SPAC activity has enjoyed a healthy uptick in recent years. More SPACs went public in 2018 than in any year since 2007, raising more than $10 billion in capital to deploy towards new investment opportunities. Private equity sponsors are increasingly finding themselves on the opposite side of the table from SPACs as the owner of a portfolio company considering a sale to a SPAC. A sale to a SPAC makes sense for certain portfolio companies, though it does raise certain issues for sellers that do not exist in a regular sale process and there have been some high profile “busted” sales of portfolio companies to SPACs. This article highlights certain key considerations for private equity sponsors in navigating a potential sale to a SPAC.
Is your Portfolio Company a Suitable Candidate for being a Public Company?
A sale to a SPAC is fundamentally an alternative to an IPO in terms of an exit strategy for your portfolio company. Like an IPO and unlike a regular way sale process it is unlikely you will be able to cash out 100% of your equity stake in the sale. You will therefore need to determine that your portfolio company is a suitable candidate for the public trading markets and that there will be enough investor support so that the company will trade well and allow you to sell the remainder of your equity stake in the company at an attractive valuation. Selling to a SPAC will also require that your company satisfy certain public disclosure requirements as part of the approval process for the transaction, akin to the level of information disclosed in an IPO prospectus, which includes preparing financial statements that meet certain SEC requirements.
Market Risk to Closing Your Deal
A sale to a SPAC has market risk that would not be present in a regular way sale transaction. First, the existing SPAC shareholders will typically need to vote to approve the transaction (e.g., a vote will be required if the SPAC is issuing more than 20% of its stock as part of the transaction, if the SPAC does not survive the merger, or if the SPAC is re-domiciling to a different jurisdiction). Second, there is usually a minimum cash condition which requires that the SPAC have a minimum level of cash available to consummate the transaction. As SPAC shareholders will have redemption rights in connection with the transaction to receive their pro rata portion of the proceeds from a trust account maintained for the benefit of the SPAC shareholders (typically a shareholder would receive the $10 per share issue price plus accrued interest on the trust account), a high level of redemptions could result in the SPAC failing to satisfy this condition. As such, sellers should ensure they understand how much cushion there is against the level of redemptions which could lead to a breach of the minimum cash condition, and ensure that the SPAC sponsor has a back-up plan in advance. Sponsors frequently try to hedge this risk by entering into PIPE transactions to provide additional capital to the SPAC in connection with the deal, but deals have failed due to high levels of redemptions.
Limited Recourse against the SPAC
In addition, another feature of SPAC transactions which are atypical in a regular sale process is that if closing fails to occur for any reason (including in the event of a breach by the SPAC), your recourse as the seller against the SPAC is very limited since the funds held in trust are solely for the benefit of the SPAC shareholders. Accordingly, the definitive agreement will typically not provide for termination fees payable to the seller and a seller will generally not have the ability as a practical matter to seek damages against the SPAC. At most, a seller may be able to negotiate an expense reimbursement from the SPAC if the deal fails to close and the SPAC subsequently consummates a transaction with another company.
Structuring the Exit — Cash versus Rollover, Founder Shares and Warrants
As noted above, it is unlikely you will be able to cash out 100% of your equity stake in a sale to a SPAC so you will need to negotiate the amount of equity you are cashing out as well as the amount you are willing to rollover. However, one of the advantages of selling to a SPAC is that you can frequently share in the favorable SPAC economics enjoyed by the SPAC sponsor. This is normally accomplished by having the SPAC sponsor transfer to you a portion of the founder shares and warrants in connection with the sale.
Additional considerations when selling to a SPAC is that, since you will be retaining rollover equity following the transaction, you will need to understand your ability to sell-down in the future. This includes careful consideration of your registration rights and any lock-up or other resale restrictions to which your equity will be subject. Moreover, you will need to consider Section 16 implications concerning “company insiders” and their reporting obligations and short-selling restrictions if you have directors or officers owning equity of the company following the transaction, or if your beneficial ownership of the company exceeds certain thresholds. Another point to understand is how much leverage you have as a seller during the negotiation phase, based upon the life cycle of a SPAC. Since SPACs typically have only 18-24 months to identify a suitable target and consummate a business acquisition, the less time left on that clock, the more leverage a seller has to negotiate a deal with the SPAC.
A sale to a SPAC isn’t for everyone and does raise execution risk that is not there in a regular way sale process. However, for certain portfolio companies that are strong public market candidates it can be an advantageous way to exit by taking some cash off the table in connection with the sale, rolling the remainder of your equity into publicly-traded securities to benefit from potential future appreciation and by sharing the SPAC sponsor’s favorable economics. You just need to balance those advantages against the risks of a busted sale to a SPAC.