Special Purpose Acquisition Companies

A SPAC evolution

THOMAS FRIEDMANN & D CHAD LARSON, DECHERT

In 2003, just one special purpose acquisition company, or SPAC, completed its initial public offering (an IPO). In 2007, SPAC offerings represented nearly 25% of the total IPO volume in the United States. SPACs are blank check companies that raise funds through an IPO for the purpose of acquiring an operating company and generally have standardised terms. Due to certain advantageous characteristics of SPACs, they have become a popular investment vehicle, significantly growing in numbers, size and prestige.

The explosion of SPAC offerings, however, has shifted the market in the buyers’ favour, and caused a dramatic change in terms, generally making SPACs much more attractive to investors. The founders of SPACs and underwriters are also revising the terms of SPACs due to current IPO market conditions and a desire to convince the stockholders of SPACs to vote in favour of proposed business combinations.

Standard market terms for SPACs

SPACs feature standardised terms that have evolved in response to market practice and comments from the Securities and Exchange Commission (the SEC) during the registration process. In their IPOs, SPACs typically issue units, which consist of one share of common stock and one or two warrants to purchase shares of common stock. Most traditional SPACs provide the founders with a ‘carry’, or initial ownership interest, of 20% of the shares of common stock of the SPAC, and founders typically also purchase a number of warrants to purchase additional shares of common stock. SPACs place the vast majority of the funds raised in their IPOs in trust accounts that can only be released upon consummation of a business combination. The SPACs have a limited existence and must complete their first business combination during such time period or liquidate, distributing the funds held in the trust to the public holders of common stock. Holders of a majority of the shares of common stock sold in SPAC IPOs must approve any potential business combination. As described more fully below, these standardised terms are now changing to become more favourable to investors.

Background to the growth boom

SPACs are popular because they benefit theirfounders, private equity firms, public investors and target companies. SPACs offer founding management teams with the prospect of substantial wealth and leadership of a public company. With the recent decline of IPOs in the United States, as demonstrated by the fact that there were only 26 IPO closings in the first quarter of 2008 versus 63 IPO closings in the first quarter of 2007, SPACs became a leading alternative exit strategy for portfolio companies of private equity firms and other companies seeking the liquidity of publicly traded shares. Public investors are attracted to SPACs by the opportunity to participate in substantial increases in shareholder value when privately held target companies become public companies.

These gains can be quite dramatic, as was the case when Freedom Acquisition Holdings, Inc, a SPAC, acquired GLG Partners LP, a London-based asset management firm, and certain of its subsidiarie in the highest profile business combination by a SPAC thus far. Freedom Acquisition Holdings, Inc, which had raised $528 million in its IPO, purchased GLG Partners for an aggregate of $1 billion, 530 million shares of common stock and over 54 million shares of preferred stock.


“The size of SPAC IPOs has grown from raising an average of $24 million in 2004 to $282 million on average in the first three months of 2008”


Freedom Acquisition Holdings, Inc renamed itself GLG Partners, Inc and is currently trading on the New York Stock Exchange. The shares of common stock of Freedom Acquisition Holdings, Inc increased in value from less than $10.00 a share before the announcement of the potential acquisition to $14.60 a share after the completion of the acquisition. Public investors are also attracted by arbitrage opportunities inherent in the unit security structure used by most SPACs and by the variety of shareholder protections adopted by SPACs to address the risks of investing in blind pool vehicles. For target companies, SPACs offer the prospect of success in ‘going public’ in a fickle equity market and the liquidity that comes with publicly traded securities.

As a result of SPACs’ many beneficial characteristics, they have grown in numbers, size and prestige. There has been a huge increase in the quantity of SPACs in the last few years. Just 11 SPACs completed IPOs in 2004 whereas 66 completed IPOs in 2007. As of 31 March 2008, there were 67 SPACs in registration with the SEC. In addition, 11 non-US investment vehicles having characteristics similar to US-registered SPACs had issued shares that trade on EuroNext Amsterdam and the AIM Segment of the London Stock Exchange. There also are several privately placed, unlisted SPACs as well. When SPACs emerged in 2003-2004, they tended to be significantly smaller than more recent incarnations.

The size of SPAC IPOs has grown from raising an average of $24 million in 2004 to $282 million on average in the first three months of 2008. SPACs have also gained esteem as a respectable investment vehicle in the financial world. Numerous established private equity and financial leaders have become founders of SPACs, including Thomas Hicks, Joseph Perella, Robert Greenhill, Bruce Wasserstein and Nelson Pelz. In recent months, several bulge-bracket investment banks have begun to underwrite SPACs, and the New York Stock Exchange and the Nasdaq Stock Market have both announced a willingness to list SPACs.

The current evolution of SPACs’ structure

SPACs’ terms have been malleable since their inception in 2003, shifting to provide enhanced investor protection and to remedy problems inherent in early SPAC offerings. For example, the percentage of IPO proceeds placed in a trust by a SPAC in favour of non-affiliate shareholders was 86% on average in 2004 as compared to 98.3% on average in 2007. Likewise, the market has recently permitted SPAC founders more time to locate and close an acquisition. In 2004, this period was typically 18 months, with an additional six months available to close a business combination assuming a letter of intent was signed by the end of the 18-month period. By the second half of 2007, this period had been extended to an average of 24 months, with many SPACs providing for possible additional extensions of six or twelve months. These changes reflect the fact that SPAC investors are unwilling to risk losing money in the event that a SPAC is unable to consummate a business combination, as well as difficulties that early SPACs encountered in locating, obtaining shareholder consent and closing business combinations in a timely fashion.

Although a uniform SPAC structure has not emerged, SPAC terms have recently undergone a rapid transformation due to market pressures. Structural changes to SPACs now percolating through the SEC registration process reflect a need to attract more demanding investors in the face of numerous SPAC registrations and a difficult IPO market. They also reflect the difficulty of convincing investors to vote in favour of a proposed business combination.

SPACs are vying with each other to provide more favourable terms to investors in the current equity market. As already noted, only 26 IPOs closed in the first quarter of 2008, which was the lowest number in a first quarter since 2003 and 37 fewer IPOs than last year’s first quarter. The large supply of SPAC securities (as of 31 March 2008, there were 95 SPACs with more than $16 billion in funds that had conducted successful IPOs and were searching for appropriate targets and 67 SPACs seeking to raise over $13 billion in IPOs) and IPO market significantly weaker than that of early 2007 have, in turn, forced SPAC founders to revise the terms of recent SPAC IPOs to render them more appealing to potential investors.

SPACs have recently agreed to hold more funds they raise in a trust account to ensure that investors receive those funds if and when the SPAC liquidates, with the average thus far in 2008 being 99.7% of the funds raised in the IPO. Another investor-friendly trend has been the reduction in the percentage of initial SPAC equity held by founders. Until recently, most SPACs provided their founders with a carry of 20% of the SPAC. GHL Acquisition Corp and BPW Acquisition Corp, two large SPACs that closed IPOs in February 2008, reduced their founders’ carry prior to closing their respective IPOs. GHL Acquisition reduced its founders’ interest by 15%, while BPW Acquisition cut its founders’ interest by almost 30%. In both cases, the restructuring of the economics of the transaction appears to have contributed to a successful IPO. Furthermore, in the registration statement filed on 25 March 2008 by Liberty Lane Acquisition Corp, the first SPAC to be underwritten by Goldman, Sachs & Co, the founders’ proposed post-IPO equity ownership was reduced to just 7.5%. If the number of SPAC offerings coming to market continues unabated, we would expect the buyers’ market to continue and SPAC terms to be further revised in a manner favourable to investors.

SPAC founders are also modifying the terms of their IPOs so as to facilitate successful future business combinations and avoid liquidation. As of 31 March 2008, 13 early SPACs had either liquidated or commenced liquidation proceedings with a view to returning their IPO proceeds to public investors, with six of those announcements occurring since 31 January 2008. Such liquidations occur because these SPACs failed within the required time period either to identify a target company for an initial business combination or to obtain shareholder approval to consummate a proposed business combination. These 13 SPACs represent approximately 19% of the total number of SPACs that closed IPOs through the end of 30 September 2006 (18 months prior to 31 March 2008).

The number of failed SPACs is higher than one might expect, which may be due to the unusual profile of SPAC investors. Early SPACs were viewed as highly speculative by traditional IPO investors, such as retail investors and mutual funds. While conventional IPO investors eschewed SPAC offerings, many hedge funds sought out SPAC investments. These hedge funds appear to have been attracted to SPACs by the opportunity to profit on their investments through arbitrage trading strategies, rather than a buy and hold approach.

The unit security offered by most SPACs, facilitates a variety of trading strategies. Hedge fund investors could either hold the shares of common stock and sell the warrants, hold the warrants and sell the common stock, or hold or sell all of the securities underlying the units.


“SPAC founders are also modifying the terms of their IPOs so as to facilitate successful future business combinations and avoid liquidation”


While the opportunities for arbitrage profits may have appealed to hedge fund investors, it appears that many of these same investors do not intend to become long-term investors in the operating business after a SPAC business combination.

Accordingly, these investors have tended to either (1) vote against a business combination (thereby making themselves eligible to redeem their shares and receive proceeds from the SPAC trust fund or to receive cash upon the SPAC’s liquidation) or (2) sell their shares to interested long-term investors prior to the shareholder vote on the proposed business combination. In recent months, the tendency of hedge fund investors to ‘cash out’ of SPACs this manner has increased as many hedge funds have sought to increase their liquidity in the face of redemptions of their own funds and liquidity issues with other investments.

SPACs’ founders are now revamping SPACs’ terms to attract long-term investors and to induce shareholders to vote for a proposed business combinations. Liberty Lane’s registration statement reflects this trend. Under the conventional SPAC unit structure, holders of shares of common stock face substantial dilution due to the large number of warrants underlying the units that warrant holders can convert into shares of common stock after a business combination. This anticipated dilution renders the common stock of SPACs less attractive to target management teams as an acquisition currency and creates a strong overhang on the value of SPAC common stock in general. Liberty Lane modified this unit structure, reducing the number of warrants included in each unit from one or two to one-half of a warrant per unit. As a result, the expected dilution in the value of common shares post-business combination is reduced substantially. This can be expected to make Liberty Lane’s shares of common stock more attractive to prospective business combination targets. It remains to be seen whether other SPACs will follow the lead of Liberty Lane, but we expect future SPAC offerings will modify their terms in this or other ways to address the difficulty of obtaining shareholder approval, both at the IPO-stage and at the time of a business combination.

Two further factors influencing SPACs to become more favourable to investors are the entry of bulge-bracket investment banks into the market for SPAC underwriting and the announcement that the New York Stock Exchange and Nasdaq Stock Exchange would seek to list SPACs. Bulge-bracket investment banks can be expected to push for more investor friendly terms than the SPACs with IPOs in 2007 to promote the sale of SPAC securities, and such investment banks will be likely to require SPACs to conform to other SPACs’ favourable treatment of investors. The proposed listing rules for the New York Stock Exchange and Nasdaq Stock Exchange, which include substantive requirements beyond those required by the SEC, would convert market practice into threshold requirements for listing, thereby setting a floor for some SPAC terms.

As compared to other types of capital market vehicles, SPACs are relatively new and their terms remain fluid. With the rapid increase in the number of SPACs seeking to raise capital through IPOs and seeking business combinations, a buyers’ market has developed. We believe thiswill cause SPAC founders and underwriters to modify the conventional SPAC structure to meet the needs of the relevant constituencies, including founders, public investors, target company owners and underwriters. These changes should improve the probability of success for future SPACs. As a result, we expect market terms to change further in the coming months and the terms of future SPACs will differ significantly from those that seized the attention of the capital markets in 2007.