SPACs: The London alternative

Introduction

The use of special purpose acquisition companies (SPACs) as an alternative route to access the equity capital markets has fluctuated in popularity over the years as a result of changes in both market conditions and investor appetite. However, US SPAC activity has been buoyant during 2020 and SPACs are increasingly a topic of discussion in the UK, with, as discussed below, the FCA is currently consulting on changes to the UK regime.

In this briefing, we discuss recent trends in the use of SPAC structures, the process for listing a SPAC on the London Stock Exchange (LSE), several key differences between US and UK SPACs, and some of the potential pitfalls and disadvantages associated with SPACs.

What is a SPAC?

A SPAC¹ is a company with no existing operations that is incorporated for the sole purpose of making one or more unspecified future acquisitions, typically targeting an identified industry sector or geographic region. The founders of the SPAC (commonly referred to as “sponsors”) will often have specific industry expertise or private equity experience.

Once incorporated, the SPAC undertakes an initial public offering (IPO) and listing of its shares on a public stock exchange. The funds it raises in the IPO are later used to acquire a private company (or companies), resulting in the acquired operating business effectively becoming publicly listed through a reverse merger.

As noted in the introduction, this briefing is primarily focused on considerations relevant to listing a SPAC in London – for further discussion of US SPAC listings please also see our separate briefing SPACs gain in popularity. 

Recent history and trends

Although there have been some high profile failures of SPACs in the past, SPACs have recently regained popularity, particularly in the US.

In terms of global activity during 2019, most of which took place in the US:

• There were 72 SPAC IPOs – the highest ever number of SPAC IPOs in any given year.
• SPACs raised $15.2 billion in aggregate (with an average deal size of $228 million), making 2019 the third year in a row during which SPACs raised over $10 billion.²

In 2020, the picture has been even more positive, with 138 SPACs having raised over $53 billion globally, almost entirely by SPACs listed in the US.³ This represents a 253 per cent increase over the amount raised by SPACs during the whole of 2019. Historically, US SPACs have raised relatively small amounts of cash, however, the market is increasingly seeing larger equity fundraisings being undertaken by SPACs, including, for example, the Pershing Square Tontine Holdings Ltd IPO, which raised $4 billion in July 2020 – the largest SPAC IPO to date.

In terms of the UK market, during the period between 2016 and 2017, there was a significant increase in the formation of SPACs, with 15 SPACs listing on the LSE in 2017 alone, raising £1.7 billion.⁴ Over the last five years, over 50 SPACs have listed in the UK and over $2 billion has been raised by SPACs on the LSE since 2017.⁵ In recent years, the UK SPAC market has been dominated by a small number of relatively large listings. The four largest SPAC IPOs in the UK (J2 Acquisition, Landscape Acquisition Holdings, Ocelot Partners and Wilmcote Holdings) represented 99.1 per cent of total funds raised by UK SPACs in 2017. J2 Acquisition Holding’s admission to the LSE was the second largest IPO in London in 2017, raising $1.25 billion – the largest amount raised by a London SPAC since 2011. Whilst the UK has not yet experienced the same uptick in activity as the US, during the first half of this year, the use of UK-listed SPAC structures is increasingly being discussed by market participants.

The recent boom in SPACs in the US has likely resulted from a combination of factors, perhaps not least the fact that the market for traditional IPOs has tightened as a result of the uncertain economic environment caused by the COVID-19 pandemic, as well as a reassessment of the traditional IPO process and the search for alternative paths to public markets such as those offered by SPACs and, to a lesser extent, direct listings.

From an investor perspective, SPACs are attractive because they allow the investor to co-invest with sponsors that have the requisite industry knowledge, expertise and access to potential acquisition targets that may not otherwise be available to investors through the public markets. The identity of the sponsors and their experience is therefore key, and a number of high profile sponsors have brought SPACs to market recently. The SPAC structure is also appealing because of its “money back” features. If the SPAC does not identify a suitable initial acquisition target within a specified timeframe then, absent agreeing an extension, investors are entitled to the return of their investment. Additionally, in the US and some other markets (but not currently the UK), if investors choose not to support the acquisition of an identified target, they may elect to have their shares redeemed prior to the acquisition which will be entitle them to the return of their investment (as discussed in more detail below). Investors are also attracted by the fact that interests in the SPAC are a relatively liquid, freely tradeable security.

SPACs are particularly attractive to financial institutions looking to deploy capital in the current climate due to the combination of the low interest rate environment and high market valuations. In distressed markets, SPACs are also well positioned to take advantage of favourable acquisition opportunities that may arise.

The market is also seeing an increasing number of well-known market participants establishing multiple SPACs. These repeat sponsors have the advantage of experience and are able to attract new investors by demonstrating a track record of successful acquisitions, with the level of fundraising often increasing with successive SPACs.

SPACs are attractive buyers for potential targets seeking to benefit from private equity expertise and a less burdensome, more stable route to the public markets than an IPO. Among other factors, target companies acquired by SPACs can generally expect to enjoy an expedited timeline to the public market compared to a traditional IPO, with management’s attention and resources likely remaining more focused on the business during the execution of the privately negotiated transaction when compared to the drawn out regulatory process associated with a traditional IPO. Vendors of target companies are also attracted to the potential for higher valuations and price certainty, since the negotiation of terms takes place privately without the uncertainty and last minute timing of traditional IPOs, where the share price is set following a book-building process with the often cited attendant risk of mispricing and “money being left on the table”.

UK listing process

The IPO process and typical features of UK SPACs

Founders

The founder(s) are typically experienced individuals who believe they can utilise their networks and sector expertise to source and execute a profitable acquisition. Given a SPAC will have no underlying operations and no financial track record at the time it is listed, the experience and reputation of the founders generally serves as the key selling point for investors in the IPO.

In anticipation of the IPO, the SPAC founders establish the company and will typically invest nominal capital in exchange for preferred shares or “founder shares”. This initial investment may fund all, or a portion, of the IPO expenses and the ownership of these founder shares (referred to as the “promote”) typically results in the founders retaining a 10-20 per cent stake of the company on completion of the IPO. On IPO, founders are generally issued a combination of ordinary shares, founder shares and warrants. These securities are typically locked-up for at least one year following the initial acquisition (subject to certain customary exceptions) to ensure sufficient alignment of interests between the founders and other investors.

Founder shares typically entitle founders to a certain percentage of the upside in the value of the company following the acquisition, usually 20 per cent, once the share price reaches a certain hurdle for a designated number of consecutive trading days, typically set at 15 per cent above the IPO price. The founder shares are intended to incentivise the founders, who usually do not draw a salary or draw any management fees until a successful acquisition is completed. It is typical for these shares to automatically convert into ordinary shares after a defined period following completion of the acquisition.

The founders will typically serve as directors on the board of the SPAC on IPO and are heavily involved in the process of identifying suitable acquisition targets based on their existing contacts and industry-specific knowledge. Conflicts of interest that may arise as a result of such existing contacts or founders’ interests in acquisition targets or related parties can be minimised by seeking appropriate undertakings from such founders and, if necessary, the issuance of independent fairness opinions.

Listed Securities

Investors in the IPO are typically issued both shares and warrants (together referred to as “units”). The warrants grant the investors the right to acquire additional shares of the company at a specified point in the future at the warrant strike price, usually a 15 per cent mark-up of the IPO share price. One warrant typically entitles the warrant holder the right to acquire one-third or one-half of a share. Following the IPO, the units become separable, such that investors can trade in the shares or the warrants.

IPO marketing and proceeds

Marketing of the IPO to potential investors typically takes place through a customary roadshow and book-building process. Following the completion of the IPO, the proceeds raised will be retained for the purpose of making one or more acquisitions. Prior to this, the interest earned on the funds is often used to fund the working capital expenses of the company.

Acquisition target

The SPAC’s investment strategy will be described in its IPO prospectus or admission document. In some cases the strategy may be more granular than others – for example there may be a focus on a specific industry, sector and/or geographic area. It is important to ensure that no specific target has been identified and no discussions are ongoing with potential targets at the time of the IPO, as this would trigger public disclosure requirements to the detriment of the acquisition negotiations.

Money-back

If an acquisition is not successfully completed within the specified timeframe (typically two to three years), the founders must either request an extension from shareholders (typically one year) or return the funds raised in the IPO to investors. The SPAC is then delisted and wound up.

Choice of market

In the UK, SPACs are considered cash shells which are not eligible for listing on the Premium segment of the Official List. This is due to the fact that they do not meet the independence and track record requirements that apply under the Listing Rules for a premium listing of a commercial company, nor do they meet the requirements for premium listing as a closed-ended investment fund (among other things, because they do not meet the diversification of risk requirements).

These eligibility requirements do not apply to a listing on the Standard segment of the Official List which (coupled with the fact that Standard listed companies do not currently have to obtain shareholder approval for material acquisitions post-listing – although see further below) means that it is the favoured UK listing venue for SPACs.

A listing on the AIM market of the LSE is another possibility as AIM companies are not required to have a minimum track record. However, a number of aspects of the AIM regime (including the AIM requirement that reverse takeovers must be approved by shareholders – see further below) mean that the Standard segment is currently generally considered to be a more attractive venue in most cases.

Some of the key requirements for AIM and Standard listings are summarised below.

Making the initial acquisition

Following the IPO, the founders’ focus will be on identifying a suitable initial acquisition target. Where the SPAC has a longer period in which to invest, this will put the founders in a better position to negotiate favourable acquisition terms as their bargaining power will weaken as the end of the SPAC’s life approaches. The founders’ negotiating position is also likely to be greater in weaker markets, where multiples are lower and distressed sellers may be more prevalent, with cash buyers being at a significant advantage.

Once a target has been identified, the acquisition process will begin, with the structure likely to be driven by the nature of the target business or assets and the desired listing venue for the enlarged group post-completion. It is not unusual for the SPAC to take on additional debt or raise additional equity (for example through a “PIPE”, or private investment in public equity) to fund the acquisition – in the latter case an investor roadshow will be required.

The initial acquisition will constitute a reverse takeover for the SPAC (whether the SPAC is listed on the Standard segment or on AIM). This means that, on completion, the listing of the SPAC’s shares will be cancelled. As a result, if the SPAC listing is to be maintained, it will be necessary to publish a prospectus or AIM admission document (as applicable) in order for the enlarged group to be re-admitted to trading – this will need to contain detailed information on the acquisition and on the enlarged business. Following announcement of the acquisition (including any leak announcement) trading in the SPAC’s shares will typically be suspended until the prospectus/AIM admission document is published – although see below for proposed changes to this rule for Standard listed SPACs..

Entities listed on AIM or the Standard segment may, either on completion of the acquisition or subsequently, seek admission to a different market if that is considered more appropriate for the acquired business. This could involve, for example, moving to a Premium listing on the LSE or to a listing venue in another jurisdiction – for example NASDAQ or the NYSE.

Following re-admission, the SPAC will function as a publicly listed, commercial operating company. Target management will then typically form the executive management of the enlarged group and be represented on the board.

As the company grows and as and when certain conditions are met, the founder’s promote will be triggered and the warrants will become exercisable.

FCA consultation on changes to the SPAC rules for Standard listed SPACs

In April 2021 the FCA published a consultation setting out proposed additional investor protection measures for Standard listed SPACs. You can read our separate briefing on the proposed changes here. In summary the FCA proposes removing the Listing Rules presumption that suspension of trading in the SPAC’s shares will be required on announcement of the acquisition in circumstances where the SPAC complies with certain additional requirements (these include, amongst others, granting SPAC shareholders redemption rights and requiring approval of the acquisition by the SPAC’s public shareholders). SPACs that do not comply with these additional requirements would continue to be subject to the current rules. The consultation closes on May 28, 2021 and this briefing will be updated later in the year once the response statement and final text of the rule changes has been published.

The FCA consultation follows on from recommendations made in the UK Listing Review earlier in the year. The UK Listing Review also makes recommendations in a number of other areas that (although not specific to SPAC structures) will be relevant in the context of SPAC listings. These include revisiting the rules on free float to take a more flexible approach (including reducing the percentage free float to 15 per cent and allowing companies to use measures of liquidity other than absolute percentage free float) and facilitating the provision of forward-looking information in prospectuses (in a SPAC context this is likely to be of particular relevance in the context of the prospectus produced at the time of the acquisition). It is expected that the FCA will consult on these wider issues and associated rule changes by summer 2021. For further information on the UK Listing Review recommendations you can access our webinar here.

Key differences between UK and US SPACs

Whilst SPACs first gained popularity in the US, UK SPACs can currently be distinguished from US SPACs in a number of ways.

The most significant difference between US SPACs and a UK Standard listed SPAC relates to the rights of shareholders at the time of the initial acquisition. In the US, shareholder approval is usually required to approve the acquisition (as on AIM), whereas currently no shareholder is approval is required in the case of a Standard listed issuer (although see above in relation to the FCA’s current consultation on proposed rule changes). In the US, shareholder approval will also typically involve filing a proxy statement with the SEC. This process can take three months if not more to complete from the date of the agreement of the acquisition – the protracted timetable and increased execution risk arguably makes the US SPAC a less attractive bidder in the eyes of the target. By contrast, an acquisition by a Standard listed SPAC involves reduced execution risk as no shareholder approval is currently needed allowing the acquisition to be closed more quickly, although an FCA approved prospectus will still be subsequently required in respect of the enlarged group. The suspension of trading in the SPAC’s shares (due to its classification as a reverse takeover under the Listing Rules) from the time of announcement of the acquisition until an FCA-approved prospectus is published (effectively locking disapproving investors into a transaction they do not support for a protracted period) is a commonly cited reason for not investing in UK SPACs (again see above in relation to the FCA’s current consultation on proposed rule changes in this context).

Additionally, unlike the UK, in the US, shareholders of the SPAC are typically granted redemption rights allowing them to redeem their shares of common stock for a pro rata portion of the trust account at the time of the closing of the acquisition or extension of the life of the SPAC. Under NYSE and NASDAQ rules, if a shareholder vote is sought, only shareholders who vote against the acquisition are required to be offered the ability to redeem their shares, but SPAC corporate governance documents typically require the offer to be made to all holders. Often, the agreement relating to the acquisition includes a condition precedent to the SPAC’s or the target company’s obligations that a specified amount of cash must remain after the SPAC satisfies all redemption requests. A shareholder that has opted to redeem its shares may still decide to retain its warrants thus retaining any upside potential associated with the acquisition. This optionality provides investors with more control and flexibility. Although redemption rights have not historically been a common feature of UK SPACs, as discussed above these are one of the features that the FCA is proposing should be required for Standard listed SPACs in order to avoid a suspension on announcement of the acquisition.

In the US, under both the NYSE and NASDAQ rules, 90 per cent of the gross proceeds raised during the IPO must immediately be deposited and held in a trust account and are subject to strict investment criteria. Additionally, among other requirements, the SPAC must complete, within the time period designated in the prospectus, one or more business combinations that have a fair market value equal to at least 80 per cent of the trust account at the time of the initial business combination. By contrast, in the UK there are currently no such requirements. Consequently, the directors of a UK SPAC have more autonomy when identifying the acquisition target or targets. In addition, the directors have more flexibility in the use of the funds in the short-term, though they of course have a fiduciary duty to deploy the funds in the best interests of the company and in the manner disclosed in the IPO prospectus/AIM admission document. As noted above, the FCA is proposing additional requirements in relation to ring-fencing of the IPO proceeds for Standard listed SPACs which wish to avoid suspension of trading on announcement of an acquisition.

Legal and tax considerations associated with the founders’ promote lead to differences in the typical capital structures of US and UK SPACs, with US SPACs issuing both founder shares (for nominal consideration) and privately placed founder warrants and with UK SPACs typically issuing founder preferred shares along with warrants for additional founder preferred shares.

It is common in the US to see a deferred underwriting fee, with a portion of the fee paid at the closing of the IPO and the remainder deferred until the closing of the initial acquisition. This is not the case in the UK where the underwriting fee will typically be structured in the same way as for any other IPO.

There is also a significant difference between the regulatory environments in the US and the UK. In the US, the ongoing listing requirements and annual and periodic filing requirements are generally considered to be more burdensome for publicly listed companies than for Standard or AIM listed companies.

Potential pitfalls and disadvantages

There are some potential pitfalls associated with SPACs, the most obvious of which is the failure to complete a suitable acquisition within the lifetime of the SPAC, resulting in the unwinding of the SPAC and associated return of capital – a scenario that inherently results in poor returns for holders of SPAC units. In addition, because of the pressure to complete a deal within the allotted time frame (and the founders’ or sponsors’ expense downside and the risk of not enjoying investment upside with regard to their holdings in the SPAC), in some instances the SPAC may proceed with the acquisition of a less than ideal target company or on less than optimal terms – this may result in the underperformance or failure of the combined business entity.

The level of disclosure provided to SPAC investors has also been criticised in the past. Because the SPAC is a cash shell with no operations or history, disclosure in the IPO prospectus or AIM admission document is fairly limited, consisting primarily of a summary of the SPAC’s acquisition strategy and criteria, its capital structure, the biographies of the directors and officers, and the terms of the underwriting arrangements. There is no historical financial information available and the risk factors are invariably fairly limited and generic in nature, particularly where the acquisition strategy is more broadly defined. As the SPAC will not have identified a specific acquisition target at the time of IPO, there will be no disclosure on this in the prospectus/admission document other than information on the SPAC’s acquisition strategy and criteria, including any target industries, sectors and/or geographies. Although substantive disclosure will be made once a target has been identified and acquisition terms have been agreed, in timing terms this will be well after the IPO, leaving investors with only the option of staying invested throughout the merger process or cashing out at an earlier stage.

As noted above, it is not unusual for SPACs to raise additional capital to fund their acquisitions, either through debt financing, the issuance of additional equity, or a combination of the two. The availability and cost of such acquisition financing will depend on economic and market conditions at the time, and investors will have little choice but to go along with financing arrangements negotiated by the sponsors. Debt financing will impact the balance sheet of the enlarged group and equity financing may (depending on structure) have a dilutive effect on existing shareholders.

By their very nature, SPACs are established by industry insiders with the experience, contacts and intimate market knowledge required to identify and complete transactions with attractive targets. Because of these existing relationships, conflicts of interest between the SPAC’s sponsors, directors and officers are possible. Conflicts of interest may arise when sponsors have existing interests in potential acquisition targets or related parties. These conflicts may create obstacles in pursuing potential targets with the result that the sponsors’ interests are not necessarily aligned with those of the SPAC or its underlying investors. Likewise, to the extent the SPAC is sponsored by a private equity firm, the inevitable conflicts associated with managers of distinct pools of funds will need to be addressed.

Another potentially problematic feature of SPACs is that sponsors generally enjoy favourable terms related to the founder shares and founder warrants (including anti-dilution provisions) which are designed to implement and protect the sponsors’ promote. Additionally, sponsors typically end up with a 20 per cent stake (on a fully diluted basis) in new company’s equity, which in many cases effectively amounts to a controlling percentage. This means that sponsors generally receive protections not afforded to other investors in the SPAC and may mean that sponsors may benefit from their investment regardless of whether the performance of the enlarged group following the acquisition is ultimately successful.

Conclusion

SPACs include many features that are attractive to sponsors and investors alike, as evidenced by the number of high quality sponsors successfully establishing SPACs both in the US and historically in the UK and in investors’ appetite for this time-tested alternative route to the public markets for target businesses. Likewise, for potential vendors/target management the SPAC represents an attractive alternative route to public markets when compared to the traditional IPO (and more recently in the US, to direct listings).

As discussed, some of the features that currently distinguish UK SPACs from US SPACs, including the lack of requirements for a shareholder vote on acquisitions for a Standard listed SPAC and shareholder redemption rights, may change going forward if the proposals the FCA is currently consulting on are ultimately implemented as proposed. Whilst in some respects the proposed changes could be seen as potentially reducing the flexibility of the UK regime for founders and SPACs, they are intended to promote greater investor confidence in SPACs which will be key if SPAC structures are to gain the same level of traction in the UK as in the US and elsewhere. And, of course, it is proposed that the current regime will continue to be available for SPACs that do not meet the enhanced investor protection standards.

It remains to be seen what the final scope of the changes to the rules will ultimately be and the impact that such changes will have on market activity, however another key factor will no doubt be the extent to which recently launched UK SPACs ultimately translate into success stories and deliver the expected returns for investors. As with any investment vehicle, the performance of SPACs will invariably be driven in part by macro-economic factors beyond the control of sponsors and their newly-formed companies, but if history serves as any guide, SPACs will continue to be a feature of equity capital markets for some time to come.