SPACS in the US v the UK

Kate Sherburne (Minneapolis) and Melanie Wadsworth (London) are corporate partners in the international law firm Faegre Drinker

Much has been written about the significant impact of SPAC IPOs on activity levels in the US public markets since the COVID pandemic hit.  On listing, these special purpose acquisition companies have no ongoing operations but raise funds to identify and pursue acquisitions within a limited time period.

 

 

At risk of generalisation, the following summarises a typical US SPAC structure:

• the SPAC traditionally sells units, including a share of common stock and a warrant to purchase a fraction of a share of common stock. The common stock and warrant are generally separately tradeable 52 days after the IPO;
• the SPAC is led by founders or sponsors who also receive a “promote,” typically amounting to 20% of the shares purchased in the IPO, conditional upon completion of a business combination or “de-SPAC” transaction.  However, that is far from being a rule. We have seen sponsors negotiate away some of their rights in connection with a de-SPAC transaction; and one of the largest US SPAC IPOs on record, by Pershing Square Tontine Holdings, featured a different structure which was intended to be less dilutive to the rank-and-file stockholders;
• the SPAC usually has two years (subject to extension in some cases) to identify and complete a business combination, failing which the fund will be liquidated and returned to investors;
• in general, a vote of the stockholders of the SPAC is required in connection with the business combination. The stockholders of the SPAC may also elect to redeem their equity in connection with a proposed transaction;
• due to the possibility of redemptions and the size of many of the de-SPAC transactions, additional financing is often required in connection with the business combination, for example, via a PIPE (where stock is sold to an institutional or accredited investor below market price) or a backstop (which may include a combination of sponsor contributions, third-party private placements and bank debt);
• the owners of the target company generally receive a combination of cash and stock in the SPAC as the consideration in the de-SPAC transaction, thereby becoming part of the stockholder base and suffering the dilutive effects of the sponsor promote and buyer transaction fees; and
• the owners of the target company sign lock-up agreements that restrict their ability to sell their SPAC shares for a period after closing of the de-SPAC transaction.

During the first half of 2021, more SPAC IPOs (377) completed in the US – backed by celebrity endorsements and even a rap video, thanks to Cassius Cuvée and Mags Lionne – than in the whole of 2020 (248) which far exceeded the 59 SPAC IPOs completed in the US in 2019.  So, why has a similar “SPAC attack” has not been seen in the UK?

There are certain regulatory features of the UK markets which currently make a SPAC IPO a less attractive option than in the US.  First, SPACs cannot meet the premium listing eligibility requirements (as they do not have an operating business or a three-year track record) and so can only list on the standard segment of the London Stock Exchange.  Perhaps more significantly, a de-SPAC transaction will be considered a reverse takeover under the UK listing rules, which means that trading in the SPAC’s shares will be suspended from the time the transaction is announced until a new prospectus (or admission document, if the relevant market is AIM) is published for readmission of the enlarged company.  Accordingly, investors have no ability to dispose of their shares after the target has been publicly identified, whether or not they support the deal.  This contrasts with the position in the US, where trading continues and investors have the option to redeem their shares for a pro rata portion of the SPAC trust account.  

The UK Listings Review, chaired by Lord Hill as part of a plan to strengthen the UK’s post-Brexit position as a leading global financial centre, recommended that the existing presumption of suspension on announcement of an acquisition by a SPAC should be replaced with additional disclosure requirements and investor protections.  The FCA announced a consultation on these proposed changes in April 2021, agreeing that presumed suspension potentially imposes a disproportionate barrier to listing for larger SPACs that have already built specific investor protections into their structures.

With the aim of providing “a more flexible regime for larger SPACs … potentially resulting in a wider range of large SPACs listed in the UK, increased choice for investors and an alternative route to public markets for private companies”, the FCA amended the listing regime relating to SPACs with effect from 10 August 2021 to include the following safeguards, with which a SPAC must comply to avoid suspension: 

• raising gross cash proceeds on admission of not less than £100 million from public shareholders, excluding funds from founders, directors and promoters;
• ensuring monies raised from public shareholders (less any amounts disclosed in the prospectus as running costs of the SPAC) are ring-fenced to fund the de-SPAC transaction.  If no relevant acquisition is completed within the agreed life of the SPAC, the ring-fenced funds must be returned to shareholders and the SPAC de-listed;
• having only a 2-year operating period (which may be extended to 3 years with shareholder approval), which may be extended by an additional 6 months in limited circumstances prior to expiry of the initial period, where the SPAC needs extra time to conclude a transaction that is well advanced;
• requiring approval of shareholders (excluding SPAC sponsors) for any proposed acquisition, having provided sufficient disclosure of key terms and information to allow them to make a properly informed decision;
• if any conflict of interest exists in relation to a SPAC director and the proposed target, receiving a Board confirmation that the terms of the proposed acquisition are fair and reasonable, with the statement reflecting the advice of an appropriately qualified independent adviser; and
• allowing investors to exit the SPAC prior to any acquisition being completed at a predetermined redemption price which could be a fixed amount or a pro rata share of the net ring-fenced funds.

The FCA hopes that these changes will generate greater traction for SPACs in the UK, while providing a measure of protection for investors. 

But it is possible that the shine is already coming off the SPAC model in the US.  The Securities and Exchange Commission (SEC) has made clear its reservations about what the SEC describes as an “unprecedented surge in non-traditional IPOs”.  In May 2021, Gary Gensler the chair of the SEC queried how these SPAC IPOs fit in with the SEC’s mission to maintain fair, orderly and efficient markets and US regulators have also raised concerns about financial reporting and auditing in relation to SPAC targets. The SPAC IPO market has certainly cooled in the US since these announcements were made.

Unsurprisingly, against this backdrop, SPAC-related litigation has reportedly increased in the US.  According to a recent blog from Woodruff Sawyer, one of the largest insurance brokerage firms in the US, ongoing claims include M&A lawsuits, derivative lawsuits, and securities class actions.  In addition, the SEC has just announced charges against a SPAC, its sponsor, its proposed acquisition target, and the target’s founder and former CEO for misleading disclosures premised on negligently deficient diligence. 

If the UK were able to replicate the SPAC boom experienced by the US, would similar issues arise?  Even if one ignores potential reporting and disclosure concerns, would there be sufficient advisers with the bandwidth to complete a run of SPAC IPOs within accelerated timelines – speed being one of the great selling points of a SPAC IPO.  And what about the subsequent de-SPAC transactions?  Implementation of appropriate internal controls and identifying and retaining an appropriate slate of directors and officers will not be easy – particularly in an environment where so many SPACs are chasing transactions.  One can imagine the dynamics created by dealing with the sponsors and bankers of SPAC which is nearing the end of its life, who face the loss of their promote and any deferred banking fees if the deal doesn’t get done…

Post-combination performance of the recent wave of US SPACs has not been fully tried and tested, as the two-year acquisition period is still running for many of them, but it is not yet clear that this is a bandwagon the UK should really wish to leap upon.  Undoubtedly, SPACs have potential to be a swift route to becoming a public company, with greater pricing certainty.  But the best advice may be to exercise caution through the journey.  

(1)Source: Testimony before the US Subcommittee on Financial Service and General Government, U.S. House Appropriations Committee, 26 May 2021
(2)https://www.sec.gov/news/public-statement/munter-spac-20200331 (Financial Reporting and Auditing Considerations of Companies Merging with SPACs, 31 March 2021)
(3)https://woodruffsawyer.com/do-notebook/more-spacs-leading-more-litigation (As Predicted: More SPACs Are Leading to more Litigation, 22 June 2021)
(4)https://www.sec.gov/news/press-release/2021-124 (SEC Charges SPAC, Sponsor, Merger Target, and CEOs for Misleading Disclosures Ahead of Proposed Business Combination, 13 July 2021)