The US market is currently experiencing a boom in the use of special purpose acquisition companies (known as SPACs). In a recent article, 'London explores hopping on Spacs bandwagon' (see https://www.ft.com/content/af75ce79-2bcd-46c4-92f4-8886513e539c), the FT reported that the LSE is exploring how to entice SPACs to the UK to take advantage of this trend. In this article we look at how a SPAC is typically structured, some key considerations and consider whether SPACs will take off again in the UK market.
What are SPACs?
SPACs are companies formed to raise capital through an initial public offering (IPO) with the proceeds being used to acquire one or more unspecified businesses or assets to be identified after the IPO. They are becoming increasingly popular vehicles in the US for entities or individuals to raise capital to pursue merger opportunities, and for private companies seeking to raise capital, to obtain liquidity for existing shareholders and to become publicly traded. Also known as 'blank check companies' or 'cash shells', SPACs have been around for some time and are a common structure in the US. Recent US examples include transactions involving Virgin Galactic and Playboy Enterprises.
The trend in the US has been so strong that an exchange traded fund which tracks the performance of the Indxx SPAC & NextGen IPO Index has been launched. The Indxx SPAC & NextGen IPO Index is a passive rules-based index which tracks the performance of newly listed SPACs and initial public offerings derived from SPACs since August 1, 2017. The ETF started trading on the NYSE on 1 October.
Activity in the UK has been much more subdued and no SPACs have listed in the UK in 2020. However, they do exist in the UK although the amounts raised have traditionally been much smaller. Previous UK SPAC transactions include Vallar plc (standard listing), Gloo Networks plc (AIM) and Derriston Capital plc (standard listing). The requirements for a premium listing under LR 6 (Additional requirements for premium listing (commercial company)) are such that anyone launching a SPAC in the UK needs to choose between the LSE’s AIM market and a standard listing on the Official List in accordance with LR 14 (Standard listing (shares)).
Why are they becoming more popular?
According to Bloomberg, SPACs are 'a mania that’s rising as each month goes by' whilst Pitchbook calls them 'all the rage'. Driven by the volatility in the markets amid the coronavirus crisis, blank check companies have become a more attractive way to go public, certainly in the US at least. Often, when a private company is looking to go public, but thinks that will be a tough undertaking, an alternative is to sell to a SPAC.
In recent years, SPACs have become mainstream in the US, attracting big-name underwriters (Goldman Sachs, Credit Suisse and Citigroup to name a few) and investors and raising a record amount of IPO money in 2019: $13.6 billion. As of the beginning of August 2020, more than 50 SPACs have been formed in the US, raising around $21.5 billion.
What are the main features of SPACs?
At the time of IPO, the SPAC is only a shell company – it has no business operations or tangible assets. However, what it does have is an experienced management team, which usually includes the sponsors or founders, who are confident that their reputation and experience will help them identify a profitable company to acquire.
The management team will incorporate the company and provide the initial capital for the company. On IPO, investors will typically receive shares and warrants in the vehicle. The management team will often have a 10 - 20 per cent equity holding and may hold a combination of ordinary shares or performance related preference shares which entitle them to a certain proportion (often 20 per cent) of the upside when the share price of the company following its acquisition reaches a certain level (often a 15 per cent hurdle). This so-called “promote” structure for the management team is there to create a positive alignment with institutional investors with the aim of incentivising the management team to generate value for investors.
The cash raised from institutional investors on IPO is often held in a trust account until a private company is identified as an acquisition target. Any interest earned in the account is typically used to fund working capital expenses incurred post IPO but prior to an acquisition. After the SPAC has raised the required capital through an IPO, the management team has 18 to 24 months to identify a target and complete the acquisition. The management team in the meantime is not allowed to collect salaries until the deal is completed. The period may vary depending on the company and industry. The fair market value of the target company must be 80 per cent or more of the SPAC’s trust assets.
In the event that an acquisition is not made within the specified timeframe (18 - 24 months), the SPAC is dissolved and the funds held in the trust account are returned to shareholders. The management team often bear the costs of the company from incorporation to winding up through the principle of 'first loss' capital whereby cash is returned to investors in priority to the sponsors.
The principles of 'first loss' capital and the founder 'promote' structure combine to incentivise the founders to identify and execute the acquisition of an attractive target within the stated investment strategy and within the designated timeframe.
What are the advantages of a SPAC?
SPACs can provide a range of advantages for companies looking to go public when compared to a traditional IPO or direct listing, such as simplicity, faster timeframe, better valuation, and well incentivised long-term partners.
Selling to a SPAC can also be an attractive option for the owners of smaller companies, as deal values can be higher, and it can offer business owners what is essentially, in the US at least, a faster IPO process under the guidance of an experienced partner, with less worry about the swings in broader market sentiment.
A SPAC also has the added benefit of being able to issue paper as part of the consideration for its acquisition which (being in the form of listed shares) is, in theory at least subject to liquidity constraints and lock-up arrangements, more marketable than equity issued to management on a traditional private equity buyout. This can provide sponsors with more firepower to make their acquisition.
In the UK a SPAC is not eligible for admission to the premium segment of the Official List as it will not meet the requirements of LR 6 (Additional requirements for premium listing (commercial company)). The choice is between an AIM admission or a standard listing on the Official List in accordance with LR 14 (Standard listing (shares)).
Attractions of a standard listing for a SPAC in the UK include:
- no requirement for three years of historical financial information;
- no requirement for a revenue earning track record;
- no need to demonstrate that it carries on an independent business;
- no requirement to appoint a financial adviser, sponsor or a Nomad (an AIM quoted SPAC must retain a nominated adviser at all times);
- no requirement to comply with the provisions of the UK Corporate Governance Code although a SPAC is likely to voluntarily adopt and comply with the QCA Corporate Governance Code;
- no obligation to substantially implement its investing policy (i.e. acquire a target) within eighteen months of admission or seek ongoing shareholder approval for that policy until its investing policy has been substantially implemented; and
- generally having greater flexibility around related party transactions.
What are we seeing in the UK market?
In the UK, there was an increase in SPACs shortly after the financial crisis from 2009 to 2011 where sponsors sought alternative sources of capital and investors sought alternative investment opportunities. However, following a series of high-profile failures (with the odd notable exception) interest in the structure dwindled.
In 2018, SPACs began to re-emerge in the UK as a viable investment for institutional investors. These investors were attracted by the private equity derived skill-set of sponsors and the opportunity to invest in, and derive substantial value from, assets that would otherwise not have been immediately available to them through the public markets. This is evidenced by the IPOs of J2 Acquisition (standard listing) and Landscape Acquisition Holdings (standard listing) in the UK which between them raised in excess of $1.75 billion in the last quarter of 2017.
Will SPACs take off in the UK?
Whilst the SPAC boom continues in the US, it is much less certain that there will be a similar boom in the UK. The main constraint in the UK appears to be the attitude of institutional investors rather than the rule book given it is already possible to list a SPAC in the UK.
It will be interesting to see whether the provisions of LR 5 (Suspending, cancelling and restoring listing and reverse takeovers: All securities) are reviewed or not in the context of investor interest in SPACs in the UK. Currently the FCA will generally seek to cancel the listing of an issuer's equity shares or certificates representing equity securities when an issuer with a standard listing completes a reverse takeover and the issuer will then need to re-apply for readmission of its shares to listing.
An AIM company carrying out a reverse takeover will be in the same position as a result of the provisions of the AIM Rules for Companies. The AIM Rules make it clear that where shareholder approval is given for the reverse takeover, trading in the AIM securities of the AIM company will be cancelled. If the enlarged group seeks admission, it must make an application in the same manner as any other applicant applying for admission of its securities to AIM for the first time.
This would be a significant regulatory change but if made it would allow the board of the SPAC to complete a major transaction without the additional burden of seeking re-admission. UK SPACs would then have the same freedom as SPACs established in the US.
Further information
If you would like any further information please speak to your usual Burges Salmon contact or contact Nick Graves.
Written by Elena Kaltsas and Nick Graves.