Despite the frothy market for special purpose acquisition companies (SPACs) in 2021, companies considering such a transaction have been met recently with significant market headwinds, a short supply of suitable targets, the onset of a highly anticipated
In this post, we provide an overview of one of the
SPAC Basics
Although the four-letter acronym for "special-purpose acquisition company" has become a common reference in recent years, a baseline refresher is in order. A SPAC is an investment vehicle used to bring a private company public in a different manner than the traditional initial public offering (IPO). A SPAC begins as a blank-check company listed on a national securities exchange with limited operations. That entity raises money from investors through a traditional IPO. The proceeds from the IPO are to be used for a specific aim, namely acquiring a private company - generally, one that conforms with the SPAC's previously identified selection criteria - in what is commonly referred to as a "business combination." Until the business combination, a SPAC is supposed to keep IPO proceeds in an interest-bearing trust account.
A SPAC typically has 18 to 24 months to achieve a business combination or it will be dissolved and its funding is returned to investors. If a SPAC successfully identifies an acquisition target, the SPAC shareholders have the right to either approve the transaction or redeem their shares in the blank-check company "sponsor" and have their initial investment returned. Although not a requirement, the SPAC will typically raise additional funds through private investments in public equity, or "PIPEs," to ensure sufficient capital to complete the business combination. Finally, the SPAC merges with the private target entity through the "de-SPAC," after which the target is the sole remaining operating entity - and a publicly listed and traded company.
SPAC Founders and Insiders Gaining Billions
SPAC sponsors - usually experienced executives and industry leaders - often manage the SPAC from the IPO through the de-SPAC transaction. Typically, they pay a nominal amount during the IPO in exchange for 20 percent to 25 percent of the shares (and associated warrants) that will be sold to the public after the SPAC's business combination. Due to the small amount needed to obtain them - generally at a significant discount from the
On the other side of the SPAC transaction, executives from private companies targeted by (or themselves courting partnership with) SPACs have often extracted significant financial packages from SPAC transactions. Target company executives are frequently compensated in some form of lump sum payouts, stock options, time-vested restricted stock units and/or performance-vested restricted stock units in the de-SPAC entity. Such equity payouts tend to come with lockup provisions restricting executive trading in the shares for a certain period. Subject to other restrictions under the federal securities laws, once the lockup expires, the former private company executives are generally free to trade the shares of their now-public company.
Founder shares and executive compensation payouts have garnered significant attention because, in many instances, insiders have won big despite post-combination share prices plummeting after the de-SPAC. The
As illustrated by a recent enforcement action, the
Investment Advisers Facing SEC Enforcement Wrath
Since 2022, the
As described in the
In addition to serving as a sponsor of the SPAC, Corvex advised some of its funds to invest more than
As a result, without admitting or denying the findings in the order, Corvex agreed to settle to allegations that it willfully violated Section 206(2) of the Advisers Act for its disclosure deficiencies and Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, for its failure to adopt and implement policies and procedures designed to prevent violations of the Adviser Act and its rules. Without admitting or denying the allegations, Corvex agreed to cease and desist from committing or causing future violations of the Advisers Act and its rules, to be censured and to pay a
Takeaways
SPACs remain a viable and legitimate means of taking a private company public. Nevertheless, SPAC participants are still in the crosshairs of the
It is paramount that investment advisers, as well as sponsors, target companies and other gatekeepers, understand potential pitfalls and take steps to make certain that they are operating transparently and in compliance with securities laws. Specifically, investment advisers should ensure: 1) investors are fully apprised of the function of the promote and the potential incentives for insiders, including the advisers themselves; 2) they adopt, implement and follow clear and concise policies and procedures on disclosing conflicts of interest and other relevant topics (compliance audits probably wouldn't hurt in this regard, either); 3) Form ADV Part 2A brochures are up to date and disclose all material conflicts of interest accurately; and 4) independent committees are at least considered and, where appropriate, established and consulted prior to recommending investment in or otherwise engaging in a SPAC transaction - especially when an adviser has multiple roles in a business combination.
Footnotes
1. Additionally, as reported in the
2. Under
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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