Special Purpose Acquisition Company (SPAC)
What is SPAC?
A Special Purpose Acquisition Company (SPAC) is a company with no operations and business whatsoever (i.e. blank check company), and is set up in order to acquire and transition a private company into a public one. The practice before was to raise capital through an initial public offering (IPO) which was an arduous process that took from 6 months to a year. SPAC effectively takes a company public at a fraction of the time it takes the traditional IPO process.
Attraction of SPAC
It is uncommon for retail investors to invest in promising privately held companies, but SPAC opens a door for public investors to ‘partner’ with investment professionals and venture capital firms who source and perform due diligence on these companies. Thus, an opportunity to gain an additional source of capital appreciation.
Life cycle of a SPAC
Stage 1 – Initiation:
People with money and industry knowledge will pool their capital and expertise and organize themselves into a SPAC for the purpose of acquiring a company. In the SPAC prospectus will be a plan explaining its search for a target in a particular industry or area of focus, usually an area where the founders of the SAPC are experts in, or they simply see potential in that area.
Stage 2 – Fund raising:
The SPAC being a “blank check company” has no operations nor assets. In order to purchase a company, the usual practice will be to put together an initial public offering (IPO) for investors and detail it in a prospectus. The public offering not only allows the SPAC to raise money for its purpose, it also benefits the future company with a ‘public’ status when the two entities eventually merge.
Stage 3 – Target search:
Once funding has been secured, the SPAC can begin seeking out a target company. However, the SPAC only has a finite amount of time in finding a target since no investor wants to have their money tied up in the search. The prospectus defines exactly how long the SPAC has to complete a combination – usually within 24 months, but it may be extended through a shareholders’ vote to extend. Since the process of the SPAC of identifying a target is so secretive anyway, investors are unlikely to rely much on the information from the SPAC.
Stage 3.5 – Business combination:
Regardless of the target search, there are three potential paths for the SPAC on the combination due date:
a) Vote to extend –
If the SPAC hasn’t found a suitable target by the combination deadline, the SPAC can ask shareholders for more time to find a target.
b) Redemption –
If there is neither combination nor extension, the SPAC can “wind down” with a redemption event. Any remaining funds will be refunded to the shareholders and the SPAC ceases to be.
c) Business combination –
If the SPAC has found a suitable target, the companies enter into a business combination agreement. Although shareholders do not play a significant role in decision makings, their approval for the target search is required for they have the ultimate say over the outcome.
Stage 4 – Merger:
Once the deal has been approved by the shareholders, it can still take some time (months) to finalize the merger. The SPAC may even ask for another extension in order to have time to finalize the deal.
Potential Risks of investing in SPACs
Less information and the implications that follow:
In a traditional IPO, companies seeking to go public typically have to provide a mountain of disclosure documentation and routinely perform due diligence prior to launch. In contrast to a SPAC, not only are there less documentation required, the time consuming due diligence process is often overlooked for its sponsors are typically against a two year deadline before acquisition. Furthermore, implications of lacking due diligence leads to inaccurate financial reporting which then leads to over reliance of the sponsors’ reputation when deciding whether to invest or not.
Potential fees and sponsor incentives:
SPAC sponsors take on reputational risk to take a SPAC public and find a suitable target company. Hence, those sponsors are usually compensated for it, in the form of a reflection to the price that a target company may obtain if it had took the IPO route. When a SPAC raises money from public investors, the public investors typically pay at least a 5.5 percent investment banking fee and generally give the sponsors a 20 percent interest in the SPAC in the form of equity, potentially in addition to other indirect fees. Considering all of these potential fees and other forms of compensation, some market participants view SPACs as more expensive than traditional IPOs. (1)
Conflicts of interest and the potential of fraud:
Underwriters and sponsor of the SPAC are heavily incentivized to identify a target during their search. Thus, investors should be aware of the potential for conflicts of interest between SPAC sponsors and SPAC shareholders since sponsors, given a heavily discounted 20% interest in the SPAC’s common stock, may profit when an acquisition is completed even if the acquisition fails. Stemming from this also raises the risk of potential misuse of funds and potential fraud through misrepresentation or omissions regarding the prospects of the target company. (2)
Comparison between SPAC and the IPO
The Future of SPACs in Hong Kong
Hong Kong is looking to continue improving its listing framework in relation to SPACs, and the HKEX has launched its most recent consultation paper in September 2021 that reflects changes to be made to the stages of a SPAC. “To maintain Hong Kong’s reputation for high quality listings and stable secondary trading” and to “welcome experienced and reputable SPAC Promoters that seek good quality ‘Targets’” Ms. Bonnie Chan.
A summary of the Consultation Paper’s key proposals is set out below (3) :
Pre-business Acquisition (De-SPAC) Transaction proposals:
- Investor Suitability – the subscription for and trading of a SPAC’s securities would be restricted to professional investors only. This restriction would not apply to the trading of the Successor Company shares post the De-SPAC Transaction;
- SPAC Promoters – SPAC Promoters must meet suitability and eligibility requirements, and each SPAC must have at least one SPAC Promoter which is an SFC licensed firm holding at least 10 per cent of the Promoter Shares;
- Dilution Cap – Promoter Shares are proposed to be capped at a maximum of 30 per cent of the total number of all shares in issue as at the initial offering date; and a similar 30 per cent cap on dilution from the exercise of warrants is also proposed; and
- Fund Raising Size – the funds expected to be raised by a SPAC from its initial offering must be at least $1 billion.
Business Acquisition Transaction proposals:
- Application of New Listing Requirements – a Successor Company must meet all new listing requirements (including minimum market capitalisation requirements and financial eligibility tests);
- Independent Third Party Investment – this would be mandatory and must constitute at least 15 to 25 per cent of the expected market capitalisation of the Successor Company, validating the valuation of the Successor Company;
- Shareholder Vote – a De-SPAC Transaction must be approved by SPAC shareholders at a general meeting (which would exclude the SPAC Promoter and other shareholders with a material interest); and
- Redemption Option – SPAC shareholders must be given the option to redeem their shares prior to: a De-SPAC Transaction; a change in SPAC Promoter; and any extension to the deadline for finding a suitable De-SPAC Target.
Liquidation and De-listing:
- Return of Funds to Shareholders – if a SPAC is unable to announce a De-SPAC Transaction within 24 months, or complete one within 36 months, the SPAC must liquidate and return 100 per cent of the funds it raised (plus accrued interest) to its shareholders. The Exchange will then de-list the SPAC.
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