Caroline B. Blitzer (Vinson & Elkins LLP) examines SPAC structure and the impact of SEC Rule 144
PLI: So how are SPACs structured, and what is the impact of SEC Rule 144?
CAROLINE B. BLITZER: Typically, a SPAC offers prospective investors the opportunity to purchase a unit consisting of one share of common stock and one warrant. Each warrant entitles the holder to purchase one share of common stock at a price that is less than the public offering price of the unit. The warrant typically becomes exercisable upon the later of the completion of a business combination or a specified period of time following the IPO which is generally about 12 months. The unit trades publicly upon consummation of the IPO, and the common stock and warrants typically begin trading separately shortly after the completion of the IPO.
PLI: So how are SPACs structured, and what is the impact of SEC Rule 144?
CAROLINE B. BLITZER: Typically, a SPAC offers prospective investors the opportunity to purchase a unit consisting of one share of common stock and one warrant. Each warrant entitles the holder to purchase one share of common stock at a price that is less than the public offering price of the unit. The warrant typically becomes exercisable upon the later of the completion of a business combination or a specified period of time following the IPO which is generally about 12 months. The unit trades publicly upon consummation of the IPO, and the common stock and warrants typically begin trading separately shortly after the completion of the IPO.
In connection with the formation of the SPAC entity, the SPAC typically issues to its insiders, who may include its sponsors, officers, directors and their respective affiliates, for a nominal amount, a number of shares of common stock that will equal 20% of the SPAC's outstanding shares immediately after the IPO. This stock will increase in value upon completion of the IPO based on the initial public offering price. There are often restrictions on the insiders' ability to transfer these shares prior to the completion of an acquisition.
Almost all of the IPO gross proceeds are deposited into an interest-bearing trust account while the SPAC's management team looks for an acquisition target (usually private) seeking to use the SPAC's funds that were raised in the IPO. Historically, 85% to 90% of the IPO gross proceeds were deposited into the trust account, but investors in more recent SPACs are demanding that 99% to 100% of the IPO gross proceeds be deposited into the trust account to ensure that adequate funds are available in the event of a liquidation of the SPAC. In such cases, the SPAC is permitted to withdraw a portion of the interest earned on the escrowed funds for working capital needs in connection with evaluating possible acquisitions and for taxes incurred prior to a business combination. In addition, many SPAC insiders will purchase additional warrants simultaneously with the IPO which provides additional funds to be deposited into the trust account for the benefit of the public stockholders and additional funds that can be used for the SPAC's working capital needs. In the event of a SPAC liquidation, the purchase price of these warrants would become part of the liquidation distribution to the public stockholders and the warrants would expire worthless. Finally, underwriters of SPAC IPOs are deferring a portion of their underwriting fees until the SPAC completes its initial business combination. This increases the amount available for distribution upon liquidation in the event that a business combination is not consummated within the specified timetable.
A SPAC must typically consummate a business combination within a specified period of time following its IPO. Generally, that deadline is 24 months (sometimes with an 18-month deadline to sign a letter of intent or definitive agreement with an additional 6 months to close). Historically, SPACs had 12 months to sign a letter of intent or definitive agreement for a business combination and 18 months to close. In addition, the business combination often must occur with a target company that has a fair value equal to not less than 80% of the amounts held in trust at the time of the acquisition. Some SPACs are required to consummate a business combination in which they will become the controlling shareholder. If a business combination meeting all of the specified requirements is not consummated within the specified time period, the trust is liquidated and the amounts held in trust are distributed to the public stockholders. The SPAC insiders typically do not participate in the liquidation distribution with respect to any units, shares or warrants acquired prior to or in connection with the IPO.
Once the SPAC's management has identified a suitable target, the business combination must be approved by its shareholders. The vote typically requires approval by a majority of the shares actually voted by the public shareholders. This requirement is imposed by the SPAC's charter and is in addition to any vote that may be required by the law of the jurisdiction of incorporation of the SPAC. In many SPACs, the insiders are required to vote in accordance with the public shareholders so as not to influence the vote on the business combination. Any public shareholder that votes against the business combination may elect to have its shares converted into its pro rata portion of the funds held in trust; however, that shareholder will continue to have the right to exercise its warrants should the business combination be approved and the SPAC continue its existence. If shareholders holding more than a specified percentage of the shares sold in the IPO vote against the business combination and elect to exercise their conversion rights, then the SPAC is not permitted to consummate the business combination. The threshold of what constitutes a "rejection" varies among the different SPACs, but is generally in the range of 20% to 40% of the shares held by the SPAC's public shareholders.
Some more recent SPAC's include a "bull-dog" provision which restricts a public shareholder from acting with its affiliates and/or other shareholders to form a group seeking conversion in excess of 10% of the group's shares. A bull-dog provision is important because without it investors could form a group to block a deal from taking place by converting their shares into cash. This conversion would essentially hold the company hostage in anticipation of the group receiving a premium for their shares in exchange for a "yes" vote on a potential business combination.
The vote on the business combination involves the solicitation of proxies in accordance with the rules of the SEC. The proxy statement will be subject to review and comment by the SEC, and this can be a lengthy process particularly if the target's financial statements do not satisfy the requirements of the SEC's rules and regulations at the time the acquisition is identified by the SPAC's management. In such cases, it may be advisable for the SPAC to discuss with the accounting staff of the SEC in advance of filing the proxy statement the proposed financial statements and other financial data of the target to be included in the proxy statement.
Upon consummation of the business combination, the funds held in the trust account, less any amounts used to repay shareholders who exercise conversion rights, are released to the SPAC and used to pay all or a portion of the purchase price of the target.
If the business combination is approved and consummated, investors who continue to hold their shares should be aware of the provisions in new Rule 144 that could limit their ability to resell those shares under the safe harbor. First, Rule 144 will not be available to holders of SPAC securities, whether affiliates or non-affiliates, until one year has elapsed from the date that the SPAC files Form 10 information indicating that it is no longer a shell company. In addition, under new Rule 144(i), if a company ever was a shell company, it must have filed all of its Exchange Act reports and other information, other than Current Reports on Form 8-K, for the 12 months immediately preceding the sale or the Rule 144 exemption is not available. The rule is written such that it applies to any issuer that was a shell company at any time during the life of the company (such as Berkshire Hathaway, Occidental Petroleum, and Texas Instruments). Interestingly, unlike the requirements for the availability of Form S-3, the requirements of Rule 144(i) do not require that the Exchange Act reports have been timely filed so long as they have actually been filed.
The significance of this really arises in two areas where it may be important to the issuer to determine in advance whether shares are freely tradable under Rule 144: (1) determining when securities cease to be registrable under a registration rights agreement and (2) determining when the legend can be removed from certificates representing restricted securities. Registration rights agreements generally provide that securities cease to be registrable securities when they can be freely resold under Rule 144. Similarly, the SEC has made clear that legends can be removed from restricted securities in advance of a sale once they become freely tradable under Rule 144. However, in the case of a company that has been a shell company at any time, it will be impossible to determine whether shares have become freely tradable under Rule 144 because one can never know in advance whether the company will have filed all of its Exchange Act reports in the 12 months preceding the sale. Thus, it will be impossible to determine when shares cease to be registrable securities or when a legend can be removed in advance of a sale.
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