Uncertainty caused by economy, Covid-19 lets investors park money as SPAC looks for opportunity
In uncertain times such as these, investors have been looking to the Special Purpose Acquisition Company (SPAC) vehicle as a smart way to park money while waiting for an opportunity, say Stephen Pincus and Bill Gorman at Goodmans LLP, a leading law firm in Canada on getting SPACS going in Canada.
While SPACs, otherwise known as a “blank cheque” companies, have been around for decades in the United States, and have been in Canada since 2015 (though the rules guiding them here first came out in 2009), they have gone through waves of popularity, says Pincus, who is considered a pioneer of several highly innovative SPAC structures and has been lead counsel on most of Canada’s SPAC transactions to date.
He says SPACs are once again becoming a popular investment vehicle, given some of the unique features that make them ideal for pouncing on opportunities, including those that come from negative events.
“I think we’re on the cusp of a new wave of SPACs in Canada,” Pincus says, noting that the U.S. SPAC market is at an all-time high, raising more than US$30 billion so far in 2020, up from US$13 billion in all of 2019.
Gorman agrees, saying the pandemic, the macroeconomic situation and even the uncertainty surrounding the U.S. election make the opportunistic nature of a SPAC an interesting investment vehicle.
Some better-known companies recently formed through a SPAC include: Spark Power Group, an independent provider of end-to-end electrical contracting operations, maintenance services and energy sustainability solutions; and AYR Strategies, a U.S. cannabis company with operations in Massachusetts and Nevada.
Both SPACs were handled by Goodmans, and in the case of AYR Strategies, the sponsor formed a second SPAC in 2019, called Mercer Park Brand Acquisition Corp, which raised more than US$402 million and is now searching for an acquisition.
In the U.S., recent SPACs include: Virgin Galactic — a vertically integrated aerospace and space travel company; Nikola Corporation, a designer and manufacturer of zero-emission battery-electric and hydrogen-electric vehicles and associated products; and DraftKings, a digital sports entertainment and gaming company.
As well, last month, famed hedge fund manager Bill Ackman raised US $4 billion in the IPO of Square Tontine Holdings, Ltd., the largest SPAC IPO to date.
So, exactly how does a SPAC work? Gorman says that one way to look at them is that they are shell companies that don’t have business plans of their own, but instead look for private companies that do. In some ways, they are like reverse mergers, but not identical. SPACS often come with management and financing, unlike reverse takeovers, which typically involve a private company buying a shell company that has no current operations but is traded publicly.
Pincus says that for private companies, hooking up with a SPAC sponsor can be a good alternative to going public through an Initial Public Offering. Merging with a SPAC can be a way to avoid some of the bureaucracy and cost of filing an IPO, as the SPAC sponsors have already done that work. The sponsor has also raised the money to buy promising private companies.
“So instead of marketing your company through an IPO, where you may succeed or you may not, a SPAC can remove some of that risk,” Pincus says. As well, there is more price transparency because it’s already been decided what investors are willing to pay for the company, as that has been already negotiated.
For those who choose to put their money into a SPAC, it can be a more secure way of investing money, says Pincus, because there is a second chance to pull their money out. Initially, the money gets put into an escrow account, and the sponsor has up to two years to acquire using that money. However, when the SPAC does its first acquisition, called a qualifying transaction, the investor has a chance to take the money back, with interest.
“That’s the key to understanding the SPAC model,” says Pincus. “It gives investors a chance to stay in or get out depending on what the company looks like.”
From a legal perspective, Gorman says here are some key differences from an IPO, the first being that at the initial investment, there is no business. The answer to that, he says is the importance of putting together a strong sponsor group, “typically people that are very well known, or have had success in certain industries.”
He points out many recent SPACs have been put together by very prominent hedge funds and private equity groups, who are selling the SPAC based on their reputation, and the strength of the target that is being acquired.
The “second look” aspect of SPACs is important from an investment and legal perspective, Gorman says, and the fact that there are two prospectuses for the investor to review — one at the time of initial investment, the other at the time of when a business is purchased — provides additional protection.
Pincus also points out that for the qualifying acquisition to be economically accretive, it has to allow for dilution of what is called the “promote,” or what the sponsor gets for putting together the SPAC and risking the initial capital to make the SPAC work.
In general, the promote in Canada and the U.S. is about 20 per cent, Pincus says, though it can sometimes be lower than that. “However, the investment opportunity has to be sufficiently attractive because of that promote dilution at the time of the qualifying transaction.”
There are two types of SPACs, Pincus says. One is a general SPAC, that looks to invest in anything that meets its criteria. The investors might be looking for opportunities in several areas, says Pincus, especially sectors that have been hurt by events such as the pandemic, but are fundamentally sound companies.
“A SPAC can be a very effective vehicle in these cases because you don’ have to deploy the money right away,” he says. “You can time your acquisition accordingly.”
The other type of SPAC is a specialty SPAC that looks to specific industries. Pincus says he believes the upcoming wave of SPACs on the horizon will likely be in the specialty category, especially in areas such as technology, and the healthcare sector, two areas that have been highlighted for opportunity by the pandemic.
Gorman says that Goodmans, which has been involved in most of the SPACS in Canada to date, has typically worked for those who have raised money in the past, and are looking for an alternative vehicle to do that. In other cases, a potential SPAC sponsor is referred to the firm because it is well known in this space.
As the phenomenon of SPAC investments continues to grow, both Pincus and Gorman say they expect Goodmans to still lead the pack on providing counsel.