The prevalence of Special Purpose Acquisition Companies (SPACs) has expanded dramatically over the past year as organizations capitalize on a more streamlined path to public ownership. But key steps still must be taken and regulatory requirements still must be observed to protect shareholders. The U.S. Securities and Exchange Commission (SEC) is watching, and SPAC sponsors need to be ready for more regulatory scrutiny in 2021.
SEC staff recently issued guidance on ways SPAC sponsors can mitigate potential liability related to public offerings and subsequent acquisitions by clearly disclosing the potential for conflicts of interest and adverse shareholder outcomes in a manner similar to those long required of other nonstandard public investment vehicles.
The guidance, published on December 22 by the SEC’s Division of Corporation Finance, is not a rule, regulation or policy statement by the SEC, which has neither approved nor disapproved of the content. But while it does not carry the force of law, it is the strongest indicator, to date, that SPACs are on the commission’s radar and that SPAC sponsors need to be serious and well prepared with their reported disclosures.
A SPAC is a public company with no operations that offers securities for cash at a fixed price, typically $10 or $20 per share, and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies. Following its initial public offering, or IPO, the SPAC identifies acquisition candidates and attempts to complete one or more business combination transactions, after which the acquired company or companies essentially become the public company – thus, the view of SPAC transactions as an alternative to a traditional IPO for private companies. These actions are typically performed under deadline, requiring sponsors to return the cash to investors if the money isn’t invested within a predetermined amount of time, generally contractual at 18 to 24 months.
In its disclosure guidance, the SEC’s Division of Corporation Finance offers specific recommended disclosures that include the following:
Conflicts of Interest
- Outside interests – The economic interests of paid SPAC advisers – sponsors, board members, management and affiliates – often differ from the economic interests of public shareholders, which creates the potential for conflict when it comes to critical decisions, such as advisor compensation and the evaluation of targets for acquisition. Unlike a traditional public offering, where the market determines the value of a security, SPAC acquisitions are private, with SPAC advisors primarily responsible for determining how much to pay for a company. Similarly, sponsors, directors and officers may have contractual obligations with multiple SPACs, including entities that might compete for the same acquisition targets, or even a financial interest in a potential acquisition target. The SEC staff guidance recommends that the potential for any and all such conflicts be clearly disclosed and that the SPAC have a published policy for how such conflicts will be addressed.
- Financial incentives – If a SPAC does not complete a business combination transaction within the specified timeframe, it must liquidate and make a pro rata distribution of the net offering proceeds held in trust to its public shareholders. To that point, during 2020, a number of SPACs disclosed extensions from shareholders to buy more time to get a deal done. Thus, as a SPAC nears the end of that timeframe, its investment options may narrow, giving acquisition targets significant leverage in negotiating the terms of a business combination transaction. The SEC staff guidance recommends that SPACs attempt to quantify the financial impact of such a failure on sponsors, officers and directors, and clearly define how much direct control each of those individuals would have over an acquisition.
In addition to conflicts of interest, the guidance recommends specific disclosures regarding critical business decisions and changes to foundational documents, including:
- Control – The extent to which individual sponsors, officers or directors may assert their will over the approval of business combinations, and the process by which a SPAC might amend its governing instruments to facilitate a nonconforming combination, especially with regard to whether shareholder approval is required to make those changes.
- Liquidation – The circumstances under which a SPAC might extend the time it has to complete a business combination transaction, and to what extent, if any, shareholders would be offered the opportunity to redeem their shares in such an event.
- Track record – Balanced disclosure about the prior SPAC experience of sponsors, officers and affiliates, and the outcomes of prior business combination transactions and liquidations.
- Underwriting – SPAC IPO underwriters often defer compensation until closing of the business combination transaction. The guidance recommends disclosing any and all underwriting services, potential conflicts of interest, and fees that will need to be paid out of any liquidation or business combination proceeds.
- Securities ownership – Full disclosure of the individual investment stakes of sponsors, directors, officers and affiliates – including prices paid as well as any opportunities they may have had to purchase stock at a discounted price or receive financial incentives different from those available to public shareholders.
- Dilution/additional funding – If the SPAC plans to seek, or has obtained, additional funding subsequent to its IPO, or has provided anyone with the opportunity to purchase or invest in the SPAC at the time of a business combination transaction, the guidance recommends disclosing the terms of the securities issued, any participation of sponsors, directors, officers or affiliates in that offering, and whether the forward purchasing commitment is irrevocable.
- Acquisition/transaction details – SPAC sponsors, directors and officers may have evaluated a number of potential acquisition candidates before presenting a business combination transaction to shareholders. The guidance recommends providing details of that decision process, along with details of any additional financing associated with the transaction.
Essentially, the SEC Division of Corporation Finance staff is recommending that SPACs keep shareholders informed of anything that could potentially dilute or work against their financial interests – including management conflicts, additional financing, or business decisions that alter the terms of their original investment. There is a lot to unpack here, so it is definitely worth a look. Again, the complete guidance is available here.
For more information on SPACs:
“Almost everything you need to know about SPACs,” Connie Loizos, Tech Crunch, August 21, 2020.
“The Spectacular Rise Of SPACs: The Backwards IPO That’s Taking Over Wall Street,” Camila Domonoske, NPR, Dec. 29, 2020.
“SPACs Are The Hot Investment Trend For 2020. Should You Buy Into These Blank-Check Companies?” Simon Moore, Forbes, Aug. 31, 2020.