The SPAC Explosion: formation, compliance, and legal issues to consider

A.   What is a SPAC?

A Special Purpose Acquisition Company, or SPAC, is a corporation formed for the purpose of effecting a merger, share exchange, asset acquisition, share purchase, reorganization, or similar business combination with one or more businesses. Benefits of the SPAC include an alternative pathway to “go public” and obtain a stock exchange listing, a broader shareholder base, status as a public company with Exchange Act registered securities, and a liquid market for shares. A SPAC initially has no commercial operations and is formed solely to raise capital through an IPO from both institutional and retail investors. Generally, 100% of the capital is placed in a trust and not released until the SPAC completes a business combination or upon a specified deadline if the SPAC does not complete a business combination by then. A SPAC ordinarily offers units in its IPO to compensate investors for allowing their capital to be held in the trust account for a period of time. Each unit is comprised of one share of common stock and a warrant to purchase common stock, which is intended to provide investors with the extra compensation. A SPAC has sponsors that acquire founder shares for nominal consideration in connection with forming the SPAC. The ownership of these shares typically results in the SPAC's sponsors owning 20 percent of the SPAC's outstanding common stock upon completion of the IPO.

B.     SEC Compliance Requirements

A SPAC is required to file a registration form with the SEC in order to offer securities in the public market. The registration statement provides details on the sector in which the SPAC intends to conduct a merger or acquisition as well as the criteria to be used in determining the suitability of a target company for combination. The registration statement also includes information on the management team, details of the securities to be offered, and any relevant potential risks. The management team then aims to find a “target company” with which to combine. They typically seek entities that are large enough to sustain a public company but small enough not to either interest private equity investors or be a viable IPO candidate. Management then presents the potential target to investors for approval. If approved the combination may be accomplished by any method, including a merger or acquisition of stock. Investors who opt out of the combination are refunded their investment to the extent required by the SPAC's organizational documents. Investors should be advised of the procedural protections the SPAC provides as well as what kind of returns are likely to be generated. Additional regulations applicable to SPACs include the Securities Act as well as the Exchange Act. A material misstatement in omission from a Securities Act registration as part of a SPAC business combination is subject to Section 11 of the Securities Act. A material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14a and Rule 14(a)-9.

C.    How are SPAC Formed?

SPACs are organized in the form of a corporation. SPACs, as registrants with assets consisting solely of cash and cash equivalents formed with the sole purpose of raising capital, are “shell companies” under the Securities Act of 1933 and forms and regulations thereunder. A shell corporation must register with the company register of the country it is created in, so SPACs in the U.S. must register with the U.S. SEC. SEC regulations prohibit or limit the use by shell companies of some exemptions and safe harbors, which applies to SPACs. SPACs and former SPACs (i) are not eligible to be well-known seasoned issuers or to use Free Writing Prospectuses (other than those limited to a description of the offering or the securities) until at least three years after the De-SPAC transaction and (ii) are limited in their ability to incorporate by reference information into long-form registration statements on Form S-1. Additionally, stockholders of former SPACs must hold their equity for 12 months from the date of filing of a “Super 8-K” before they can rely on Rule 144 of the Securities Act, which provides a means by which “statutory underwriters” may sell their equity without registration.

D.   RF Observations

Investors considering investing in SPACs are relying on the management team’s experience and knowledge to successfully execute the initial business combination.  Evaluating the prospectus and reports by the sponsor should be of the upmost importance. It’s important to note that unlike a traditional IPO of an operating company, the SPAC IPO price is not based on a valuation of an existing business.  When the units, common stock and warrants begin trading, their market prices may fluctuate, and these fluctuations may bear little relationship to the ultimate economic success of the SPAC.

For questions, please contact Todd N. Robinson or Nicholas G. Moore.

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