Over the past two years, special purpose acquisition companies (SPACs) have experienced a renaissance in popularity as both an investment and an acquisition vehicle. While SPACs were previously viewed as an investment strategy for institutional investors and hedge funds, their recent popularity has also garnered a great deal of media attention and piqued the interest of retail investors. High profile US SPAC sponsors from within the investment community such as Bill Ackman, Chamath Palihapitiya and Michael Klein as well as an influx of celebrity sponsors have added to the recent notoriety. While the renewed popularity of SPACs has posed certain challenges, this surge in SPAC activity has benefited from past sector experience and an increased understanding of the advantages and certain of the limitations of the SPAC structure, resulting in SPACs appearing set to become a fixture of Canadian capital markets.
What Is a SPAC?
A SPAC is a publicly traded “blank-cheque” or “blind pool” company created to gather capital by way of an initial public offering (IPO) and thereafter to utilize such funds to acquire business(es) or assets (referred to as its “qualifying acquisition” or “qualifying transaction” or more colloquially, “deSPACing”). Pursuant to a prospectus, a SPAC issues “units” on its IPO with each unit typically comprised of a share and a full or partial share purchase warrant which securities are listed on one of Canada’s senior exchanges. The gross proceeds raised through the IPO are placed into an escrow account to be used towards the SPAC’s qualifying acquisition or to satisfy redemptions of shares in specified circumstances. A SPAC must complete its qualifying acquisition within a permitted timeline or the escrowed funds are to be returned to the SPAC’s shareholders.
The majority of recent media attention has been focused on SPACs based in the US, where the sector has grown at a rapid pace, with more than 250 SPAC IPOs being completed since the beginning of the year (as of March 15, 2021), which surpasses the full number of SPAC IPOs launched in 2020. The Canadian market has also seen an increase in SPAC activity over 2020 and 2021 but at a more measured pace.
SPACs are an attractive vehicle for potential sponsors as the structure provides them with the opportunity for significant upside upon the closing of a successful deSPACing. A SPAC’s sponsors typically acquire a 20% equity interest in the SPAC on closing of its IPO for nominal consideration. Balancing this upside is the significant financial risk faced by sponsors as they must capitalize the SPAC with sufficient “at-risk capital” to fund all of the SPAC’s fees related to launch and its operating expenses prior to a qualifying acquisition. These include, among other things, funding IPO expenses, transaction costs and ongoing fees and expenses of a publicly traded issuer. If the SPAC fails to consummate a qualifying acquisition, this money will be lost.
SPACs provide retail investors with an opportunity to co-invest in a private-equity-like vehicle while benefitting from downside protection facilitated through a redemption right. This right provides investors with the return of their invested capital if they determine to exercise with respect to the SPAC’s qualifying acquisition, an extension of the SPAC’s permitted timeline, or termination of the SPAC. A SPAC is also attractive to investors as it provides them with liquidity through its exchange listing.
Investors’ recent demand for SPACs has also been driven in part by the ability to arbitrage ongoing near-zero interest rates (which has resulted in an abundance of available cash to deploy) and the increasingly well understood investor-friendly structure of a SPAC, which permits redemptions of the SPAC’s shares (generally at the IPO price), while typically allowing investors to retain their warrants.
As a result of the growing interest in SPACs, including from retail investors, the trading price of certain popular SPACs prior to the announcement of their qualifying acquisition has been significantly higher than the amount an investor would receive for redeeming their securities in connection with one of the above noted events. This exposes secondary market investors to possible losses if they purchase their shares at such a higher price and the shares are ultimately redeemed. Illustrating this risk is the example of Churchill Capital IV Corp., which traded above US$58 following its IPO but prior to an announcement of its qualifying acquisition (against an approximate US$10 redemption value).
While cannabis has been the dominant sector for recent Canadian SPACs, more recent qualifying acquisitions for Canadian SPACs have included companies in the specialty lending, alcoholic beverages (wine) and recreational vehicle sectors. In addition, a real estate-focused SPAC recently completed its IPO on the TSX. This shift in focus illustrates that while SPACs are typically viewed as an acquisition vehicle to be deployed in high growth sectors, the structure is flexible and is available for utilization by companies showing consistent, long term growth. Specifically, the terms of a SPAC’s warrants issued as part of the IPO “unit” – which typically includes a five-year term and $11.50 exercise price (on a $10/share IPO) – provide investors with upside over the long term. As a result, significant short-term share price appreciation following the closing of the qualifying acquisition is not required to provide returns to investors, making SPACs a sector-agnostic vehicle.
The growth and popularity of SPACs have benefitted significantly from interest from target companies in SPACs as an alternative to a traditional IPO or other liquidity event. Private companies are increasingly recognizing the relative benefit of SPACs over traditional IPOs due to a generally shorter timeline, earlier price and transaction certainty, and the opportunity to partner with SPAC sponsors with significant industry experience on a go forward basis. These benefits are partly set off by SPAC-centric concerns, such as potential redemptions and dilution.
The Art of the deSPAC
The deSPACing process is complex and particular and demands expertise and sector knowledge from the SPAC’s advisors (financial, legal, and accounting). The experiences and lessons learned advising earlier Canadian SPACs, specifically regarding challenges presented by deSPACing mechanics, have resulted in increasingly creative and efficient structures in recent SPAC IPOs and qualifying acquisitions.
Most notably, this has resulted in the creation of new structures which seek and provide greater deal certainty. At the time of a deSPAC, it is now near-ubiquitous to have a fully subscribed private placement (PIPE) in place upon the announcement of a qualifying acquisition – something that was not common for earlier Canadian SPACs. The PIPE typically includes sophisticated investors that are provided access to financial projections and plans for the business as part of the marketing; their participation in the qualifying acquisition by way of the PIPE provides validation of the transaction and contributes to deal certainty by guaranteeing available cash at closing.
Recent Canadian SPACs have also used new structures such as forward purchase agreements and “stapled” units (where an investor’s warrants are “stapled” to their shares and are cancelled upon a redemption), which both encourages long term investment and discourages arbitrage, as well as entering into non-redemption agreements with key investors, which are intended to increase the likelihood of completing a successful deSPAC. Bill Ackman’s Pershing Square Tontine Holdings SPAC took the “stapled” unit strategy one step further by providing that certain warrants would be transferred pro rata to the investors who did not redeem their shares as part of the qualifying acquisition. The Pershing Square SPAC also introduced an investor-friendly compensation structure for the sponsor.
As the SPAC sector continues to mature, sponsors and other market participants will continue to innovate and modify their use of the SPAC structure, both at the IPO and deSPACing stages, providing for an increasingly attractive investment and acquisition vehicle poised to retain a vital place in our capital markets.
Norbert Knutel is a Partner at Blake, Cassels & Graydon LLP in Toronto. He provides advice on all facets of securities laws with particular emphasis on public and private funds and other forms of structured products. He has extensive experience in structuring, development, offering and sale of both domestic and offshore funds, including alternative, closed-end, private equity, mortgage, infrastructure and real estate funds and other pooled investments. Norbert regularly provides advice to fund managers and dealers on securities registration, regulatory and compliance matters as well as environmental, social and governance (ESG) strategies and criteria.
Norbert has significant experience acting as counsel for purchasers and vendors in a wide range of purchase transactions and for many companies in connection with amalgamations, statutory arrangements and reorganizations in industries such as asset management, financial services, cannabis, cryptocurrency and digital assets, technology, gold and precious metals, and pharmaceutical. He has also acted as counsel to issuers and underwriters in public financings and private placements of equity and debt securities.
Norbert has played a significant role in the development and growth of Canada’s special purpose acquisition company (SPAC) sector, including advising on the first two initial public offerings of Canadian SPACs, and has acted as counsel to SPACs and targets on various qualifying transactions. He is a member of the Blakes Investment Products & Asset Management group and Cannabis group.