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SPAC: A Financing Tool with Something for Everyone Lola Miranda Hale

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posed business combihis article A special purpose acquisition company (SPAC) is nation. The investors reviews the typiare granted voting cal structures a shell company formed to raise capital for a rights to approve or employed in connecbusiness that will be acquired in the future. Manreject the business tion with special puragement, investors, and the target company can combination to achieve pose acquisition comall benefit from a SPAC—it has something for a guaranteed minimum pany (SPAC) initial everyone. © 2007 Wiley Periodicals, Inc. liquidation value per public offerings share in the event that (IPOs). The SPAC profor the latest details and develno business combination is vides a vehicle for experienced opment. effected. Thus, the investors’ and proven management to downside is minimized. Since obtain substantial capital to fund the SPAC shares and warrants their goals for the next phase of ALIGNING WITH INVESTORS’ trade freely in the marketplace, their careers and avoid the cost INTERESTS investors have liquidity. of an equity sponsor. The SPAC is structured so Investors may also reduce their A SPAC is a newly formed risk of loss by selling their warshell or blank check company— that management’s interests are rants in the open market and a company that has no operating closely aligned with the investors. Hedge funds find the reduce their cost basis in the business and minimal assets— structure attractive because it common stock below the converthat launches an initial public provides potential upside while sion price. The liquidity of the offering registered with the U.S. at the same time providing SPAC securities also enhances Securities and Exchange Comdownside protection. The lack of SPAC’s negotiating position mission (the SEC) in order to specificity in terms of industry when negotiating the business raise capital for a yet unidentiand targets is not an issue, since combination. The target compafied business to be acquired ny can receive immediate capital within a specified time period. If hedge funds typically do not have the strict portfolio guideraised through the IPO. the business is not acquired The fact that there is no within the specified time period, lines institutional investors have. The SPAC provides investors business or acquisition identified the net proceeds of the offering with potential access to acquisimakes the registration and disare returned to the investors. tions and buyouts, which are closure process for a SPAC The information in this artitypically restricted to private much less complex than in a typcle was current when the article equity funds. Investors are given ical IPO of an ongoing operating was written and edited in Sepfull disclosure of the target busi- business. tember 2006. However, this is a SPAC offerings are typically very fast-moving area of the law. ness, including audited financial statements and terms of the pro- done on the basis of a firm comConsult your corporate attorney © 2007 Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com). DOI 10.1002/jcaf.20278

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also been listed on the American mitment underwriting. As one Stock Exchange. might expect, the key to attractThe SPAC is a vehicle that ing the underwriter and the success of the offering is the quality has been around for a number of years but has within the last three and depth of management. Usuyears seen a substantial increase ally, there are three or more management team members. The in utilization. The first wave occurred in the 1990s. The first types of executives that have generation of SPACs was smallerbeen involved in SPACs include sized deals and often involved a executives who have been sucreverse merger. According to pubcessful in building companies, lic records from August 2003 to principals at successful private June 30, 2006, there were approxequity firms, and successful imately 64 similarly structured investment bankers experienced blank check companies that had in interacting with the investcompleted initial public offerings ment community, each of whom for a total capital raise of $4 bilhas sufficient wealth to meet financial obligations imposed on lion. Of that number, seven had actually completed a business them in connection with the offering. SPAC offerings range SPAC offerings range from being from being rather specific rather specific about the industry about the industry and type of business the entity seeks and type of business the entity seeks to acquire to not imposing to acquire to not imposing any any restrictions whatsoevrestrictions whatsoever. er. The SPAC may also target companies in a particular geographic location. combination and an additional 20 Recently, in response to market had announced execution of pressures, SPACs are more spedefinitive agreements for a busicific as to the industries in ness combination but had not yet which they will seek targets, related to the experience of man- consummated these transactions. From September 2005 through agement identified in the prospectus. One of the drivers of May 31, 2006, the size of the offerings ranged from a low of the specificity is the need for $36 million to $225 million. traditional institutions, which have been one of the active investors in SPACs, to determine BUSINESS ACQUISITION how an investment fits into their DEADLINE AND TRUST portfolio. ACCOUNT FOR PROCEEDS As outlined below, the regisPENDING ACQUISITION tered offerings are structured to avoid the application of Securities Typically, there is a selfAct of 1933 Rule 419. As thus imposed requirement to acquire structured, the units offered in the a business within 18 to 24 IPO may trade immediately, and months after the effective date of the warrants, after a self-imposed the offering, and approximately set period, may trade separately 90 percent (recently 97–98 perfrom the common stock. cent) of the proceeds of the A number of the SPACs are offering are placed in a trust traded in the OTC Bulletin account pending closing of an Board (OTCBB), and a few have acquisition, or if no acquisition DOI 10.1002/jcaf

transaction is completed, the SPAC is liquidated. The amount needed to cover the underwriters’ discount, expenses of the offering, and money for working capital can range from 8 percent to 15 percent of the offering proceeds. In recent offerings, 25 percent of the underwriters’ discount is deposited in the trust as well (approximately 2 percent of gross offering proceeds). The offering proceeds held in trust are not released until either the completion of a business combination or liquidation of the SPAC, whichever is earlier. Proceeds held in the trust are not available for any expenses related to the offering or expenses incurred related to the investigation and selection of a target business and negotiation of an agreement to acquire a target business. These expenses are payable only from net proceeds of the offering not held in the trust account or from interest earned on the principal in the trust account up to some preset maximum. SPACs will typically include a requirement that management have “skin in the game,” which is accomplished by means of a private placement of the SPACs’ securities with management on the date of the prospectus or a purchase of warrants in the offering. A portion of the proceeds from the private placement of the SPAC securities with management is also used to help fund expenses, and the rest is deposited in the trust.

SECURITIES STRUCTURE The typical structure involves the offering of a unit consisting of common stock and one or two separate warrants for common stock. © 2007 Wiley Periodicals, Inc.

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In a two-warrant unit, the unit price is $6, including one share of common stock and two warrants. In a one-warrant unit, the price is typically $8, with one common share and one warrant. An important element of the economics is that the warrants may trade separately from the common stock 90 days after the effective date of the offering. The warrants may also trade separately sooner if certain conditions are met and the underwriters give their consent. The warrants are not exercisable until after consummation of a business combination. Separate trading of warrants and common stock begins after the filing of a balance sheet, reflecting receipt of the gross proceeds in the SEC Current Report on Form 8-K.

Warrants Typically, each warrant entitles the holder to purchase one share of common stock at a price of $5 each and becomes exercisable on the later of the completion of a business combination or one year after the effective date of the offering. The warrants typically expire 3 to 5 years after the effective date of the offering or earlier in the event of redemption. In the event the SPAC is liquidated, the warrants will expire worthless.

Redemption Redemption is typically permitted after the warrants become exercisable only with the prior consent of the underwriters’ representative. The price is nominal (i.e., $.01 per warrant). There is a minimum of 30 days’ prior written notice of redemption, which can only be effected if the last sale price of the common © 2007 Wiley Periodicals, Inc.

stock equals or exceeds a hurdle number trading at a premium over the offering price—for example, 140 percent of the offering price for a period of 20 days within a 30-day trading period ending three business days before the notice of redemption is received.

Separate Trading Once SPAC registration is declared effective, it files a Current Report on Form 8-K containing an audited balance sheet reflecting the proceeds of the offering including the underwriters’ overallotment option, if

Redemption is typically permitted after the warrants become exercisable only with the prior consent of the underwriters’ representative. exercised. Thereafter, the units are separated into common stock, warrants, and the unit itself—which then trade separately.

Underwriting Underwriters offering SPACs include Morgan Joseph, Blue Bird Capital, Deutsche Bank Securities, and Ferris, Baker Watts Inc. The underwriting discounts are typically around 7–7.5 percent of the public offering price. Recently, a portion of the underwriters’ discounts and commissions (2 percent of the offering proceeds) are deposited in the trust account and released to the underwriters upon the consummation of a business combination or to the public stockholders upon liquidation of the SPAC. The underwriters are also typically granted options for

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$100 to purchase up to 5 to 10 percent of the offering at 125–150 percent of the offering price. A nonaccountable expense allowance in the amount of approximately 2 percent of the gross proceeds is also typical. A portion of this allowance is also deposited in the trust account. If the underwriting is with a fullservice firm such as Morgan Joseph or Deutsche Bank, the firm can provide additional financial services including advising with respect to potential targets. The exercise price of underwriters’ warrants is 120–125 percent of the exercise price of the warrant included as part of the offering units. In addition, the overallotment option enables the underwriter to purchase, within 30–45 days of the date of the prospectus, up to 15 percent of the total offering at the offering price, less the underwriting discounts. The National Association of Securities Dealers (NASD) considers the underwriters’ option and the shares and warrants underlying the units as compensation and therefore subject to a 180-day lockup pursuant to Rule 2710(g) (i) of the NASD Conduct Rules. The option may not be sold, transferred, assigned, pledged, or hypothecated (given as a pledge for debt) for a oneyear period following the effective date except to any underwriter or selected dealer participating in the offering and their bona fide officers and partners. The option and underlying securities are registered under the same registration statement as the public units. The option grants, to the holders, demand and “piggyback” registration rights for periods ranging from DOI 10.1002/jcaf

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five to seven years from the date of the prospectus. The exercise price and number of units issuable upon exercise may be adjusted in certain circumstances, but not for issuances of common stock at a price below its exercise price. The underwriter may also be granted the right to have an observer present at all board meetings at least until the business combination is consummated.

PROMOTERS-INITIAL SHAREHOLDERS/MANAGEMENT Initial Share Ownership The initial shareholders typically own 100 percent at the commencement and 20 percent of the outstanding shares upon completion of the public offering, plus whatever amount they and management purchase in the private placement effected on the same date as the prospectus. The initial 20 percent is typically issued for the purchase price of approximately 1 cent per share and will have demand and piggyback registration rights, which are exercisable at any time commencing three months prior to the date on which the shares of common stock are released from escrow.

Escrow of Management and Initial Stockholders’ Shares Management and the initial stockholders typically are required to deposit the shares owned before the offering and the shares acquired in the private placement into an escrow account with the underwriter. The shares are not transferable during the escrow period, except for certain estate planning transDOI 10.1002/jcaf

fers, and are held until a set date—for example, three years after the offering or six months after the initial transaction is closed, earlier if there is a subsequent transaction that involves an exchange for stock. The release time can vary from deal to deal. In the event the SPAC must be liquidated for failure to acquire a business within the deadline, initial stockholders do not participate in any liquidation distribution occurring upon the failure to consummate an initial transaction with respect to shares of common stock acquired by them prior to the offering. They

In 2006 transactions, management has been required to acquire stock or the warrants in a private placement as of the date of the prospectus. may, however, participate in any liquidation distribution with respect to any shares issued in the offering, which they acquire following the offering. The stockholders depositing their shares in escrow retain all other rights as stockholders, including the right to vote the shares of common stock and the right to receive cash dividends if declared. If dividends are declared and payable on the shares of common stock, dividends will also be placed in escrow.

Commitment to Acquire Securities in a Private Placement or to Buy Public Warrants In most of the SPACs offered to date, management is required to commit to purchase stock and/or warrants. Until the

latter part of 2005, that commitment was principally to purchase warrants within 90 days of completion of the offering after the warrants trade separately in an amount somewhere under 2 percent of the total offering (10 percent of outstanding warrants once trading commences) at a price per warrant not to exceed a set ceiling. The commitment had to be met within 90 trading days beginning on the date that the warrants begin to trade separately. These securities may not be sold or transferred until after completion of the initial acquisition transaction. The requirement of the promoters or management to purchase units in the offering is effected in accordance with the guidelines that are specified under Rule 10b51 under the Securities Exchange Act of 1934. A broker dealer who has not participated in the offering is used to make the purchases of the warrants on behalf of management pursuant to an irrevocable order in such amounts and at such times that the broker dealer may determine, at its sole discretion. In 2006 transactions, management has been required to acquire stock or the warrants in a private placement as of the date of the prospectus. A portion of those proceeds is deposited in the trust account. This is primarily in response to the increase in the size of the trust fund from 90 percent of the proceeds to 95 or 98 percent. A portion of the private placement proceeds may be used to cover the printing and legal costs of the offering, working capital, and due diligence expenses in connection with a business combination. © 2007 Wiley Periodicals, Inc.

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Voting Agreements Initial shareholders, officers, and directors agree to vote their initial shares with the majority of the public shareholders in connection with any proposed approval of a business combination. Initial shareholders do not have a conversion right even if they purchase units in the aftermarket. The officers and directors waive the right to receive distributions with respect to their initial shares in the event a business combination is not effected. This waiver does not extend to any shares of stock acquired in the aftermarket.

Promoters’ Advance of Funds An advance of funds from the promoters to cover start-up and offering expenses can typically range from $75,000 to $100,000.

Restrictions on Transfer of Initial Shares The initial shares outstanding prior to the offering and those acquired in a private placement on the date of the prospectus are restricted shares under the 1933 Act Rule 144 since they are typically issued in private transactions not involving a public offering. None of those shares are eligible for sale under Rule 144 until they have been held at least one year from the date of original issuance and payment in full. The SPAC has to have been subject to and in compliance with the reporting requirements of the Section 13 of the Securities Exchange Act of 1934 for a period of at least 90 days immediately preceding the sale of the securities. © 2007 Wiley Periodicals, Inc.

In any event, those shares and those owned by all officers and directors will have been placed in escrow and typically are not transferable for a period of at least six months after consummation of a business combination.

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tions. In some SPACs, there may also be a payment to an affiliate of a stockholder for providing limited administrative, technology, and secretarial services. No finders’ fees can be paid to the insiders.

Conflicts Compensation of Initial Shareholders and Management Typically, no compensation of any kind, including finders’ and consulting fees, are paid to existing stockholders and any new officers or directors or any of their respective affiliates for

In some SPACs, the initial shareholders may provide a capital line to the SPAC to pay management’s salaries.

services rendered prior to or in connection with the business combination. In some SPACs, the initial shareholders may provide a capital line to the SPAC to pay management’s salaries. The capital funded by management can be sourced from a combination of (1) the purchase of SPAC securities by the initial shareholders and management in a private placement, (2) lines of credit for working capital, and also (3) the purchase of warrants in the offering.

Reimbursement of Expenses Existing stockholders, officers, and directors are reimbursed for any out-of-pocket expenses incurred in connection with activities on behalf of the SPAC such as identifying and performing due diligence on suitable business combina-

The officers and directors of the SPAC are not required to commit their full time to the SPAC and consequently may have conflicts in allocating their time among various business activities. Officers and directors are free to become affiliated with other entities, including other blank check companies engaged in business activities similar to those intended to be conducted by the SPAC. Directors typically own shares of SPAC common stock that will only be released from escrow if a business combination is successfully completed and may also have warrants that will expire worthless if the business combination is not consummated. In addition, until consummation of a business combination, management is typically not compensated. Arguably, these factors create an incentive to complete a business combination whether or not it is the optimal choice. To minimize potential conflicts from multiple corporate affiliations, officers and directors agree, until the business combination, liquidation, or such time as he or she ceases to be an officer or director, whichever is earliest, to present to the SPAC prior to any other entity any business opportunity that may reasonably be required to be presented to the SPAC under Delaware law, subject to any preexisting fiduciary obligations he DOI 10.1002/jcaf

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or she might have. It is important, therefore, to determine whether management is subject to noncompete or other restrictive covenants from their other affiliations. To minimize conflicts, the SPAC will agree not to consummate a business combination with an entity that is affiliated with existing stockholders, officers, and directors unless an opinion is obtained from an independent investment banking firm that the business combination is fair to the stockholder from a financial point of view.

BUSINESS ACQUISITION

Stockholder Approval of Business Combination After the SPAC has entered into a definitive agreement for its business combination, a proxy statement fully disclosing the transaction is disseminated to SPAC stockholders. Public stockholders are given the right to vote in favor of the transaction or to exercise conversion rights. There is typically a requirement that less than 20 percent of the shares sold in the offering exercise their conversion rights. Public stockholders may, instead of exercising conversion rights, elect to sell their

The initial target must Management will typically remain have a fair market value involved with the SPAC following the equal to at least 80 percent of the net assets initial transaction although manage(excluding the amount ment is not generally obligated to held in the trust account do so. representing a portion of the underwriters’ discount) at the time of such shares in the open market if the acquisition. The value is deterprice is more favorable than the mined by the board of directors per-share liquidation value. based on generally accepted Whether or not it is standards. Due to the 80 percent required under applicable state requirement, it is possible that the SPAC, initially, will only be law, the business combination will not be effected if it does able to effect a single business combination and, therefore, will not receive the approval of the majority of the stockholders. lack business diversification. Existing stockholders agree to In some circumstances, an opinion is obtained from an unaf- vote shares of common stock owned by them immediately filiated independent investment banking firm that is a member of before the offering, in accorthe National Association of Secu- dance with the majority of the rities Dealers with respect to sat- shares of common stock voted by the public stockholders. isfaction of the criteria. Copies The obligation to seek stockof such an opinion are not automatically distributed to the stock- holder approval of a business holders, although copies could be combination may delay or threaten the completion of a transacprovided upon request. tion and/or make it less likely a Management will typically potential target will want to enter remain involved with the SPAC into an acquisition agreement following the initial transaction with the SPAC and place the although management is not SPAC at a competitive disadvangenerally obligated to do so. DOI 10.1002/jcaf

tage if successfully negotiating a business combination. This is offset by the fact that in dealing with a target that is privately held, the SPAC status as a wellfinanced public entity may give it a competitive advantage over entities that are seeking to acquire a target with significant growth potential on favorable terms, which are not public and are well capitalized. The business combination could take any number of forms such as a merger, capital stock exchange, asset or stock acquisition, or other similar business combination. The business combination can involve one or more operating businesses, portfolios of financial assets or real estate, or other assets.

Conversion Right Public stockholders voting against a business combination are typically entitled to convert their stock into a pro rata share of the trust account including any interest earned on their portion of the trust account, if the business combination is approved and completed. Initial stockholders do not typically have such a conversion right with respect to any shares owned by them directly or indirectly. In addition, officers and directors typically will not have conversion rights to the extent that they receive shares upon distribution from the initial shareholders or purchase any shares in the private placement, in the offering or the aftermarket. The conversion right is equal to the amount in the trust account, inclusive of any interest (calculated as of two business days prior to the consummation © 2007 Wiley Periodicals, Inc.

The Journal of Corporate Accounting & Finance / January/February 2007

of the proposed initial transaction), divided by the number of shares of common stock sold in the public offering. Public stockholders continue to have the right to exercise any warrants they may hold even after exercise of the conversion right. The conversion right excludes the amount held in the trust account representing a portion of the underwriter’s discount. The portion of the underwriter’s discount that is placed in the trust account is set aside for possible distribution to investors if liquidation occurs prior to the consummation of an initial transaction. Trust proceeds would not be released prior to whichever is earlier: the completion of an initial transaction or liquidation.

Liquidation In a typical offering, liquidation will occur if a business combination is not effected within 12 to 18 months after consummation of the offering. That period is extended if a letter of intent, agreement in principle, or definitive agreement has been executed within a specified period (12 to 18 months) after consummation of the offering. In such an event, liquidation will also occur, if within a specified period (18 to 24 months) from the consummation of the offering, the business combination has not yet been consummated. Officers and directors owning common stock in the SPAC waive their right to receive a distribution (other than with respect to common stock they may acquire in the aftermarket) upon liquidation prior to a business combination. No distribution from the trust account with respect to the warrants is made, and all rights with © 2007 Wiley Periodicals, Inc.

respect to the warrants effectively cease upon liquidation. If liquidation occurs, public stockholders will receive less than the offering price per share upon distribution, and the warrants expire worthless. The amounts held in trust are subject to the claims of creditors. The expense of liquidation, estimated at $50,000 to $75,000 is payable out of the trust funds and the interest earned on the principal and from assets remaining outside of the trust fund.

Additional Financing for Acquisitions The SPAC reserves the right in connection with any acquisition to obtain additional financ-

There is a requirement that the market value of the initial business acquired be at least 80 percent of all the net assets in the offering. ing through borrowings or private debt or equity offering of securities. There is a requirement that the market value of the initial business acquired be at least 80 percent of all the net assets in the offering. Consequently, only a single acquisition will usually be initially effected. Upon completion of the initial business combination, some SPACs may finance a portion of the purchase price of additional assets, effect cost reductions, and make complimentary acquisitions and divestitures of nonstrategic assets in order to enhance shareholder value. Most will use leverage to finance a significant portion of the acquisition or acquisitions the SPAC will make.

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EXPENSES OF OFFERING Expenses of the offering excluding underwriting discounts could exceed $600,000. Management typically will be required to advance some funds to pay a portion of the expenses of the offering. The advances are repaid out of the proceeds of the offering not being placed in trust. The legal fees are typically in the $350,000 to $400,000 range, printing and engraving from $60,000 to $100,000, and accounting fees and expenses of $25–$30,000, plus the SEC registration fee, which varies depending on the size of the offering.

LISTING ON AN EXCHANGE AND COMPLIANCE WITH SARBANES-OXLEY SPACs listed on the AMEX and NASDAQ have the benefit of preemption from the state registration requirements. SPAC securities listed on the OTCBB must register in those states where offers and sales will occur. Due to the provisions of state securities laws, unlisted SPACs may only be sold in about 11 states. Subsequent to the registered offering, a SPAC may register the units’ common stock and warrants under the 1934 Act and, therefore, become subject to reporting obligations, including the requirement to file annual and quarterly reports with the SEC. As required by the 1934 Act, annual reports must contain financial statements audited and reported on by the independent accountants. Thus, the SPAC would not acquire a target in the business combination if audited financial statements based on the United States’ generally DOI 10.1002/jcaf

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accepted accounting principles (GAAP) could not be obtained for the target. The audited financial statements prepared in accordance with GAAP are included in the proxy solicitation materials sent to the stockholders. For SPACs that will be listed on an exchange and registered under the 1934 Act, consideration needs to be given to the extent to which Sarbanes-Oxley will become immediately applicable as well as the corporate governance rules of the applicable exchange. A review needs to be made to ensure that the target company is compliant, on a timely basis, with the requirements of the Sarbanes-Oxley Act of 2002. Generally those requirements relate to: 1, Director independence—the requirement that a majority of directors be independent directors; 2. The establishment of an audit committee, each of

whose members is an independent director and financially literate with at least one member who has past employment experience in finance or accounting, requisite professional certification and accounting, or the comparable experience of background that results in the individual’s financial sophistication; 3. The establishment of a nominating committee of the board of directors consisting of independent directors; and 4. The adoption of a code of ethics that applies to all executive officers, directors, and employees, and that codifies the business and ethical principles that govern all aspects of the SPAC’s business.

AVOIDING THE SEC RULE 419 Not being subject to SEC Rule 419 enables the units to

become immediately tradable and gives the SPAC additional time to complete the initial transaction. The SPACs are structured to avoid SEC Rule 419 by having net tangible assets in excess of $5,000,000 upon successful consummation of the offering and by filing a Current Report on Form 8K with the SEC, including an audited balance sheet demonstrating that fact.

SOMETHING FOR EVERYONE The SPAC is a financing tool that has something for management, investors, and the target companies. The SPAC vehicle provides an avenue for management to capitalize on their industry expertise and experience. The SPAC also provides target companies with a new publicly available pool of potential buyers. The vehicle provides investors with an investment with upside potential and downside guarantees.

Lola Miranda Hale, a corporate securities attorney and lecturer with Epstein Becker & Green, P.C. in Chicago, leads the firm’s corporate and securities practice. She counsels on federal and state securities, mergers and acquisitions, and corporate governance matters. She advises public and private companies in connection with corporate, finance, and securities transactions, including equity, debt, and primary and secondary public and private offerings. In addition, Hale advises public companies on compliance with securities law disclosure, filing, and reporting under federal securities laws. She also represents companies seeking venture capital, and venture capital firms in connection with their portfolio acquisitions. Feel free to contact Lola Hale at [email protected].

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© 2007 Wiley Periodicals, Inc.