A special purpose acquisition corporation, commonly known as a "SPAC," and formally a "development stage company," is a corporation formed for the purpose of raising capital through an initial public offering ("IPO") of its securities, in order to fund an acquisition of an existing operating company or companies. Though the SPAC itself has no business operations, investors entrust an experienced founding management team to seek out and consummate a value-building acquisition of an operating business, often in a particular industry, sector or geographical area. The IPO's proceeds can also provide the target company with immediate capital, an advantage over other more traditional structures.
Although, the SPAC concept is often compared to a 'blind leap of faith' on the part of investors because the publicly traded investment vehicle has no assets, no product and no business plan, the noted advantages of SPACs have caught the attention of American and British investment bankers, hedge funds, and other professional investors. Such investors have invested over $3 billion in SPAC IPOs since August 2003.1 Investors are entrusting more and more money into the hands of talented SPAC management teams in the hopes that the SPAC might find a lucrative acquisition in a specified sector. This article discusses the evolution of SPACs and SPAC structures over the last 12 months, as certain deal terms continue to evolve.
The investor's vision of a lucrative acquisition is not an impossible dream. Many past SPAC deals have seen impressive profits in various sectors.2 The sectors attracting SPAC attention are extremely broad, ranging from media and technology to retail, homeland security and even foreign markets, including China and India.3 Some SPACs choose not to limit their scope but instead target a company in any field.4 Acquisitions of well-known, successful companies are within reach of talented management teams. As Ciaran O'Kelly, head of U.S. equities at Banc of America Securities notes, "[w]e're seeing higher-quality management teams with proven track records that are extremely interested in this vehicle."5
The philosophy is simple, as targets of SPACs and their investors say, they use a "bet on the jockey" strategy when making investment decisions regarding SPACs, putting increased emphasis on having pedigreed management.6
Many management teams have found success in consummating acquisitions. For example, in November 2006, fruit-juice seller Jamba Juice Inc., was purchased by Services Acquisition Corp., for $265 million and is now trading on the American Stock Exchange ("AMEX").7 The Services Acquisition management team is made up of partners in a private equity fund who have various experiences in the retail sector.8 Savvy investors were attracted by this expertise, including financier George Soros's hedge fund, now holding more than 5% of Jamba Juice.9
In another deal, Endeavor Acquisition Corp., recently acquired the trendy, edgy and extremely profitable American Apparel. The Endeavor management team includes Jonathan Ledecky, who founded U.S. Office Products; Kerry Kennedy, Bobby Kennedy's daughter; and Edward Mathias, a managing director at the Carlyle Group.10 Diverse and experienced teams can contribute to the marketability and possibilities of consummating attractive business combinations with existing successful companies. American Apparel's CEO and Founder, Dov Charney, opted to sell to a SPAC for $384.5 million in restricted stock, cash and debt. He was attracted to the idea of selling to an already-public company. Charney reasoned that this arrangement allows him "to raise capital relatively quickly, remain the largest shareholder and avoid having to sell other investors on his vision until after the company is already publicly traded."11
Increasing Size And Sophistication
The size of SPAC deals are beginning to reflect increased investor interest. According to Dealogic, 87 SPACs have begun trading in the U.S. since the end of 2003.12 Through May 1, 2007, 22 SPACs IPOs were announced since the beginning of the year. In addition to more SPACs hitting the market, the size of the offerings are also becoming larger. In 2005, less than one-third of new SPAC filings sought to raise $100 million or more. In 2006, 40 SPACs worth $3.4 billion were announced, up from $484 million two years earlier and over one-half have sought to raise $100 million or more and large deals are a presence already in 2007.13 For example, on January 31, 2007, the team that formed Endeavor Acquisition Corp. (and is acquiring American Apparel) formed a new $250 million SPAC, Victory Acquisition Corp.14 Some speculate that the size of SPACs may continue to move upward. A member of one of the largest SPAC offerings to date says he believes "larger SPAC deals - even a $1 billion SPAC - will eventually happen."15 An interesting trend seen in the larger offerings is an increased offering price. Historically, the securities were offered in units, at a set public offering price of $6.00 or $8.00 per unit, consisting of one share of common stock and one or two warrants. The recent trend with the large offerings is a trend toward $10.00 unit offerings, consisting of one share of common stock and one warrant.
One explanation for greater investor interest is the presence of larger top-tier underwriters in the SPAC market. According to the Wall Street Journal, "SPACs are very much on the radar of most bulge-bracket investment banks."16 SPACs initially were underwritten by small, specialist investment banks, such as EarlyBird Capital and Ladenburg Thalmann. Recently, however, Deutsche Bank, Citigroup and Merrill Lynch are becoming involved as lead underwriters in the larger SPAC offerings. The arrival of these top-tier underwriters demonstrates the newfound respect SPACs are receiving on Wall Street and has led many to speculate that the market will continue to grow and gain credibility.
Funding The SPAC
The amount of the IPO proceeds placed in the trust account has been consistently rising. Issuers are now opting to put up to 100% in trust. Approximately 85-100% of the proceeds raised in the IPO are held in trust to be used to fund the initial business combination. Earlier deals tended to put 85% in trust. More recent deals are placing between 95-100% in trust (net of underwriters' compensation and expenses but not of other offering expenses).17 SPACs that place 100% into the trust account raise the necessary funds for their offering expenses and other expenses incurred in connection with identifying and evaluating a target business through private placements to, and borrowings from, the founding stockholders or sponsors. By placing a greater amount in trust, deals are providing greater protection for investors, coupled with greater risk for insiders and underwriters. Some deals are allowing money market funds to be placed in the trust account, while some still impose restrictions, allowing investment only in treasury and tax-free bond money-market funds. These funds are still an attractive alternative to illiquid investments in U.S. treasuries.18 Others are permitting disbursements of all or a portion of the interest for use as working capital.
The proceeds placed in the trust account are typically not released until used for the completion of a business combination. As a result, to adequately fund the costs of the identification and evaluation of a target business, SPACs often seek substantial investment by their founders. Of 22 of the most recent SPACs to go effective, Founder's warrants accounted for an average of 3.4% of the amount raised in the offering.19 Historically, management was obligated to buy warrants in the aftermarket after the IPO, which served to align management and investors interests and arguably to provide increased liquidity for the warrants. The recent trend, however, is for founders to acquire warrants directly from the SPAC.
Some SPACs will also conduct a private placement offering to sponsors with the units or warrants sold at the offering price. For example, Freedom Acquisition Holdings privately offered 5,000,000 units at $10/unit ($50,000,000 in the aggregate) to sponsors in which the private placement occurred immediately prior to consummation of an initial business combination. The private placement units were identical to the units sold in the offering. Each of the sponsors agreed not to transfer, assign or sell any of these units or the common stock or warrants included in these units (including the common stock to be issued upon exercise of these warrants), until one year after the consummation of a business combination.20 Another variation, Dekania Corp., offered a wholly owned subsidiary of one of the initial stockholders an opportunity to purchase 250,000 units at $10/unit ($2,500,000 in the aggregate) prior to the effectiveness of the registration statement. SPAC management teams use the proceeds of sponsor private placements to raise capital for the business combination.
Increasing The Conversion Threshold
Most typical SPACs require that the acquisition be approved by a majority of its public stockholders and that not more than 20% of its stockholders vote against the acquisition and elect to convert their shares for cash. A recent trend of many SPAC issuers has been an increased conversion rights threshold. The traditional 20% is creeping upwards in recent deals to as high as 40%. For instance, Trans-India Acquisition Corp. increased the threshold to 25%, Affinity Media International Group to 27.6%, Energy Infrastructure to 30%, Star-Maritime to 33% and, at the highest percentage, Transforma Acquisition Group to 40%.21 The reason for this trend is to maintain investors' role in the deal, but allow the management team more flexibility in completing an acquisition within the 18-24 month time frame.
Regulation Of The SPAC Market
Many SPAC deals typically were listed on the over-the-counter market, but the AMEX now lists SPACs, lending the credibility of being on a regulated exchange.22 Securities listed on the AMEX are "covered securities" and are not subject to blue sky regulation. At least thirty SPACs are currently listed on the AMEX and many more are in the filing process. A SPAC issuer must be able to meet the quantitative listing standards as well as certain qualitative standards. AMEX places emphasis on such qualitative factors as the quality of management, nature of the underwriter and the corporate governance structure when reviewing SPACs for listing.
Issuers are also subject to the SEC review process for SPAC offerings which has become more tedious for issuers. According to a survey of SPAC offerings filing their initial S-1 with the SEC, it appears that the SEC is reviewing these deals with caution. One commentator suggests that "the SEC is deliberately taking its time vetting deals, hoping to slow down the pace of offerings."23
Paul Belvin, an Associate Director at the SEC commented that SPAC IPOs and acquisitions are reviewed in the Office of Emerging Growth Companies ("OEGC").24 As the volume of SPACs has increased, the Division has shifted a number of small business public offerings to one of the other groups and, although the SEC has experienced significant attrition of legal staff, the OEGC plans to maintain adequate staffing to deal with the volume of SPAC filings. The OEGC reviews not only the SPAC IPOs but also the SEC filings relating to the acquisition which can contribute to the sometimes lengthy process.
SPACs continue to grow and evolve. With the recent increase in offering sizes, the presence of top-tier underwriters and active involvement of talented management teams combined with a strong equity market, SPACs should continue to attract investors and provide a platform for growth.
M. Ridgway Barker is Chair of the Corporate Finance & Securities Practice Group of Kelley Drye & Warren LLP. Randi-Jean G. Hedin is a Partner in the Corporate Finance & Securities Practice Group. Acknowledgement is given to Kristen A. Hartofilis , an Associate at Kelley Drye & Warren LLP, for her efforts in the preparation of this article. Please see our website, www.metrocorpcounsel.com, for the text of the footnotes in this article.