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Assessing the Costs of SPACs

February 22, 2021 By Andrew Abramowitz

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.

Related posts:

  1. Spotify’s Possible Direct Listing
  2. Reverse Mergers
  3. Allowing Departing Employees a Longer Stock Option Exercise Period

Filed Under: Financing Transactions/Securities Offerings, General Corporate/M&A Matters

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

November 21, 2020 By Andrew Abramowitz Leave a Comment

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.

[Read more…]

Related posts:

  1. Reluctance to Engage in Accredited Investor Verification
  2. Verification of Accredited Investor Status
  3. Simultaneous Regulation CF and Rule 506(c) Offerings

Filed Under: Crowdfunding, Financing Transactions/Securities Offerings

The SEC Broadens the Crowdfunding and Regulation A Exemptions

November 9, 2020 By Andrew Abramowitz Leave a Comment

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.

[Read more…]

Related posts:

  1. Regulation A+ – An Improved Way for Smaller Companies to Go Public
  2. Regulation A+ Proposed Rules
  3. The Latest from the SEC on Private Offering Regulation

Filed Under: Crowdfunding, Financing Transactions/Securities Offerings

The SEC’s Proposed Expansion of Accredited Investors

January 21, 2020 By Andrew Abramowitz Leave a Comment

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. [Read more…]

Related posts:

  1. The Latest on Possible Tweaks to the Accredited Investor Definition
  2. Reluctance to Engage in Accredited Investor Verification
  3. A Possible Expansion of Regulation A+

Filed Under: Financing Transactions/Securities Offerings, Startup Matters

The SEC’s Concept Release on Exempt Offerings and Investment Limits

July 23, 2019 By Andrew Abramowitz Leave a Comment

Share Buybacks as a Political Issue | Andrew Abramowitz, PLLCThe SEC recently issued a long “concept release” on harmonization of securities offering exemptions. Whenever I hear about one of these, my first thought is that it’s somehow like a concept album from a ‘70s prog rock outfit (and therefore to be avoided), but in reality, the point of concept releases is to solicit input from the securities law community on a broad topic without immediately proposing changes. In this case, it’s about the complex web of exempt offering types that have evolved over the years and whether and how to harmonize them.

[Read more…]

Related posts:

  1. Investment Limits in Title III Crowdfunding
  2. Simultaneous Regulation CF and Rule 506(c) Offerings
  3. The Latest on Possible Tweaks to the Accredited Investor Definition

Filed Under: Crowdfunding, Financing Transactions/Securities Offerings

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"Andrew Abramowitz, a lawyer in Manhattan who has worked with both buyers and sellers of private placements, said every investor should approach a private placement skeptically." -- Paul Sullivan (New York Times)

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