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Assessing the Costs of SPACs

The casual reader of the business pages has seen over the past year or so many articles about SPACs, the financial structure du jour, which have actually been around for a while. (I worked on some in the ‘00s.) The acronym stands for Special (or Specified) Purpose Acquisition Company. For those of my readers that are not corporate finance professionals, the way to conceptualize a SPAC is that it’s a private equity fund that is publicly traded. In other words, investors put funds in a newly created entity via an initial public offering (IPO). The entity has no operations other than a plan to acquire an operating company with the IPO funds within the next couple of years, with a management team that is tasked with doing the acquiring. From the perspective of the operating company being acquired, it’s a way to go public, by merging with the already-public SPAC, as an alternative to a traditional IPO. (In a traditional IPO, there is no merger; rather, a bunch of new shares in the private company are sold to the public, and poof, it’s a public company.)

The investment community has been abuzz recently about an academic paper, summarized here, that found the costs of going public via SPAC merger to be much higher on average than doing so via a traditional IPO. For my non-finance professionals out there, the most concise way I can put it is that the typical SPAC structure is designed to favor the initial sponsors and initial investors, over investors who buy shares in the open market after the SPAC’s IPO and the target company shareholders. This is because of two concepts present in most SPACs but not in most other contexts: the promote and warrants.

A promote is a form of compensation for the management team that forms the SPAC, brings it public and finds an acquisition target. Generally, this sponsor team gets, for nominal cost, 20% of the post-IPO shares of the company. Ultimately, these shares dilute the ownership of the SPAC investors and of the target company’s shareholders, post-merger, in a way that doesn’t occur in a traditional IPO.

Additionally, in most SPACs, the IPO is done as a sale of units, comprised of regular shares and warrants to purchase additional shares. The warrants (which are like stock options for those unfamiliar with the term) have an exercise price somewhat higher than the IPO price. The warrants are essentially a free add-on for the SPAC IPO investor. They can elect to have the company redeem their shares in advance of the merger and get their invested money back, but they still can keep the warrant and cash in if the stock pops. The additional shares that are issued when warrants are exercised constitute dilution to other holders, again in a way that wouldn’t occur in a traditional IPO. At least as compared to the promote, a warrant exercise for cash would bring funds into the company, but if the warrant is in the money (i.e., the market price exceeds the exercise price), then the shares are being purchased at a discount, which is not the kind of dilution that existing holders want to see.

Ultimately, there are some advantages for private companies in going public by SPAC merger over a traditional IPO. For example, whether an IPO can be completed can depend on general market conditions at the time of pricing of the IPO that are completely outside the company’s control. A SPAC merger may be the right choice for certain companies. But they need to be sure they are taking into account and fully understand the SPAC structure before choosing this option over other alternatives, like a traditional IPO, an acquisition by another operating company or private equity fund, or simply staying put as a private company.

New York Relents on Form D Filings

Form D FilingsAs of December 2, 2020, New York has joined other states in requiring that Form Ds filed with the SEC for securities offerings be submitted to the state via the EFD electronic system, replacing the state’s previously-required Form 99.

New York has long been a holdout on this front since 1996 when Congress passed the National Securities Market Improvement Act, which was intended to rationalize the crazy quilt patchwork of individual state “blue sky” laws to be complied with wherever securities were sold. NSMIA expressly preempted any requirements from a state beyond filing a copy of the Form D along with a filing fee and a consent to service of process. Most states quickly amended their blue sky laws to require only what NSMIA permitted. New York, however, continued to require the filing of a Form 99, which clearly required more disclosure from issuers than was permitted under NSMIA. …

The Golden Age of Non-Interruption

The Golden Age of Non-InterruptionI have found over my 23 years of law practice that, assuming I’ve consumed my usual copious amount of coffee, I can be quite productive and efficient when I get into a flow. When that flow is interrupted – by a phone call, someone popping into my office for a quick question, a car alarm going off, etc. – it can be difficult to get back into the groove. The good news is that a number of workplace trends in recent years have resulted in a general decline in interruptions, leading to more efficient work.

At least for me, the key development has been the advent of email. Everyone likes to complain about email – not me! As long as you don’t set your email system to notify you of every incoming email, which for me would be crazy-making, you are in control of when you look at it. Unlike someone making a phone call, the sender of an email is not expecting a literally immediate response. Of course, law is a service business and clients have reasonable expectations of a prompt reply, but the checking of the email can wait until you’ve finished reviewing that convoluted contractual provision.

The SEC Streamlines Accredited Investor Verification Under Rule 506(c)

The SEC’s recent final rule release regarding exempt offerings covered various topics, including the subject of my previous post, on the expanded offering limits for Regulation CF crowdfunding and Regulation A offerings. In the release, the SEC also provided some welcome relief in the accredited investor verification process for Rule 506(c) offerings.

The SEC Broadens the Crowdfunding and Regulation A Exemptions

The SEC issued a 388-page final rule release, entitled Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets. (The clunky wording seems like it was done to accommodate a catchy acronym, but “FCFAEIOBIATCIPM” doesn’t really flow.) The release details rule changes in a variety of areas relating to private offerings, but I will focus for this post on the expansion of the crowdfunding (Regulation CF) and Regulation A offering exemptions, and cover other topics in future posts. Here are the SEC’s press release and fact sheet about all the new rule changes.

The SEC Proposes a Clear Finder Exemption

I’ve noted in several blog posts (most recently here) that the SEC had not provided definitive guidance on an exemption for so-called “finders” from broker-dealer registration requirements. Now we have that guidance, at least in proposed form, which if enacted would provide clarity for issuers and would-be finders. The proposal was approved by the SEC Commissioners on a 3-2 vote (because it’s 2020 and of course it’s contentious), so there is perhaps a greater than usual possibility of changes to the rules before finalization.

Payments to Independent Contractors Under Paycheck Protection Program Loans

The Small Business Administration (SBA) has just launched the Paycheck Protection Program (PPP), arranging for forgivable loans to small businesses affected by COVID-19. There are, however, widespread implementation issues, with several banks that will administer the loans not yet being ready to process loan applications, as of April 6, 2020. For general guidance on the program, I can provide you with this fact sheet from the Treasury Department and a website guide from the SBA. Additionally, most large law and accounting firms are constantly issuing client alerts summarizing the latest developments, which are available on those firms’ websites.

The SEC’s Proposed Expansion of Accredited Investors

When to use a Private Placement Memorandum | Andrew Abramowitz, PLLCThe SEC has issued a proposal to expand the definition of “accredited investor” as used for the Regulation D safe harbor for private offerings. This press release/fact sheet summarizes the changes. There are a number of technical updates to reflect developments in how business is now conducted, e.g., LLCs with sufficient assets would qualify in the same manner as corporations now do. However, the change that would likely have the most impact, at least in my practice, is the inclusion as accredited investors of natural persons with appropriate professional certification, such as holders of a Series 7 securities license, even if they don’t qualify under the existing standards for natural persons for income or net worth. I’m not aware of any significant opposition to this concept and assume it will be enacted by the SEC after public comment.

However, any time the topic of the accredited investor definition is raised serves as a trigger for me to raise the issue of investment limits in private offerings. Crowdfunding offerings under Regulation CF, enacted in recent years and still used far less than Regulation D, impose investment limits on investors that are based on a percentage of the investor’s income or net worth. Accordingly, the structure precludes a total financial wipeout of the individual investor as a result of a failed investment. …

The “Get Everyone in a Room” Fallacy

Every deal lawyer has had the experience. The deal negotiations have gone on longer than anyone expected. Frustration is setting in. At that point, one of the individuals involved, more likely to be one of the principals instead of an attorney, demands an all-hands, in-person meeting to get the deal done, and “we’re not leaving until we have a deal.” This impulse, while understandable, is often misguided and can lead to additional frustration.

Should Solo Lawyers Seek to Partner Up?

Use of Debt Financing by Law FirmsWriting in Above the Law, Jordan Rothman argues from personal experience that solo lawyers would be better off partnering in a law firm with one or more other attorneys. As someone who has operated partner-less for almost 10 years now, after Big Law partner experience (where one literally doesn’t know many of one’s partners because there are so many of them), I’ve seen different arrangements and have some thoughts on these issues. While there are some clear advantages to having partners, much of Rothman’s argument is based on an unduly restrictive assumption about how solo firms must operate.