Key considerations for targets in negotiating purchase terms with SPACs

The SPAC (special purpose acquisition company) trend was well in the making prior to the latest round of marquee deals. However, there has been a bevy of SPAC initial public offerings in the last three years, resulting in frequent and high-profile SPAC mergers, or business combinations that have gripped the attention of investors from institutional private equity and venture capital, to retail traders alike.

As a result, a new cadre of SPAC targets have started paying attention to this growing source of capital, over $36 billion raised in 91 SPAC IPOs to date in 2020 alone according to SPACInsider. Many of these companies are seeing inbound indications of interest from SPACs land on their virtual boardroom tables. Indeed, some companies have even begun proactively engaging in SPAC-specific strategic processes, looking for just the right SPAC suitor for their needs.

Given this trend, it is incumbent upon private company executives, boards and their investors and sponsors to educate themselves about these potentially attractive, though complex transactions.

For an increasing number of companies, a business combination is motivated less by immediate liquidity for existing investors. The focus is on raising cash and gaining access to public capital markets for financing flexibility in the near future. This may sound much like a traditional IPO; and in some respects, it is. However, it comes with the added complexity of being structured through an arms-length M&A transaction on the front end. This M&A transaction sets a valuation based on significant third party due diligence by the SPAC, and is often further validated by reputable institutional anchor investors in a concurrent PIPE (private investment in public company) financing. That valuation is less susceptible to the rise and fall of a volatile stock market that can dramatically affect IPO pricing.

With this valuation in hand, a SPAC business combination allows for companies and their investors to paint with precision the pro forma public company picture that suits them best. The questions of how much cash will be used in the transaction vs. SPAC equity, how much liquidity is being given to shareholders, and how much cash is being used to pay off debt or to shore-up the balance sheet, will all have a significant impact on what the pro forma capitalization of the resulting public company will look like.

In turn, these considerations will inform everything from what kind of shareholder approvals the company needs to accomplish the transaction, to what kind of financing conditions and structure are required to ensure closing certainty. Other factors to consider include how much dilution the company's shareholders will experience and what governance and control rights are appropriate for the company's shareholders post-closing.

M&A terms therefore play a significant role in a SPAC transaction, as these matters and more are all determined upfront in a merger agreement with the SPAC. However, these are not your standard private company M&A terms, and companies and M&A practitioners alike need to think outside the traditional private M&A box.

Where private company M&A practitioners are accustomed to common deal features like purchase price adjustments and tightly restrictive interim operating covenants, business combinations practitioners are increasingly adopting terms such as fixed purchase prices and exchange ratios, limited representations and warranties and agreement-related disclosures, no indemnification or related escrows, and more permissive interim operating covenants. These terms are driven by the fact that the target company will itself become the public operating company, and often with existing investors retaining a majority of the public company shares. The target company will therefore be subject to significant disclosure requirements in connection with the SPAC's proxy statement or S-4 filed in connection with the approval of the transaction. Its existing stakeholders will continue to have significant 'skin in the game', thus protecting the SPAC's existing and new public investors notwithstanding more target company-friendly M&A terms.

A SPAC business combination is a hybrid of an IPO, an M&A exit, and a late-stage financing event. Therefore, it can offer many things to a company: shareholder liquidity, cash to the balance sheet, broader long-term financing opportunities and investor base, simplification of a complex private company preferred equity structure, access to a sponsor's finance, public company and industry expertise (and connections). Knowing precisely what its objectives are at the outset will allow a company to properly tailor a business combination to its own needs and determine the unique legal and structural terms required to complete the transaction.

As more SPACs come to market every day, and more companies consider potential business combinations, now is the time for companies and their stakeholders to educate themselves about these transactions and to engage professionals and well-versed third party advisors in the many evolving market terms in the SPAC process. 

This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The content therein does not reflect the views of the firm.