SPACs post-Hill: a blank cheque to growth?

"Why do we need to act? Although listing on the premium listing segment of the FCA’s Official List has historically been globally recognised as a mark of quality for companies, the figures paint a stark picture: between 2015 and 2020, London accounted for only 5% of IPOs globally…… At one point last summer, Apple alone was worth more than the combined value of every company in the FTSE 100".[1]

It is safe to say there have been some undulations in the use of special purpose acquisition companies (SPACs) over the last 20 years, in part caused by fluctuating market conditions and investor sentiment.

A SPAC is a newly incorporated company having the sole purpose of making one or more future acquisitions in a targeted industry sector, a specific geography or both.  The "sell" to investors in the SPAC is concentrated on the expertise and knowledge of the founders (or "sponsors") and their ability to find a suitable target acquisition.  If a target is acquired (by reverse merger) that target secures the benefits of being listed. If no such target is found within a prescribed period (typically, two to three years) the SPAC collapses, is delisted and the proceeds of the IPO (less costs) are returned to the investors.

Why is this relevant today?

There is no single reason, though in the COVID-19 period traditional IPOs have somewhat dried up.  Some also point to the low returns achievable on more mainstream securities and debt at this time, particularly for financial institutions, as an opportunity for more high-risk-high-reward propositions.  Perhaps in such an uncertain environment the (qualified) "money-back" aspect of a SPAC is also appealing to investors.  Lastly, as SPAC deal-flow has now been lucrative in the US for several years, some sponsors are now able to point to a persuasive track record of successful launches and acquisitions.

And what of the benefit to the target companies?  If the sponsors have PE or VC expertise coupled with that track record, this arguably opens an expedited route to an IPO with a much lower tariff on management and resource than in a traditional IPO process.  It can also be argued that a sale and purchase eliminates pre-IPO pricing uncertainty for sellers of those target companies.

There are, however, some pitfalls. The returns for the sponsors are considerable, and that bill is effectively picked up by (the investors and) the owners of the target company. The partial "money-back" return is also hardly a panacea, though if interest rates go any further down….  SPACs have from time to time lost their lustre, owing to failures to close acquisitions and, in some cases, to closing them successfully; as the sands of time pass through the SPAC hourglass the impending deadline can result in the pursuit of sub-optimal target companies or less than satisfactory deal terms.

This time around, at least, SPACs are giving some definition to their target market.  No longer do we see somewhat anaemic descriptions of a potential target business such as "industrial" or such gems as "in China or elsewhere in the world" next to "territory".  But you get the point.  The listing document particularises the capital structure of a cash shell, the acquisition strategy, the underwriting and the biographies of the board.  For voracious prospectus readers, there are few details and almost no financial data.  This is a journey based largely on trust.

What of the process?

The SPAC founders will typically set up the company and the subscriptions for those founder shares will fund some or all of the IPO expenses. These founder shares will be preserved on the IPO as preferred shares, giving the founders a substantial minority holding. This can be up to 20 per cent. of the SPAC.  As part of the IPO, they are typically issued further "promote" shares, a fruity cocktail of ordinary and/or preferred shares, as well as performance warrants linked to the success of the acquisition.

As to the investors, they are typically issued "units" containing listed shares and warrants. The warrants grant rights to purchase further shares at a certain time, but only post-acquisition and once the share price of the listed business has advanced beyond a certain threshold over the IPO price.

What regulations apply in the UK?

There are no SPAC-specific (SPACific?) rules on UK markets, and so SPACs are governed by the usual admission criteria and the additional rules relating to any “investing company”. SPACs are largely not eligible (at least, initially) to list on the Premium segment of the Official List. This is because they do not meet the three year revenue requirement which applies under the Listing Rules and tend not to fall within the narrow exemptions to those rules.

This leaves the Standard segment of the Official List and the AIM market. It is important to note that Standard listed companies do not (currently) need to secure shareholders’ approval for material post-listing acquisitions, which is key to the SPAC structure. The Listing Rules also place no time restriction on a SPAC deploying funds raised on the listing, though typically a two-three year restriction is agreed separately.  In contrast on AIM shareholders’ approval is required for a reverse takeover, but funds must be deployed within an 18 month period. For these reasons a listing on the Standard segment of the Official List is the usual initial preference. We say "initial" as post acquisition, the listed business (which is no longer a cash shell) may move to the Premium segment (or another exchange) if the relevant conditions can be satisfied.

Whilst not requiring shareholders to approve a business acquisition can be said to reduce execution risk, this does mean that a speedy conclusion is attainable – primarily because an FCA-approved prospectus must be published that covers the post-acquisition company group. During the period from the announcement of the acquisition until the date that the FCA approves the prospectus the SPAC’s shares are usually suspended and no dealings may take place. Not only are investors not required to approve the acquisition, but also they become locked into to a business whose pathway they may not support.

Moreover, it is not untypical that the acquisition could require additional financing. The availability and cost of this financing will depend upon market conditions at the time and investors will have no option but to go along with this.

So inbuilt investor protections are rather lacking in the UK compared with our friends on the other side of the Atlantic - even if the right to withhold approval is perhaps a little vague, the ability to sell (or redeem, see below) is much more meaningful. 

How is this different in the US?

In terms of this note the approach of the NASDAQ and the NYSE are broadly similar and certainly embrace greater protections for the shareholders in the SPAC, with specific rules that govern the structure.

90 per cent. of the gross proceeds raised during the IPO must immediately be paid into a trust account and are subject to strict investment criteria.  Additionally, the initial business combination must be in respect of one or more businesses having an aggregate market value of 80 per cent. of the amount isolated in that trust account. Neither of these requirements exists in the UK. 

Importantly, shareholders’ approval is typically required in the US and the SPAC will offer redemption rights to all at the point of the acquisition (even though the regulations only require it be offered to those who do not support or vote for the acquisition).  It is major difference from the UK "no dealings" approach which places shareholders in handcuffs and ankle chains. These redemption rights are well-protected as any acquisition agreement will be conditional upon sufficient funds being set aside to meet all potential redemption requests.  Some say that the comfort blanket afforded to investors by the redemption option has led to greater marketability for SPACs in the US.

On top of the advantages in terms of market rules, US SPAC market practice creates another important advantage; in the UK underwriting fees are typically settled in their entirety upon the occurrence of the IPO, but for US SPACs, a part of this fee is typically deferred until the acquisition is closed.

It is perhaps somewhat unsurprising that UK capital markets practitioners have been peering through the coin (or token)-operated Land’s End telescope somewhat wistfully over the last few years.

What of Lord Hill and the UK Listing Review?

Whilst the markets are markedly different in size, Lord Hill cites some rather jarring statistics for 2020: 248 SPACs launched in the US raising the dollar equivalent of £63.5 billion as against 4 such deals in the UK raising a paltry £0.03 billion.[2]

Undoubtedly the call to change is long overdue, and the number and nature of the recommendations are telling.

Freshly "onshored" (or liberated) from the EU Prospectus regime the FCA is invited to review the prospectus regime.[3] Our sense is that this will lead to decoupling the need for a prospectus on a public offering (arguably its real purpose) from other forms of capital raising or admission events.

If implemented, this is likely to lead to changes to the prospectus exemption thresholds and to documentation which is far more tailored to the type of transaction being undertaken. This is to be welcomed as a prospectus on a SPAC or capital raising can add very little to an investor’s knowledge which is not provided by other disclosure requirements.

It is also suggested that "amending" (read, diminishing) the liability for issuers and its directors should be considered further, thereby enabling the publication of forward-looking information as opposed to information based on careful (but rather unhelpful) modelling. Anything further is considered too risky to include under the current regime, but in any event is distributed to shareholders shortly after the listing! Issues of responsibility are a cornerstone of the current admission process, so changing this orthodoxy may prove to be a little more thorny.

It is further proposed to revise the troublesome presumption that trading of a company’s shares must be suspended following announcement of an acquisition, at least for SPACs above a certain size,[4] and perhaps even to implement specific shareholder approval and redemption rights for investors. The US inspiration is clear.

For those who enjoy the contemplative policy bubble, the focus on the Premium segment and the Standard segment of the Official List is interesting particularly in terms of which needs to move in order to be closer to the other. Lord Hill appears mildly to favour the beefing up of the Standard segment, though its renaming as the "Main" segment is not quite what many of us had in mind. We do agree that this segment has rather lost its way in terms of lack of index inclusion, volume and as a result research coverage.

Some favoured the alternate approach (a point recognised in the report) of lowering the velvet rope to the Premium segment a little more often. Whilst no per se reduction to the three year revenue requirement is proposed, it may well be that the existing exemption is to be expanded beyond scientific research-based companies to high growth innovative companies. There are undoubted definitional difficulties here (just ask HMRC) and we fear the onset of the "you will know one when you see one" approach.

As the changes relating to SPACs require changes to the Listing Rules (as opposed to primary legislation), we may not be pushing water up-Hill for much longer.  The FCA has indicated that these changes may be implemented by "late 2021". If history is any guide the SPAC will burn brightly but not indefinitely - for fear of missing the market opportunity, we suspect that these proposals will be implemented sooner and that other workarounds will be explored in the meantime.

Lord Hill's letter to the Chancellor noted that the recommendations are "the beginning of a conversation, not the end" and that the input of the whole marketplace would be needed to achieve the changes which are required. Is that a good thing? We were rather hoping for the 50:50 implied by arriving at the “end of the beginning”.