Big Name Betting (AKA SPAC Investing)

 

Ofir Hadari

 

New opportunities bring new legal challenges, and Special Purpose Acquisition Companies, commonly referred to as “SPACs,” paved a new channel for companies to go public, meaning the Securities and Exchange Commission (SEC) and corporate law will need to find new ways to moderate the booming SPAC economy. SPACs, or so-called “blank check” companies, are publicly listed acquisition vehicles with no operations that raise money in initial public offerings (IPO), and place that money in a trust or escrow account to be used for a future acquisition of one or more private operating companies.[1] In its IPO process, the SPAC does not disclose its potential acquisition candidates and may not even have private companies which it identifies as worthwhile.[2] The SPAC is bound by its charter, which typically requires it to identify and fully acquire a private company within 24 months.[3] This process of completing the initial business combination, often referred to as the “de-SPAC” transaction, effectively transforms the once-private target company into a publicly traded company by means of fully merging it into the shell acquisition vehicle.[4]

The management team that forms the SPAC, also called the “sponsors,” are responsible for negotiating the SPAC’s business combination transaction, which includes valuing the private operating company and determining how much the SPAC will pay for it.[5] SPAC sponsors run the gamut of types of investors, recently coming to include celebrity players such Shaquille O’Neal, Steph Curry, and Colin Kaepernick.[6] In Kaepernick’s SPAC registration statement, for example, he listed Mission Advancement Corporation as a company “with the aim of creating meaningful financial and societal value.”[7] The statement also included a disclaimer that the sponsors have not selected potential business combination targets, nor solicited any potential targets for substantive discussions,[8] which is language common to SPAC registration statements. Essentially then, those investors who provide capital during the SPAC IPO are betting on the ability of the SPAC sponsors to carry out the outlined mission. The blank check company is nothing but a mission with some big-name sponsors behind it.

The very nature of the SPAC, coupled with a recent expansion of the SPAC economy, prompted the SEC to promulgate new disclosure guidance specific to such companies.[9] The guidance provides the SEC’s views about certain disclosure considerations which SPACs should take into account in connection with their IPO and de-SPAC transactions.[10] The SPAC sponsors are bound by the ordinary fiduciary duties of care and loyalty to their shareholders. In its guidance, the SEC focuses heavily on potential “conflicts of interest,” which would trigger duty of loyalty violations.[11] Such a duty requires that directors and corporate officers act in the best interest of their shareholders by not engaging in self-dealing or conflicted transactions.

There are several points in the SPAC lifecycle which can give rise to inherent self-dealing. First, SPAC sponsors, directors, and officers may likely have fiduciary or contractual obligations to other entities upon launching the SPAC’s IPO.[12] The SEC disclosure guidance asks sponsors to consider whether they adequately disclosed such conflicts, or if they will eventually encounter such conflicts, how will they handle them as they arise.[13] Later, when the SPAC solicits acquisition candidates and engages in negotiations, the sponsors’ financial incentives can greatly differ from those of the public shareholders. Conflicts of interest can arise from executive security ownership, compensation agreements, or relationships with affiliated entities. Again, the SEC merely asks sponsors to clearly disclose any potential conflicts of interest in advance of the business combination process.[14] Finally, and most notably, SPACs have a limited lifetime, usually 24 months, to successfully complete the de-SPAC transaction, or liquidate and distribute net offering proceeds pro rata to its public shareholders.[15] As the SPAC nears the end of that timeframe, its acquisition options may narrow, giving target companies significant leverage in negotiations.[16] And again, the SEC recommends disclosure of the financial incentives of the SPAC sponsors, as well as the amount of control sponsors have over approval of the business combination transaction.[17]

The SEC’s disclosure recommendations can be useful for investors, but the idea that such disclosure can foreclose sponsor self-dealing is a lofty aspiration considering the nature of SPAC transactions. If a public shareholder can allege sufficient facts that give rise to a self-dealing transaction, the SPAC sponsors will have the burden of proving entire fairness, which means fair dealing and fair price. However, a SPAC is merely an organized group of investors with a registered mission. The SPAC does not have any assets or financial projections on which investors can rely. Rather, the investor gives funds to the SPAC because she believes the sponsors will be able to create value how they see fit, which may ultimately be in a self-dealing transaction. Essentially, the sponsors’ investment ideals and network become the real predictive measure of profit. Traditional means of protecting shareholder interests do not fit this new corporate tool, and rather than create new rules, perhaps the SEC needs to create a new framework.

 

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[1] See Special Purpose Acquisition Companies, CF Disclosure Guidance: Topic No. 11 (Dec. 22, 2020), https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies; Bruce E. Ericson, Ari M. Berman, & Stephen B. Amdur, The SPAC Explosion: Beware the Litigation and Enforcement Risk, Harv. L. Sch. F. on Corp. Governance (Jan. 14, 2021), https://corpgov.law.harvard.edu/2021/01/14/the-spac-explosion-beware-the-litigation-and-enforcement-risk/.

[2] See Ericson et al., supra note 1.

[3] See Christopher M. Barlow, Howard L. Ellin, Michelle Gasaway, Gregg A. Noel, C. Michael Chitwood, & Franklin P. Gregg, The Year of the SPAC, Lexology (Jan. 26, 2021), https://www.lexology.com/library/detail.aspx?g=5c20bff9-3df4-4979-8e7e-bf8fe056a6d7.

[4] See id.

[5] See Special Purpose Acquisition Companies, supra note 1.

[6] See Chris Katje, 5 ‘Celebrity SPACs’ to Consider: Shaq, Serena, Steph, A-Rod and Ciara, Benzinga (Feb. 9, 2021), https://www.benzinga.com/news/21/02/19562249/5-celebrity-spacs-to-consider-shaq-serena-steph-a-rod-and-ciara; Elena Dure, Colin Kaepernick Latest Athlete to Form a SPAC, Investopedia (Feb. 10, 2021), https://www.investopedia.com/colin-kaepernick-latest-athlete-to-form-a-spac-5111837.

[7] See Mission Advancement Corp., Registration Statement Under The Securities Act of 1933 (Form S-1) (Feb. 9, 2021).

[8] See id.

[9] See Special Purpose Acquisition Companies, supra note 1.

[10] See id.

[11] See id.

[12] See id.

[13] See id.

[14] See id.

[15] See Barlow et al., supra note 3.

[16] See Special Purpose Acquisition Companies, supra note 1.

[17] See id.