1. 2020: The Year of SPACs
The year 2020 has been defined as the “year of SPACs.”[1] SPACs, Special Purpose Acquisition Companies, are raising more money and outnumbering traditional initial public offerings (IPOs). As of August 2020, SPACs have attracted $60 billion of capital across more than 100 SPACs and made up 111 of U.S. IPOs.[2] 2020 closed with 248 SPACs which raised around $83 billion through IPOs.[3]
Since the start of 2021, SPACs have already raised $38.3 billion, compared with the $19.8 billion raised so far by traditional IPOs.[4] SPACs are on everyone’s mind. Think of Colin Kaepernick, who recently formed a SPAC with an eye on social justice in order to create meaningful financial and societal value.[5] Sometimes SPACs have made a ‘deal in heaven’ if we think of Bill Ackman with his $4 billion SPAC; Michael Klein with his four Churchill Capital SPACs; Shaquille O’Neal;[6] the former U.S. House speaker Paul Ryan;[7] Gores Group (a Californian-based private equity firm);[8] Harry Sloan;[9] the French billionaire Xavier Niel;[10] the former Facebook executive Chamath Palihapitiya;[11] and now in March 2021, the banker Ken Moelis,[12] who has filed for three new SPACs seeking to raise $1.2 billion total to find targets in sectors including sports betting and online gaming. The list could continue infinitively.
Every day we receive news regarding SPACs. Sometimes we hear bad news such as news about share devaluation,[13] or articles criticising SPACs’ opaque structures[14] and value destruction mechanisms, and sometimes in articles that promise to identify SPACs as the next dotcom bubble[15] or solely as the next bubble to burst.[16]
Those who dislike or oppose unconventional ideas, such as the SPAC, mainly argue that SPACs are dangerous investment tools, and that they represent hazards against common wisdom. These people see the traditional IPO as the sole legitimate process to provide a company with full compliance and disclosure to access capital markets.[17]
I first wrote about SPACs in 2014, describing them as new tools of market liquidity and promoting a new “M&A era.”[18] Subsequently, in 2017, I predicted the SPAC-boom and was awarded with the Colin B. Picker Prize by the American Society of Comparative Law.[19] Hence, the reader can see I am a firm believer and supporter of the SPAC.
Here, I shall argue that it seems that the “SPAC saga” is not destined to end but rather to consolidate market shares in the economy through completion of business combinations as well as to provide investors and sponsors with a viable alternative to private equity and traditional IPOs. In other words, the importance and legitimacy of SPACs is becoming a compelling reality today, and it is imposing a new economic order through which for instance, start-ups and tech companies can finally compete with well renowned companies, such as Airbnb or Facebook, to access public markets. To this end, I cannot deny that SPACs are a form of equality distribution too.
2. What is a SPAC and the Promote
Special Purpose Acquisition Companies are cash-shell companies set up, as their name indicates, with a special purpose: to conduct an acquisition.[20] The capital is raised via an IPO of unit securities composed of common shares and warrants. The gross proceeds net of any up-front underwriting fees, operating expenses, and working capital, are put into an independent trust or escrow until the acquisition takes place. The acquisition phase–where the capital is drawn-down—is defined in the specific SPAC jargon as “De-SPAC” or “De-SPACing,” which ends with the liquidation of the vehicle. The acquisition and the subsequent release of funds for the acquisition generally take place within 24 to 36 months from the incorporation of the SPAC. This period can vary depending on the practices of the exchange and the jurisdiction in which the SPAC is listed. In the case of failure of the acquisition, the SPAC will be wound up and the funds returned to investors.
For these reasons, it is said that SPACs are risk-free investments[21] because they present a risk-free opportunity to their initial investors. In fact, investors are guaranteed full redemption of funds from the escrow account until the acquisition materialises (for example, in 2008 HD Partners Acquisition Corp was dissolved after shareholders did not approve an acquisition, or in 2009 the board of directors of Highlands Acquisition Corp. approved a liquidation plan after the impossibility of finding a profitable business combination, or on 22 September 2020 the liquidation of LF Capital Acquisition Corp. was avoided through a proxy solicitation to vote in favour of an extension to the original liquidation date that was meant to be on 22 June 2020).
Once the SPAC issues units composed of common shares and warrants, SPAC managers or sponsors usually acquire 25% of the capital raised for a nominal value (often $25.000 that equals approximately to $0.0035 or $0.00435 per share as well as a reserved offer of founders shares for a symbolic par value per share such as $0.0001). Usually, all warrants in a SPAC are tradable and detachable until the moment of business combination to make this appealable to investors, and especially, as some would like to claim: to hedge funds.[22]
The mechanism is simple: SPACs aim to get a private company public by virtue of a reverse or direct merger. For this reason, some identify SPACs as “backdoor listings.”[23] At merger time, the SPAC shares maintain their $10 nominal value. However, the real value drops due to dilution when the merger occurs. For all shareholders, dilution arises from paying the sponsor’s fee in shares (called the “promote,” often about 20% of the equity).[24]
Summing up, SPAC sponsors receive a promote which typically grants them equity in the SPAC equal to 25% of the capital raised or 20% of the fully-diluted SPAC shares. This is what has been defined as the sponsor compensation or sometimes in a critical way as the SPAC bonanza.[25] Indeed, for example Michael Klein had more than $60 million from a $25,000 investment in his founders shares in June 2020 (the merger between Churchill Capital Corp. IV and Clarivate Analytics PLC). It means that the initial investment of $25,000 converts into a slice of equity of the new merged entity when the SPAC finalises a business combination. The main reason to justify the promote has been its construction as compensation for the management’s efforts in finding the target company and executing the merger.
3. Bill Ackman and the Tontine Warrants
Bill Ackman has redesigned the terms for SPACs through his SPAC, Pershing Square Tontine Holdings (“Pershing Square”), that has sponsored the largest SPAC ever raised.
The structure of Pershing Square is unique:
- Each unit is composed of one share of common stock, and one-ninth of a redeemable warrant exercisable at $23.
- Two-ninths of a warrant exercisable at $23 provided that are not redeemed in connection with a proposed business combination.[27]
Essentially, the Pershing Square structure is based on raising $4 billion by offering 200 million units at $20 per share[28]. This is already uncommon for a traditional SPAC that usually sells its units at $10 per share. The real revolution is on the second point above. Indeed, it means that one-ninth of a warrant is detachable, a normal incentive for SPAC investors. However, as opposed to a traditional SPAC, where all warrants are detachable, here:
- Two-thirds of the warrants issued to shareholders are not detachable, encouraging long term investors.
- Investors do not receive these two-thirds of warrant if they choose to redeem their stock prior to the closing of the business combination. This provides the acquisition model with more certainty.
- If investors redeem, their warrants are distributed pro-rata to the shareholders who remain in the SPAC (here the name “Tontine holdings”).
Finally, the compensation terms of the sponsors are new too. As we said, typically SPAC sponsors receive 20% of the shares in the SPAC for a nominal value. The founders’ shares compensate the sponsor even when the value of shares decline due to market volatility once listed. With Pershing Square, the sponsor is not taking any founders shares. Indeed, under Pershing Square’s warrant structure, the sponsor does not receive any compensation until shareholders receive a 20% return, whereas, under a typical founders’ shares compensation structure, the shareholders do not see any return until after the company receives a 20% return. Finally, Pershing Square has paid $67.8 million for these warrantsThat money will not give back to the sponsor if a business combination is not procured and closed.
Having said that, Bill Ackman’s SPAC stands alone. In SPACs, it cannot be said that “one size fits all.” Indeed, it is unlikely that this structure will be used as a model or market practice for future SPACs due to its uniqueness in terms of creating alternative investors’ incentives (the “tontine warrants”), while compensating the sponsor based on performance[29]. In particular, the average SPAC cannot afford to sustain the costs of such a mechanism due to the lock-up provisions in relation to the majority of warrants, a very stringent requirement on the side of investors. Freedom is key in SPAC deals.
4. Conclusions
By definition, in a financial crisis, unregulated market practices can be often seen as trigger (or at least as an amplifier). However, regulators have mostly focused their attention on managing crises’ effects rather than regulating A direct instance can be observed in the 2007-2010 crisis when a lack of proper regulation of the over-the-counter (“OTC”) derivatives market and subprime mortgages prompted the enactment of legislation focused on financial stability effects rather than on triggers profiling.
As opposed to the 2007-2010 financial crisis, SPACs’ main evolutionary market trends are disciplined by the regulator (so far, mainly the SEC) and listing requirements (the Rule 102.6 under the NYSE and the Rule IM-5101-2 under the NASDAQ) i.e., the exchanges where they are listed. Hence, the trigger has been expressly codified. However, it cannot be denied that SPACs pose a risk like any other similar investment vehicles, as risks cannot be completely eradicated. However, these risks can be curtailed through proper contractual risk allocation and enhanced governance.
As George Akerlof would argue, it is difficult to spot a “bad lemon” in the lemon market with the only possible indicator or signal being the premium price.[30] In SPACs, premium prices do not exist because the offering is always at $10 per unit, hence they all look the same in terms of pricing of securities Having said that, SPACs greatly differ on the side of management, although personal competences cannot be quantified or calculated in terms of risk (being subjective personal features of single individuals unmeasurable). Hence, SPACs are imbued with uncertainty, that is the subjective feature of risk, and can lead investors to irrational investment decisions. Nonetheless, as Frank Knight once argued, there is no profit without uncertainty.[31] Many disbelievers of SPACs shall blame our own Western economic system based on profit and uncertainty[32] rather than identifying SPACs as the main issue of a possible financial collapse. In other words, SPACs are a derivation of financial innovation; products of the system and not the system itself.
Furthermore, sponsors often invest further cash into the SPAC at the De-SPACing phase (for example, Mr. Palihapitiya had to invest $100 million in Virgin Galactic at a cost of $10 a share when it went public). Sometimes sponsors decide to align themselves with the target shareholders by giving up a portion of their promote and only letting some of their shares vest at higher stock prices in the new merged entity.
In other words, the promote is the “skin in the game” of SPACs. Hence, to eliminate the inclusion of the promote tout court, as Ackman did, would create more complex financial structures that need to impose terms on investors such as the lock-up limit on the detachability of the vast majority of warrants. This is not sustainable for most sponsors. Additionally, this is not in line with a SPAC-culture where the risk distribution between issuers and investors is construed by virtue of risk management techniques.
To this end, a virtuous promote scheme necessarily must focus on concessions on the side of SPACs’ sponsors to target shareholders in terms of performance. For example, Morgan Stanley has developed a new promote structure called a Stakeholder Aligned Initial Listing (SAIL) vehicle.[33] Instead of the SPAC sponsor receiving 20% of the equity of the vehicle irrespective of post transaction share price performance, the SAIL promote is entirely performance based.[34] This system is able to connect the sponsor compensation directly to performance much like a management incentive program does.
Those should be the viable options to be preferred in the near future, possibly paving the way to legitimise SPACs as a real alternative to private equity and one day possibly final substitute of the traditional IPO.[35]
Dr. Avv. Daniele D’Alvia
CEO and Founder of SPACs Consultancy Ltd, Teaching Fellow in Banking and Finance Law at CCLS – Queen Mary University of London, Associate Research Fellow at IALS, Senior Visiting Scholar at Harris Manchester College (University of Oxford)
[1] Brooke Masters, Year in a Word: SPAC, Fin. Times (Dec. 31, 2020), https://www.ft.com/content/80458983-1693-4022-ba23-113925d24d70.
[2] McKinsey & Company, ‘Earning the premium: A recipe for long-term SPAC success’ (Sept. 2020).
[3] Michael Klein-Backed SPAC Raise $1.68 Billion in IPOs, Reuters (Feb. 12, 2021), https://www.reuters.com/article/us-churchill-capital-corp-vi-ipo-idUSKBN2AC1J8.
[4] Jose Sepulveda, ‘SPACs have raised over 38$ billion in 2021, but the new NYSE rule looms’ (Feb 10, 2021) https://www.cnbc.com/2021/02/10/spacs-have-raised-over-38-billion-in-2021-but-new-nyse-rule-looms.html.
[5] Kori Hale, ‘Colin Kaepernick is raising a $287 Million Social Justice SPAC’ (Feb. 18, 2021) https://www.forbes.com/sites/korihale/2021/02/18/colin-kaepernicks-raising-a-287-million-social-justice-spac/?sh=adadcde124eb.
[6] Brendan Coffey, ‘Shaq SPAC II: O’Neal, Disney Vets Mayer and Staggs seek $300 million for media business’ (Feb. 19, 2021) https://www.sportico.com/business/finance/2021/shaquille-oneal-disney-executives-1234623077/.
[7] Reuters, ‘Paul Ryan-backed blank-check company files for $300 million IPO’ (Aug. 24, 2020) https://www.reuters.com/article/us-enpc-ipo-idUSKBN25K26O.
[8] Adam Lewis, ‘Alec Gores strikes again with biggest SPAC merger to date’ (Sept. 24, 2020) https://pitchbook.com/news/articles/gores-group-biggest-spac-merger.
[9] James Cutchin, ‘Sloan looks to raise new $1.5 billion SPAC’ (Jan. 5, 2021) https://labusinessjournal.com/news/2021/jan/05/sloan-looks-raise-new-15-billion-spac/.
[10] Leila Abboud, ‘Xavier Niel’s organic food SPAC rallies in Paris debut’ (Dec. 9, 2020) https://www.ft.com/content/6180627c-9c12-46ac-b8eb-ec0f010a57ff.
[11] Matthew Frankel, ‘Chamath Palihapitiya just filed for 7 more SPACs’ (Feb. 17, 2021) https://www.fool.com/investing/2021/02/17/chamath-palihapitiya-just-filed-7-more-spacs/.
[12] Ben Scent, ‘Rainmaker Moelis joins exclusive club with SPAC triple play’ https://www.bloomberg.com/news/articles/2021-03-02/rainmaker-ken-moelis-joins-exclusive-club-with-spac-triple-play.
[13] Lora Dimitrova, Perverse incentives of Special Purpose Acquisition Companies, the ‘Poor Man’s Private Equity Funds, 63 J. Acc. & Econ. 1 (2017).
[14] Michael Kalusner et al., A Sober Look at SPACs, (Stan. L. & Econ. Online, Working Paper No. 559, 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3720919.
[15] Will 2020 Be Seen as the Year of the SPAC Bubble?, Knowledge @ Wharton (Jan. 12, 2021), https://knowledge.wharton.upenn.edu/article/will-2020-seen-year-spac-bubble/.
[16] Ivana Naumovska, The SPAC Bubble is About to Burst, Harv. Bus. Rev. (Feb. 18, 2021), https://hbr.org/2021/02/the-spac-bubble-is-about-to-burst.
[17] Dimitrova, supra note 14.
[18] Daniele D’Alvia, SPAC: A Comparative Study Under U.S., Asia, and the Italian Corporate Framework. Soft Law vs. Hard Law (2014), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2476867 (unpublished manuscript) (on file with author)).
[19] Daniele D’Alvia, The International Financial Regulation of SPACs Between Legal Standardised Regulation and Standardisation of Market Practices, 21 J. Banking Regul. 107, (2020).
[20] Daniele D’Alvia & Milos Vulanovic, The Limit and Promise of a SPAC Revolution, Bloomberg Law (Sept. 2020), https://www.bloomberglaw.com/product/BLPG/document/X3NIGRNO000000.
[21] Id.
[22] Antoine Gara & Eliza Haverstock, How SPACs became Wall Street’s Money Tree, Forbes (Nov. 19, 2020), https://www.forbes.com/sites/antoinegara/2020/11/19/the-looming-spac-meltdown/?sh=23028fe470d7.
[23] Naumovska, supra note 5.
[24] For example, Third Point sponsored in 2018 the SPAC Fair Point Acquisition Corp., which raised $500 million at $10 per share. Third Point received 20% founder shares for a nominal value of $25.000 meaning that if a deal close, Third Point receives $100 million of its shareholders’ investment regardless whether the investment is successful or not. Kristi Marvin, Far Point Upsizes SPAC to $500 Million, SPACInsider (June 6, 2018), https://spacinsider.com/2018/06/06/far-point-upsizes-spac/.
[25] Ortenca Aliaj et al., The SPAC Sponsor Bonanza, Fin. Times (Nov. 13, 2020), https://www.ft.com/content/9b481c63-f9b4-4226-a639-238f9fae4dfc.
[26] Id.
[27] Nicholas Jasinski, Bill Ackman’s SPAC splits today. Here’s what that means, Barrons (Sept. 11, 2020), https://www.barrons.com/articles/pershing-square-tontine-holdings-units-split-on-friday-heres-what-that-means-51599756914.
[28] Id.
[29] Infra Section 4.
[30] George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q. J. Econs. 488 (1970).
[31] Frank H. Knight, Risk, Uncertainty, and Profit (Martino Publ’g 2014).
[32] Daniele D’Alvia, Risk, Uncertainty, and the Market: A Re-thinking of Islamic and Western Finance, 16 Int’l J. L. Context 339 (2020).
[33] SPACs, an IPO Alternative, Explained, Morgan Stanley (Jan. 6, 2021), https://www.morganstanley.com/ideas/spacs-IPO-alternative.
[34] Id.
[35] D’Alvia & Vulanovic, supra note 21.
