What Comes After the Year of the SPAC? Diligent De-SPACing and Other Considerations

The Special Purpose Acquisition Company ("SPAC") is a shell company used to raise money for the purpose of acquiring or merging with another company. They’re modeled after the blank check companies first seen in the 1980s[1]. SPACs were hugely popular in the runup to the great recession before seeing a drop-off in activity[2], but if recent years are to be taken as indicative, SPACs are enjoying a massive resurgence. As of mid-December 2020, SPACs had raised $73 Billion for the year and that figure outpaced money raised by traditional IPOs by $6 billion according to Goldman Sachs[3].

Why the frenzied demand? The benefits of SPACs are similar to those of a reverse merger.  In fact, SPACs are designed to operate as a form of reverse merger[4] where a private company, the target, is merged into the SPAC, a public shell company, resulting in the private company becoming public. SPACs have all the traditional benefits of a reverse merger. The target is not subjected to intense SEC review, they require less legal preparation, which reduces indirect IPO costs, the relative speed afforded by the nature of the transaction makes them less subject to timing risks should market conditions turn, and they require less time commitment from the private firm’s management team as they do not have to engage in typical IPO prerequisites such as road shows[5]. The added benefits with SPACs are that the SPAC has vetted management who are involved with the SPAC’s IPO process and that the management is financially incentivized to acquire a prime target, usually only earning a return if the SPAC goes onto make an acquisition before its timeline, usually two years, runs out[6].  Some of the highest performing SPACs in 2020 returned between 97% and 171% for investors[7]. With 219 SPACs raised in 2020 in a white-hot market, one has to wonder what comes next.

 

The Risks During De-SPACing  

There are two general areas to risk as these companies look to de-SPAC. One source of risk is disclosures made during the SPAC IPO and in proxy statements ahead of the vote on the de-SPAC transaction. Another source of risk is the actions of the management and officers of the SPAC who may be incentivized to close on transactions that will not provide significant returns for original SPAC investors.  This incentivization comes from their compensation structure in which their equity only vests if the SPAC makes an acquisition. As has been pointed out, this may incentivize SPAC management to propose less attractive deals to SPAC shareholders towards the end of the lifespan of the SPAC[8].

 

Disclosures and Proxy Statements

While less burdensome than a traditional IPO process, SPACs still must make disclosures to the SEC in the form of a registration statement wherein SPAC management is subjected to strict liability for misstatements and omissions under the Securities Act of 1933, providing one potential source of litigation[9]. The De-SPAC proxy statement wherein disclosures are made to the SPAC shareholders to enable them to vote on the proposed acquisition also provides a basis for litigation if shareholders feel that they statements are inadequate or inaccurate[10]. These disclosures are governed by section 14(a) of the Securities Act of 1934. While challenges brought before the conclusion of a transaction can be remedied by amending the proxy statement (see Wheby v. Greenland Acquisition Corp., No. 1:19-cv-01758-MN (D. Del. Oct. 14, 2019), ECF No. 4.) it is more difficult to deal with inadequacies in the proxy statement after the transaction closes. An example can be seen in In re Heckmann Corporation Securities Litigation which resulting from a SPAC purchasing a bottled water company in China[11]. When the target dislosed financial results which were inconsistent with the projected financial data a shareholder class action was brought under §§ 10(b), 14(a), 20(a), and Rule 10b-5 of the Securities Exchange Act of 1934 alleging fraud, recklessness, and materially false and misleading statements[12]. The class ultimately settles for $27 million in cash and stock[13]. This provides a warning to SPAC management and the management of acquisition targets when they are writing proxy statements and making disclosures to shareholders.

 

Management Conflicts of Interest

The conflict of interest between SPAC management and the SPAC’s shareholders is especially evident as the SPAC approaches its deadline to acquire a company or liquidate because shareholders stand to have their funds returned to them whereas management will be left empty-handed without a deal. In Welch v. Meaux shareholders alleged that there was no material basis for the revenue guidance provided by the SPAC’s proxy statement[14]. Plaintiff’s also alleged that SPAC management rushed into the deal as the SPAC approached its deadline to acquire or liquidate, perfectly illustrating the conflict of interest between SPAC management and SPAC investors[15]. Law firm Pillsbury advises both SPAC management and the management of targets to seek extensions to the SPACs liquidation deadline as opposed to rushing a deal in order to reduce the risk of a de-SPAC transaction appearing unscrupulous and triggering litigation from shareholders[16].

 

 

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[1] Cumming et al., The fast track IPO – Success factors for taking firms public with SPACs, 47 J. of Banking & Fin. 198, 199 (2014).

[2] Id.

[3] Matthew Fox, 219 'blank-check' companies raised $73 billion in 2020, outpacing traditional IPOs to make this the year of the SPAC, according to Goldman Sachs, Business Insider (Dec. 18, 2020, 4:06 PM), https://markets.businessinsider.com/news/stocks/spacs-raised-73-billion-more-than-traditional-ipos-blank-checks-2020-12-1029906693.

[4] Cumming et al., supra.  

[5] Id.

[6] Id.at 200.

[7] Elana Dure, Top Performing SPACs of 2020, Investopedia (Dec. 30, 2020), https://www.investopedia.com/top-performing-spacs-of-2020-5093918#:~:text=Special%20purpose%20acquisition%20companies%20(SPACs,according%20to%20data%20from%20Dealogic.

[8] Cumming et al., supra at 200.  

[9] Bruce A. Ericson et al., The SPAC Explosion: Beware the Litigation and Enforcement Risk, Pillsbury (Dec. 15, 2020), https://www.pillsburylaw.com/en/news-and-insights/spac-litigation-enforcement-risk.html.

[10] Id.  

[11] In re Heckmann Corporation Securities Litigation., No. 1:10-cv-00378-LPS-MPT, at 1 (D. Del May 22, 2014), ECF No. 298.

[12] Id.

[13] Ericson, supra.

[14] Welch v. Meaux, No. 2:19-cv-01260-TAD-KK, 15-19 (W.D. La. Oct. 16, 2020), ECF No. 37.

[15] Id.

[16] Ericson, supra.