO issuers are exposed to the strict causes of liability in sections 11 and 12 of the Securities Act. Conversely, plaintiffs in actions arising out of private securities are referred to Section 10 (b) of the Stock Exchange Act, which requires evidence from a scientist; and it has become increasingly difficult to establish scientists since the Supreme Court added a plausibility standard to the pleading requirements. In fact, SPACs significantly reduce liability under sections 11 and 12 for private companies wishing to go public.
In addition, M&A attorneys often proclaim the advantages of SPACs over traditional IPOs and M&A transactions. These benefits include the potential of a SPAC to improve the conventional IPO process by reducing information asymmetry, increasing price and business security, improving efficiency, and creating the potential for flexible contract terms. From a political perspective, proponents of SPACs argue that SPACs democratize investing and allow non-accredited investors to invest in potentially lucrative businesses alongside private equity and hedge fund managers.
Disadvantage of SPAC transactions
Critics of SPACs argue that the investment structure is extreme and unnecessarily dilutive. The dilution arises from the compensation sponsors received in the form of a “grant” from a sponsor (usually 20% of equity after the IPO). Subscription fees (usually 5% of the IPO proceeds); and SPAC warrants and rights. Inevitably, the non-redeeming SPAC shareholders and / or the target company shareholders will absorb the dilution inherent in traditional SPAC structures. Since the sponsor’s advertising and related rights partially protect the sponsors from the disadvantages of a de-SPAC transaction, traditional SPAC structures can create a moral hazard problem and lead to conflicts of interest between the sponsors and the SPAC shareholders. On December 22, 2020, the SEC released CF Disclosure Guidance highlighting this issue.
The Pershing Square Tontine SPAC model
Pershing Square Tontine Holdings, Ltd. (PSTH) has numerous provisions that distinguish it from conventional SPAC structures. Of particular note:
- The PSTH sponsors will not receive the traditional 20% post-IPO promotion of the common stock at a nominal price. Instead, the sponsors acquire sponsor warrants at fair market value with an exercise price of USD 24.00 per share.
- PSTH sponsor warrants are usually only transferable or exercisable three years after a de-SPAC transaction.
- PSTH Sponsor Warrants cannot be exercised until the value of the common stock is at least 20% above the IPO price.
- The partial guarantees associated with the PSTH SPAC units are considerably lower than with conventional SPAC warrants. The terms of the warrants are designed to reward non-redeemable shareholders and minimize profits for short-term investors.
The structure of PSTH alleviates some of the structural concerns of SPACs that could give the PSTH structure a competitive advantage over traditional SPACs in the capital market and possibly more importantly in the market for suitable acquisition targets. The PSTH model is less dilutive than traditional SPAC models. In addition, the warrant structure of the PSTH model aligns the disadvantage for sponsors with the common shareholders and the shareholders of the target companies.
In terms of the capital market, the PSTH model might be more attractive to some investors and less so to others. Investors who tend to dispose of their shares prior to the completion of the De SPAC transaction will be less attracted to the redemption and warranty rights of the PSTH model. However, the PSTH model may be able to offset the loss of capital of short-term investors by the loss of traditional institutional investors. To the extent that the PSTH model converts compensation for SPAC sponsors to align sponsor interests with SPAC shareholders and create a fee structure similar to traditional hedge funds and private equity funds SPACs that use the PSTH model are becoming more attractive to institutional investors. Additionally, the PSTH model could help address the concerns of regulators and policymakers as retail investors engage in investment activities traditionally referred to accredited investors through SPACs as the debate unfolds over the right balance between investor protection and democratization of funding .
It is particularly noteworthy that the basic M&A law could give the PSTH model a competitive advantage if it offers a suitable acquisition target. Under Delaware law and many other jurisdictions, a target company’s board of directors has a fiduciary duty to “seek the best transaction to shareholders that is reasonably available” when the company resolves to merge. The PSTH model provides structural benefits that help sponsors structure deals that are considered the best deals in deals for target companies. As mentioned above, traditional SPAC models are inherently dilutive. To the extent that a target company has to bear some of the dilution costs or the PSTH structure helps produce a superior offer for a target company, the target company’s board of directors has a fiduciary duty to accept the offer from the PSTH structure.
As SPACs continue to develop and gain in importance as part of the toolkit for private companies to procure liquidity, competition for capital and attractive companies for listing on the stock exchange will intensify. In addition, capital will accumulate from SPAC IPOs that will be provided for transactions. At the same time, M&A trust laws and market forces will influence the development of SPAC transactions. As SPACs with a structure similar to the PSTH model win competitive offers for attractive target companies because their structure helps to get the best deal, market forces will put pressure on market participants to adapt. The composition of the SPAC investors could also change with a change in the structure of the SPACs. In particular, when short-term investors leave the market, institutional investors who wish to take advantage of the transactional and regulatory advantages of SPACs over IPOs and conventional M&A transactions can increase their SPAC investment allocation.
 See SPACInsider, https://spacinsider.com/stats/.
 See Investor Bulletin: What You Need to Know About SPACs, available at: https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor- Notice.
 See Frantz Jacques, Securities Law and Digital Asset Products, Bloomberg Law (January 22, 2021).
 See Skadden, Arps, Slate, Meagher & Flom LLP, The Year of the SPAC: Insights, available at: https://www.skadden.com/insights/publications/2021/01/2021-insights/corporate/the- year of the Space.
 See Michael Klausner, Michael Ohlrogge and Emily Ruan, A sober look at SPACs, available at: https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/.
 See Special Purpose Acquisition Companies, available at: https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.
 The PSTH registration statement is available at: https://www.sec.gov/Archives/edgar/data/1811882/000119312520175042/d930055ds1.htm.
 See Ann Beth Stebbins & Tom Kennedy, the US chapter of the International Comparative Legal Guide on: Mergers & Acquisitions 2019.