SPACs Regain Populartiy on U.S. Market

I.OVERVIEW

(a)What are SPACs? 

Special Purpose Acquisition Companies (“SPACs”) are public company investment vehicles, also known as “blank check” or “shell companies”.  A SPAC is formed by a limited number of sponsors, consisting primarily of experienced investment, financial and business management professionals, with the objective of acquiring an unidentified operating business in certain industrial or geographical sectors.  Soon after the establishment of the SPAC, it is capitalized through an initial public offering (the “IPO”) of its equity securities comprised of shares of common stocks and warrants.  The securities of the SPAC are listed and publicly traded on the stock exchanges. 

The SPAC must find a target company (“Target”) and consummate a business combination within 18-24 months following the completion of its IPO, otherwise it is voluntarily liquidated and the proceeds of the IPO will be returned to the public shareholders.  If a Target is identified and the business combination is consummated, then the SPAC will merge with the Target and form a new company (“Surviving Company”), which will become the successor entity to the former SPAC and continue on as the listed company.  

(b)SPAC market 

The SPAC market saw its last peak time before the 2008 financial crisis. In 2007 alone, a then unprecedented 60 plus SPAC IPOs were launched.  It has regained popularity in the U.S. capital market in recent years after having been quiet for almost a decade, as the chart below shows both the number and the average size of SPAC IPOs offerings have seen rapid growth[1]. 

According to the registration statements of these SPACs, a significant number of SPACs aim at acquiring businesses in China and other Asian countries.  Nevertheless, statistic shows the SPACs have experienced a mixed bag of both successes and failures.  Only approximately 40% of the SPACs formed have managed to consummate business combinations, a little less than 9% of them have announced potential targets for acquisition, 33% are still in search of suitable opportunities and nearly 16% of SPACs have liquidated for failing to complete any acquisition.  It can be expected that the competition for potential business acquisition opportunities will further intensify with the increasing number of newly formed SPACs joining the pool.  

II.THE MECHANISM OF THE SPAC 

(a)Formation of the SPAC 

A SPAC is essentially a blank check company with no prior operational history.  It attracts investors solely based on the background and track record of the sponsor/management team.  Therefore, SPACs are usually led by sponsor/management team members with extensive prior experience in private equity, mergers and acquisitions and business operations.  The management teams of SPACs do not receive any remuneration, consulting fee, finder’s fee or any other kind of compensation from the proceeds of the SPAC’s IPO, until the SPAC has consummated a business combination.  But the sponsor/management team will be reimbursed for any loans they advanced to the SPAC for payment of the offering expenses out of the proceeds of the offering, and will be reimbursed for any administrative and reasonable out-of-pocket expenses.  

Since management does not receive remuneration from the SPAC, members of management often maintain positions in other organizations which may be engaged in businesses that are similar to or in competition with the SPAC.  In order to avoid any conflict of interests issues, members of management will typically be required to represent that they will refer any potential business combination opportunities to the SPAC before referrals to any other entities; and that they will avoid proposing any business combinations with entities with which the members of management are affiliated.  

It has become market convention that, prior to the IPO, the sponsors will purchase, by way of private placement, the equity at a discounted price approximately equal to 20% of the total equity of the SPAC post-offering.  The proceeds from any such transactions will be held in the trust account, and the equity purchased by the sponsors will be put in escrow and locked up for several years (typically 3-4 years) and will only be released upon the SPAC’s successful consummation of a business combination. In the event that the SPAC fails to consummate a business combination, the funds held in the trust account will not be returned to the sponsors and will instead be liquidated and distributed to the public shareholders, and the sponsors will lose all of their initial investment.  

(b)IPO of the SPAC

(i)Structure 

The SPAC conducts an IPO through filing with the U.S. Securities and Exchange Commission (“SEC”) a registration statement on Form S-1 or F-1, depending on whether the SPAC is a U.S. domestic issuer or a foreign private issuer (“FPI”).  The securities registered and offered are units comprised of the shares of common stock and the warrants.  Examples of some of the typical SPAC IPO structures are set forth below:  

The warrants are exercisable for the shares of the Surviving Companies only after the consummation of a successful business combination, and will become worthless if no business combination is completed.  The warrants normally bear a redemption term allowing the SPAC to “call” the investors to exercise the warrants for shares where the SPAC’s common stock closes at or above a specified price for a pre-determined number of consecutive days (normally 20 trading days within any 30-day period).  This “forced redemption” term will allow the Surviving Companies to eliminate the burdens imposed by the term of the warrants if the trading price of the common stock surges significantly after the business combination, and allows the investors to participate in the increased value of the common stock.  

The units of the SPAC are tradable upon the pricing of the IPO, and the common stock and warrants will be separately tradable after the SPAC has filed with the SEC a Current Report including an audited balance sheet reflecting the gross proceeds of the IPO on Form 8-K (or on Form 6-K for FPIs), and after a certain period (e.g. 20 days) following the over-allotment option granted to the underwriters has been exercised in full or has expired.  

(ii)Use of proceeds  

In practice, 85-100% of the gross proceeds of the IPO, together with those of the private placement prior to the IPO, will be held in a trust account.  As a market convention, the underwriters normally will agree that a certain portion of the underwriting discounts and commissions payable to them be put in the trust account as well, with a view to securing their position as advisors in either the SPAC’s future acquisition transactions or offerings.  This portion of the amount in the trust account will be released to the underwriters in the event of a business combination consummation, and will otherwise be waived by the underwriters and disbursed to the investors in the liquidation if the SPAC fails to complete any business combination.  A small portion of the proceeds and the interests accrued on the proceeds will be left outside the trust account and may be used to fund the SPAC’s operations for the following 18-24 month period and to consummate a business combination.  

The proceeds held in the trust account will only be released: (i) in order to consummate the business combination; (ii) when the SPAC is liquidated; or (iii) to the investors who vote against the proposed business combination that is eventually consummated, as discussed in more details below.  Before being released for any of the above listed purposes, the proceeds held in the trust account will generally only be invested in short-term U.S. government securities (e.g., the Treasury Bills issued by the U.S. government with maturity dates of 180 days or less), in order to prevent the SPACs from being classified as an “investment company” for the purpose of the Investment Company Act of 1940 (the “Investment Company Act”), and thereby subjecting the SPACs to under burdensome and comprehensive scheme of regulation and reporting obligation. [2]   

(iii)Listing

The Over-The-Counter Bulletin Board (the “OTCBB”) and AMEX were once the popular venues where SPACs could be listed and traded.  Having noticed the growing offering size and the increased popularity of SPACs, both the NYSE and NASDAQ amended their listing standards in order to allow SPACs to list on their exchanges in 2008.  The amended standards relaxed the requirements for listing companies without an operating history but impose certain additional conditions on SPACs.  These extra SPAC-specific conditions correspond, to a large extent, to Rule 419 of the Securities Act of 1933 and codify the “self-imposed” investor protections of the SPACs.  

(c)Business Combination 

SPACs must consummate the initial business combination within 18-24 months following the completion of the IPO.  If any letter of intent or definitive agreement with respect to a business combination has been entered into within such period, an additional period of time (typically six months) will be extended to allow for consummation of the transaction.  

(i)Fair market value of the Target

As a general requirement, the Target must meet the threshold requirement of having a fair market value of not less than 80% of the proceeds held in the trust account (excluding any deferred underwriting discounts and commissions) at the time of the business combination.  If the SPAC intends to purchase a portion of asset or business of the target, such portion of asset or business must have an aggregate fair market value of not less than 80% of the balance in the trust account (excluding any deferred underwriting discounts and commissions).  In any event, the SPAC must acquire the controlling interests of the Target’s business in order to complete the subsequent merger process.  

The board of directors of the SPAC is generally granted the power to independently determine whether the fair market value of a Target is equal to 80% of the balance then held in the trust account.  However, such determination must be made according to standards generally accepted by the financial community, such as actual and potential sales, earnings and cash flow, and book value.  In the event that the board is not able to independently determine that the Target has a sufficient fair market value, or if a conflict of interest exists (e.g., any member of the management is affiliated with the proposed target business), an independent opinion shall be sought from an unaffiliated investment banking firm with respect to whether the Target’s fair market value satisfies the threshold requirement.  A summary of the investment bank’s opinion, if sought, will be included in the proxy materials distributed to the public shareholders soliciting votes in connection with the proposed business combination.  

(ii)Shareholders’ approval 

SPACs generally build into their charter documents a provision providing that the execution of any proposed business combination will be subject to approval by public shareholders’ vote, even if the transaction itself does not require such an approval under the relevant applicable laws, so as to afford the public shareholders the right to re-affirm the investment decision.  Generally, in order for SPACs to proceed with the proposed business combination, it will require that (i) a majority of the common stocks voted by the public stockholders are in favor of the business combination, and (ii) the common stocks owned by the public stockholders voting against the business combination and exercising their conversion rights must not exceed a certain percentage (this percentage has traditionally been 20% but has trended up to 35-40% in certain offerings, which increases the likelihood for SPACs to proceed with the proposed business combination).  The sponsors of the SPACs will voluntarily agree to waive their independent voting rights attached to all of the shares they own, thereby leaving the power to decide the business combination entirely in the hands of public investors.  

In the proxy materials distributed to the shareholders to solicit their votes, a full disclosure of the Target including financial statements audited pursuant to the U.S. Generally Accepted Accounting Principles or the International Financial Reporting Standards and the terms for the proposed business combination must be included.  If the SPAC is incorporated in the U.S., it will be subject to the comprehensive proxy rules under Section 14 of the Exchange Act that regulates the disclosure furnished to shareholders when soliciting their proxies in connection with the shareholder meetings, including requirements for pre-filing with and review of materials by the SEC.  SPACs which are FPIs are exempt from the proxy rules and therefore, can prepare proxy materials pursuant to the laws of their home jurisdiction and can furnish the materials to the SEC after distributing them to the shareholders, without having to make a prior filing with the SEC for its review.  

Public shareholders generally will have three options when confronted with the proposed business combination of the SPAC: they may either vote “for” or “against” the proposal, or they can sell the shares of the SPAC on the open market.  Those public shareholders who vote against the proposed business combination, may exercise their “conversion right” to “opt-out” and convert their shares to the proportionate funds held in the trust accounts upon consummation of the business combination.  Recently, many SPACs have started to set limits (normally no lower than 10% of shares sold in the IPO) with respect to the maximum number of shares a public shareholder, or a group of shareholders acting in concert, can exercise under their conversion right, to restrict the accumulation of large blocks of shares before the vote held to approve a proposed business combination.   The objective of setting such limits is to prevent attempts to use the conversion right as a threat to force the SPAC (or the sponsors) to purchase accumulated shares at a significant premium.  

If a proposed business combination is approved by a majority of the shareholders, the SPAC will proceed with consummation of the transaction.  The business combination is typically structured as two major steps; first, the SPAC will acquire the equity interests or assets of the Target to acquire control, and then combine itself with the Target through a merger, or more often a “reverse merger”, thus creating the Surviving Company.  

Upon the consummation, the Surviving Company is the successor entity of the SPAC and continues on as the listing entity.  The shares of common stock of the SPAC are converted into shares of common stock of the Surviving Company on a one-to-one basis, and the warrants are assumed by the Surviving Company upon the same terms, and exercised for the shares of common stock of the Surviving Company.  The former SPAC’s directors and management will resign from the Surviving Company, and the directors and management of the Target will take control of and operate the Surviving Company.  

For SPACs initially quoted on the OTCBB, the Surviving Company may seek to move and list the stocks of the Surviving Company on the NYSE or NASDAQ after the business combination, in order to pursue higher liquidity and a better channel for any future financing.  

The shares and warrants of the sponsors of the former SPAC, which were deposited in the escrow account, will be released upon the consummation of the business combination and the expiration of the “lock-up” period. The warrants purchased by the sponsors through private placement in some cases are not subject to the forced redemption, which rewards them with a higher potential profit after the successful business combination as a return for the significant risks they have undertaken.   

(d)Liquidation 

If a SPAC fails to complete a business combination within the time limit, it is required to immediately commence dissolution and liquidation proceedings.  At the time of the liquidation, the amount that is returned to the public shareholders shall include the proceeds of the IPO and the private placements to the sponsors held in the trust account and the interests accrued therefrom, as well as deferred underwriting discounts and commissions.  The net assets held outside the trust account, after deducting the debts or liabilities owed by the SPAC and the relevant liquidation expenses, are also distributed to the public shareholders.  

In the event of liquidation, the sponsors do not participate in the liquidation distribution and thus lose their initial investment. Additionally, as the sponsors typically represent in the registration statement that they personally guarantee that the amount held in the trust account is not reduced by any claims brought against the SPAC, they risk additional liability if the potential Target that the SPAC attempts to acquire or any other third parties bring legal action against the SPAC. 

III.Conclusion

Forming a SPAC brings certain advantages to the parties involved.  In particular, SPACs provide:  

the sponsors with a legitimate means to raise capital from public investors to fund the acquisition of a Target, and motivates them to complete the business combination; 

the public investors with down-side protections and opportunities to participate in investments that are traditionally restricted to private equity funds ; and 

the Target with immediate funds for development, a quicker route for going public, as well as a channel for future financing. As a matter of fact, a number of Chinese companies have completed mergers with SPACs and listed on the U.S. capital market.   

On the other hand, there is also substantial risk that the SPAC may fail to consummate any business combination, in which case the sponsors will lose their investment funds and may even be liable for a significant amount of potential loss, and the investors and the Target will miss out on other business opportunities.    

 注释 

[1]https://www.spacanalytics.com/.

[2]The Investment Company Act defines an investment company as any issuer engaged in primarily the business of investing and trading in securities.  Also included in the definition is any issuer that is engaged in the business of investing, reinvesting, owning, holding and trading in securities and owns “investment securities” (that is, all securities other than U.S. government securities and securities issued by majority-owned subsidiaries of the owner that are not investment company) having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis.  If a SPAC is deemed an investment company, it will be subject to burdensome requirements including registering as an investment company, adopting certain specific forms of corporate structure, and reporting, record keeping, voting, proxy and disclosure requirements.  Also, it will be restricted on the nature of its investments and on the issuance of any securities.  

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白俊林律师本科毕业于北京理工大学，获得法学学士学位。随后，白律师先后取得英国利物浦大学法学硕士学位、美国西北大学法学硕士学位，以及美国西北大学凯洛格商学院工商管理课程学位。

白律师于2019年加入竞天公诚，成为合伙人。在加入竞天公诚之前，白律师曾在美国和中国领先的律师事务所工作多年，并在香港服务于大型金融机构担任法务合规总监。

白律师的主要业务领域包括私募股权投资、兼并与收购、境内外股票及债券的发行、企业重组、以及公司清算与破产等。

白律师拥有中华人民共和国律师资格和美国纽约州律师执业资格。白律师的工作语言是普通话、英文和粤语。

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