So far this year there have been 26 initial public offerings (IPOs) on AIM (excluding new listings where no capital was raised), raising a total of $1,299 million (19 June 2008, Dealogic). This compares with the same period in 2007, when more than three times that many IPOs raised over four times that much.
Will special purpose acquisition companies, or SPACs, be able to cause a few ripples in this relatively stagnant IPO market (see box, “SPAC listings”)? None of the listings so far this year have been SPACs, but there have been a number of high-profile listings of SPACs elsewhere.
SPACs are formed for the sole purpose of raising capital in an IPO (also known in the US as "blank check offerings") and using the proceeds to fund one or more mergers, acquisitions or business combinations, typically in a specific business sector. SPAC Analytics estimates that there are around 64 SPACs worldwide currently looking for an acquisition, with a combined $12.2 billion to spend.
SPACs have a limited window for making an acquisition, typically just 18 months, and the size of the pot currently available for investment has led to speculation about whether SPACs will start to play a more noticeable role in private M&A in 2008, as conventional private equity funds cut back on acquisitions in response to new limits on leverage (see box, “Doing deals with SPACs”).
A SPAC usually begins life as a company formed by a small group of sophisticated investors and managers (the founders). The company will be incorporated in a jurisdiction that is tax efficient, bearing in mind a number of factors including where its targets are likely to be situated (Delaware is common where possible targets are likely to be situated in the US; otherwise tax havens such as the Cayman Islands are commonly used).
The founders subscribe for shares for a nominal consideration, generally around $25,000. The number of shares subscribed for will generally entitle the founders to approximately 15-20% of the SPAC’s equity, following the IPO.
This is a generous (some would argue over-generous) incentive structure compared with conventional private equity, where management receive a share of the profits rather than the equity. However, Goldman Sachs failed to set a new precedent when it earmarked just 7.5% of equity for management in its SPAC, Liberty Lane Acquisition in March 2008. The offering had to be postponed indefinitely after it failed to attract sufficient investors.
The founders usually enter into a three-year escrow arrangement limiting their rights to transfer or dispose of their shares in the SPAC. SPACs listing on AIM are also subject to the usual requirement that directors and substantial shareholders may not deal in the company’s shares for a period of one year following admission (AIM Rule 7).
If a SPAC fails to find a suitable target for acquisition by the deadline, it is liquidated and the proceeds distributed to its shareholders. The founders’ shares carry only limited rights on liquidation.
Historically, none of the founders or their affiliates would receive salaries, management fees or finders’ fees before, or in connection with, the SPAC’s acquisition other than a nominal monthly charge (typically around $7,500) to cover office overheads.
To align more closely the interests of the founders with those of its other shareholders, some SPACs now allow or require founders to subscribe for additional units or purchase additional warrants in the IPO, typically amounting to around 3-5% of the gross proceeds. This creates a pool of working capital, and enables more of the proceeds of the IPO to be put into the trust fund (see "IPO proceeds placed on trust" below).
To raise capital for its acquisition, the SPAC will offer securities in an IPO. The securities will invariably be in the form of units, consisting of a combination of shares and warrants to subscribe for further shares at a discount to the IPO price.
Typical units comprise one share and one warrant to subscribe for one further share (exercisable on the later of a shareholder-approved acquisition by the SPAC or the first anniversary of the IPO). However, some recent SPACs, such as Liberty Acquisition Holdings, have offered just one half warrant per unit, in an effort to attract more longer-term investors than the usual hedge funds.
By investing in the units, investors in the IPO (the IPO shareholders) provide the SPAC with a cash pool to fund an acquisition in accordance with the terms set out in the offering circular and its constitutional documents. However, substantially all the proceeds of the IPO are held in a separate trust fund for the benefit of the SPAC’s IPO shareholders.
No withdrawals are permitted from the trust fund except on one of the following:
Completion of a shareholder-approved acquisition (or more than one such acquisition, in the case of an AIM SPAC) (see “Shareholder vote on acquisition” below).
Election by a shareholder of its right to have its shares repurchased by the SPAC when voting against a proposed acquisition (or a pro rata portion of its shares, in relation to an AIM SPAC proposing a second or subsequent acquisition).
Distribution on liquidation of the SPAC, if it has failed to complete an acquisition by the deadline.
Any expenses incurred before a shareholder-approved acquisition (other than expenses relating to the trust or taxes on interest earned by the trust fund) can be paid only from the proceeds to be withheld from the trust fund by the SPAC for working capital expenses.
Historically, this would have been 10-15% of the gross proceeds of the IPO, but this proportion has decreased in more recent SPACs and it is now common for 99-100% of the gross proceeds of the IPO (less brokers’ commissions) to be placed in the trust fund, leaving a very small pot of working capital.
In these instances, IPO expenses, taxes and other expenses in connection with pre-acquisition operations are funded through a combination of interest on the trust fund and the proceeds from subscriptions for units and purchases of warrants by the founders in the IPO.
In addition, underwriters defer a portion of their fees (in some cases as much as half) until a shareholder-approved acquisition is successfully completed. This also increases the potential pot to be distributed to the IPO shareholders if no acquisition is made.
One of the key investor protections offered by SPACs is that cash to fund an acquisition can be released from the trust fund only if a majority of the shareholders approve the acquisition. The founders will typically be required to vote their shares with the majority of the IPO shareholders (or do not vote on the acquisition), so that they cannot influence the outcome.
The other key investor protection is that, when voting against a proposed acquisition, shareholders have the right to elect to have their shares repurchased. In practice, this means that, even if a majority of the shareholders vote in favour of the acquisition and it goes ahead, shareholders who vote against the acquisition can elect to receive their share of the trust fund instead (repurchase rights).
More than a majority approval is required. Historically, SPACs could not proceed with an acquisition if 20% of their IPO shareholders exercised repurchase rights. A 30% threshold is now more typical, and it can be as high as 40%.
As a practical matter, even if the SPAC overcomes these hurdles (so that the acquisition has majority shareholder approval and fewer than the threshold number of shareholders exercise their repurchase rights), to complete its acquisition, the SPAC must also have sufficient cash resources left after it has paid out shareholders exercising repurchase rights to fund its working capital requirements as a listed vehicle.
If no acquisition is approved by the SPAC’s deadline, the SPAC is dissolved and the trust fund is distributed pro rata between the shareholders other than the founders. In practice, this means the IPO shareholders should get most, though not all, of their money back.
Rather like Monty Brewster, SPACs therefore have a limited period of time to spend their millions. The typical deadline is between 12 and 18 months from admission to complete a shareholder-approved acquisition.
Some SPACs have an initial deadline that is automatically extended for a further six months if a binding conditional letter of intent in relation to an acquisition is signed by the deadline. In some SPACs, shareholders can approve extensions (and exercise repurchase rights if voting against such extension).
While the deadline is primarily driven by what the market will bear, the market standard is partly driven by regulatory and stock exchange requirements.
Due to a number of investor frauds relating to forerunners of today's SPACs, US blank check companies are heavily regulated (Rule 419, US Securities Act of 1933). Today, while most US SPACs are structured to avoid having to comply with Rule 419, most endeavour to satisfy a number of its substantive requirements, which include giving investors the right to a refund if an acquisition is not completed within 18 months of the initial offering.
Neither AIM nor the American Stock Exchange (AMEX) stipulate a deadline, but when Nasdaq and the New York Stock Exchange (NYSE) recently changed their rules to permit SPACs to list, they set deadlines of 36 months.
The acceptance of longer deadlines by Nasdaq and NYSE is likely to encourage SPACs listing elsewhere to extend their acquisition deadlines. Investors are keen to ensure their money does not rest inactive for long periods, but they will probably welcome a general move towards longer deadlines.
The fact that the founders can be left with nothing if the SPAC fails to make a shareholder-approved acquisition by the deadline can create enormous pressure on the SPAC to do a deal and that may not always work in the IPO shareholders’ best interests. For example, in December 2007, Endeavour Acquisition, a US SPAC, had to agree to increase its consideration for retailer American Apparel because of the “growing time constraints” imposed by its 15 December 2007 deadline for completing a deal.
Most SPACs are listed in the US on the Over-the-Counter Bulletin Board, an electronic trading service offered by the National Association of Securities Dealers. Many also choose to list on AMEX to avoid the need to comply with local securities laws. As noted above, both Nasdaq and the NYSE have recently amended their rules to permit SPACs to list. It remains to be seen whether this will prove popular.
Listing in the US makes sense for SPACs, as their investors are predominantly US-based hedge funds. However, for some SPACs, listing on AIM or Euronext is an attractive alternative.
Nasdaq and the NYSE place specific requirements on SPACs over and above their standard listing criteria and, while AMEX does not place specific additional requirements on SPACs, like Nasdaq and NYSE it has ongoing corporate governance requirements that can be onerous for SPACs, which typically have small management teams.
By contrast, AIM offers a flexible regulatory approach. It does not impose any specific listing requirements on SPACs and, as a junior market aimed at young companies, it has proportionate corporate governance requirements (for background on AIM, see feature article, “Ready, AIM, fire! Floating on London's junior market”).
Perhaps more importantly, AIM does not require a company to have a trading record, a minimum number of shareholders or a particular percentage of shares in public hands.
In addition, listing a SPAC on AIM gives the management team flexibility to acquire a portfolio of smaller companies rather than making a single massive acquisition (in the US, SPACs must target a single company with a fair value of at least 80% of the SPAC’s net assets). For example, when shares in Titanium Asset Management was admitted to trading on AIM on 21 June 2007, the company planned to acquire two relatively small companies and certain contracts, based on existing letters of intent, as well as looking for another, larger target.
SPACs listing on AIM may need to seek derogation from certain specific AIM Rules. AIM is aware of these issues with SPACs and this is generally a technicality.
SPACs need to obtain derogation from:
Rule 8. Given that a SPAC has only a limited period in which to make an acquisition, which will in any event be subject to shareholder approval, a SPAC will want to obtain a derogation from the requirement to seek the consent of its shareholders for its investing strategy on an annual basis.
Rule 32. If the SPAC is a US company, it will need to obtain a derogation from the requirement that shares admitted to trading on AIM must be freely transferable. To avoid a need to register under the US Securities Act of 1933, the company's shares generally cannot be purchased by US investors for a “prohibited period” (usually two years) after the IPO (Reg S securities) (Regulation S, US Securities Act of 1933, as amended).
Rule 36. If the SPAC is a US company, it will need to obtain a derogation from the requirement that trades must be eligible for electronic settlement, as such trades generally need to be settled in paper form to ensure greater certainty that US investors do not purchase them during the prohibited period. However, it is hoped that changes are afoot to enable electronic settlement for Reg S securities for all investors via CREST (changes were introduced in July 2006 to assist with settlement for US shares) (for background, see News brief, “AIM: electronic settlement for US shares”).
Listing a SPAC on AIM is not without its drawbacks.
For US companies, paper settlement means that settlement is slow and this reduces the liquidity of the shares. For this reason, such trades often end up taking place off-market in the US amongst qualified institutional buyers.
In addition, the SPAC’s first acquisition will constitute a reverse takeover, which means that trading in the SPAC’s shares will be suspended following announcement that a takeover has been agreed or is in contemplation until the SPAC publishes an admission document in respect of the proposed enlarged entity (unless the target is a listed company or another AIM company) (AIM Rule 14).
AIM expects the negotiations leading to a reverse takeover to be kept confidential until the point at which the SPAC can announce that a binding agreement that effects the reverse takeover has been entered into. In practice, the SPAC will endeavour to ensure that the required admission document is published at the same time or as soon as possible thereafter, to minimise the period of time during which its shares are suspended.
It is in principle possible to avoid any suspension at all; market practice is a very short period of suspension, between 2 and 4 days. However, it is also possible for suspension to drag on in circumstances where, for example, a breach of confidentiality means that the SPAC has to make an early announcement before the reverse takeover has been fully negotiated. For this reason, it has been suggested that AIM may lose some non-US SPAC listings to Euronext, where suspension is not required.
Sara Catley, PLC.
The author would like to thank: Lena Hodge, a partner at Orrick, Herrington & Sutcliffe LLP whose SPAC clients include FutureFuel, Titanium Asset Management and Globe Specialty Metals; Ann Chamberlain, a partner at Bingham McCutchen LLP who advised on the first SPAC offering on Euronext (by Pan European Hotel Acquisition) and Paul Tetlow, a partner at Hunton & Williams who advised on mining SPAC Platinum Diversified Mining’s AIM listing.
The first SPACs emerged in the US in the 1980s but they fell out of favour after a series of investor scandals. SPACs incorporating new protections for investors began to re-emerge in 2003, and since then there have been a number of SPAC listings in the US, UK and Europe.
While none of the 26 listings on AIM so far this year have been SPACs, by the middle of May 2008 there had been 13 SPAC listings in the US, raising a total of $3.4 billion according to SPAC Analytics. This is not far off track to match the 36 listings for the full year 2006 but it is well below the 66 SPAC listings of 2007, which included the largest ever: a massive $1.03 billion listing by Liberty Acquisition Holdings in November 2007.
However, all but one of the 2008 listings were concentrated in the first quarter and, at the end of May 2008, Liberty Lane Acquisition, a SPAC underwritten by Goldman Sachs and designed to appeal to longer term investors, postponed indefinitely its $350 million IPO on the American Stock Exchange after failing to attract enough interest to provide a meaningful acquisition pot.
In Europe, the largest SPAC IPO took place on Euronext Amsterdam in January 2008, when Liberty International Acquisition raised €600 million, but had to cut back the size of the deal by 25% because of poor market conditions.
SPACs have a number of advantages and disadvantages doing deals in the current market.
Unlike conventional private equity investors, SPACs are not reliant on high yield debt to do their deals (although they may make use of leverage or offer shares as well as cash by way of consideration for an acquisition). In the absence of significant inflationary pressure, they are relatively immune from falls in share prices generally, as the value of their cash trust fund does not diminish in a falling market (which may enable them to get more for their money).
In addition, SPACs have a route to market for additional fund-raising and the flexibility to offer sellers some ongoing interest in the target, which is more liquid than their existing investment in either a limited partnership (if the seller is a private equity fund) or a private company.
SPACs also enable a company that cannot get an IPO off the ground to go public. In the largest SPAC acquisition of 2007, US SPAC Freedom Acquisitions paid $1 billion (funded partly from its IPO proceeds and partly from borrowings) and 230 million shares for a 28% holding in GLG Partners, the UK hedge fund, enabling GLG to go public at a time when other new listings were being pulled. The SPAC is attractive to such a target partly because it represents a pristine shell company with no legacy operations.
On the other hand, SPACs need to obtain shareholder approval for their acquisitions. This has generally left them at a disadvantage in competitive auction processes because it creates both delay and a level of deal risk. It also makes SPACs vulnerable to activist shareholders: one US SPAC recently had to offer some of its shareholders additional rights to get them to accept a proposed deal. Sellers also end up in a very strong bargaining position when a SPAC nears its deadline.