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The Complex Capital Structure of SPACs
Even though special-purpose acquisition companies (SPACs) have been a financing vehicle for private companies (merger targets) going public for years, their recent popularity in the financial media can lead some businesses to think SPACs are new and, potentially, simple to execute. In fact, SPACs are an alternative route to going public, and their capital structures require careful consideration.
Because each negotiation contains points specific to that deal, each SPAC capital structure is unique. They can range from simple to very complex, depending on their inclusion of a variety of warrants, common equity, preferred equity and other components. It is crucial that capital holders of a SPAC understand these important elements of its capital structure along with their complexities. Beyond the concept that each SPAC is structured differently, capital holders should prepare for the possibility that nearly every term of the SPAC's structure can change throughout its lifecycle.
SPAC Capital Structure Components
A SPAC is essentially a trust fund of cash raised in anticipation of a merger transaction. While each capital structure of a SPAC is unique, what they share is that however they are designed, they are created to provide value to the SPAC sponsor as consideration for developing the structure and execution of the ultimate de-SPAC deal. A SPAC capital structure can be made up of a combination of several security types, and each one can impact the valuation of the other securities. Further, the securities issued by the SPAC can change over the SPAC lifecycle adding complexity to financial reporting and investor communications. These securities may include:
- Publicly traded units comprised of a common share and a warrant
- Founder shares
- Private placement warrants
- Equity-earnout shares
- Convertible notes
Because the securities of the SPAC can change throughout the SPAC lifecycle, understanding of how these securities are included in financial reporting is critical to understanding their value.
The De-SPAC
Once a merger target has been identified for acquisition, the process switches to a de-SPAC-ing transaction. Prior to 2020, a typical SPAC formation, through its initial public offering (IPO), raised $100 million to $300 million. The average capital raised in 2020 was over $300 million. Those funds raised from investors and sponsors are held in a trust account. The SPAC typically has 12–24 months to find a merger target following the completion of its IPO. When a merger target has been identified, the SPAC goes through what is called a "de-SPAC transaction," which is the actual purchase of the target wherein the target essentially steps into the shoes of the SPAC as a public company. This may include the tripping of warrant terms, the issuance of debt securities and/ or a Private Investment in Public Equity (PIPE).
PIPEs are very common to de-SPACing. To buy the merger target, the SPAC has its cash in a trust fund but may also raise more equity capital and incur debt to fully fund the negotiated purchase price, creating some debt. PIPE transactions, which have been around for at least two decades, essentially allow another institutional investor to buy a block of public equity in a private transaction. PIPEs are commonly allocated shares at the same price as the initial SPAC offering.
How DHG Can Help
The popularity of SPACs in 2020 has resulted in the Securities and Exchange Commission (SEC) placing a new layer of scrutiny on SPACs to go along with the common accounting considerations for these vehicles. Earlier this year, the SEC issued a statement that certain warrants very common in SPAC transactions must now be classified and treated as liability awards. It is important to recognize the elevated complexity in the warrant agreements held by the sponsors as well as the accounting rules required by the SEC. In addition, valuation issues arise from restrictive covenants, redemption provisions and other customized terms in these securities, making SPAC financial reporting complicated.
To help you navigate the SEC guidance and mitigate risk in your SPAC participation, look to DHG professionals to help you formulate strategies specific to your goals. You can also learn more about our technical knowledge about SPACs and a client-centric approach in the replay of this podcast.
Please connect with us at dhgadvisory@dhg.com.
