Modern De-SPAC and the Way Forward – Securities

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I Background of SPACs and de-SPACs

A special purpose acquisition company, or SPAC, is a publicly traded company with no operations, products, or assets. Unlike an initial public offering (IPO) of a traditional public company, the primary function of a SPAC is to raise capital that is held in a trust account and seek out and combine with a private operating company to take that private company public, avoiding the traditional process EVEN AFTER. for a private company. After merging with the SPAC in a “de-SPAC” transaction, the acquiring entity takes over the business operations of the target company and continues as a publicly traded company, with the proceeds held in the trust account used to fund the target company’s business.

It is well known that the insatiable appetite for SPAC IPOs that dominated the US capital markets in 2020 and most of 2021 subsided in late 2021 and further declined in 2022 and the first half of 2023. With the decline in SPAC IPOs also came a decline in resulting initial business combinations, or IBCs, between a SPAC and a target operating company, with a peak closing of 200 IBCs in 2021 compared to just half that number in 2022, and only 40 de-SPAC transactions in the first quarter of 2023. Additionally, unlike earlier de-SPACing transactions, in the most recent de-SPACing transactions, SPAC shareholders exercised their right to return the IPO proceeds while voting to approve the merger. Although recent IBCs have not been a source of significant capital for the target businesses, many of the recent transactions have been accompanied by separate financing transactions, which are described in more detail below, and which run concurrently with the IBCs.

A number of companies that went public through IBCs in the past two years have not fared well, contributing to the negative perception of the SPAC structure in recent quarters. However, although the frenzied market in 2021 and 2022 may have led some companies to go public early through the de-SPAC process, the SPAC structure itself is not primarily responsible for their subsequent performance. Rather, this performance can be attributed to a number of other factors, including that many of the targets were early-stage technology or biotech companies whose problems can be attributed to current macroeconomic conditions, particularly the difficulty of meeting their demanding capital requirements, rather than their association with a former SPAC.

II. Latest trends in De-SPAC through flexible alternative financing structures

De-SPAC transactions have the ability to raise additional financing for their mergers through private investment in public equity transactions (PIPEs), where the SPAC issues new securities to institutional accredited investors contingent on the closing of the IBC. PIPE investments help both the fund’s investors share in the buyouts and finance the merger itself. Because it is uncertain how many shareholders will repay their investments prior to the IBC, the resulting amount of cash that will be available in the SPAC’s trust account upon the de-SPAC’s closing may not be known immediately prior to the merger. Securing PIPE financing helps mitigate the risk that sufficient cash will not be available for a de-SPAC transaction. While some of these PIPE transactions involve straight equity, de-SPAC transactions increasingly use alternative, creative financing structures. Some SPACs have raised funds by issuing convertible bonds or preferred stock or entering into forward purchase contracts with favorable conversion features, while others have issued warrants as part of their common equity deals.

In de-SPAC transactions, returns refer to the right of target company shareholders to receive additional equity once certain milestones are met, usually based on stock price or financial ratios, with a certain number of shares issued as additional consideration when the target company’s stock price reaches a certain threshold or at various share price thresholds through a tranche structure or the relevant financial metric is met. Proceeds can help bridge the valuation gap between targets and buyers by reducing the sponsor’s or target shareholder’s reward if those stock price targets are not met, which in turn reduces the parties’ incentive to enter into bad merger deals. Another financing development is that the SPAC acquires commitments to issue convertible bonds with semiannual cash interest payments depending on when the bonds are converted.

While business combination transactions are being announced with traditional PIPEs, it is clear that the de-SPAC market continues to allow SPACs and target companies fluidity and alternative financing structures that are utilized where appropriate.

III. A look into the future of de-SPAC

Many of the SPACs that went public in 2021 and 2022 are now nearing the end of their hunting period to identify and complete IBCs before the time they are required to liquidate the SPAC and return IPO proceeds to investors. 300 SPACs have dates to merge with the operating company through the end of 2023, so this small window of time is opportunistic for de-SPAC transactions. Additionally, the economics of the SPAC structure, which provide significant incentives for SPAC sponsors to consume IBCs, result in SPAC sponsors being highly motivated to negotiate IBC terms that are favorable to the target. While SPAC volume has and may continue to decline, there are still opportunities for highly motivated SPACs and strong target companies looking to come public. Despite their decline in volume, SPACs have been around for decades and provide an important function in the capital markets, providing an alternative form of venture capital financing that still has advantages over traditional IPOs and bringing private companies public.

SPACs approaching de-SPAC deadlines should look to these mature private companies that are ready to take to the public capital market. 2023 could be a breakthrough year in the de-SPAC process, showing a higher percentage of successful de-SPAC companies.

Seward & Kissel will continue to monitor the development of de-SPAC transactions and how they continue to evolve during this opportunistic time.

Originally published on July 27, 2023

The content of this article is intended to provide a general guide to the issue. Professional advice should be sought regarding your particular situation.

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