Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Corporate Finance, August 2008
Despite a significant slowdown in traditional initial public offerings, the U.S. has experienced significant growth in IPOs over the past 24 months by special purpose acquisition companies (SPACs). A SPAC is a shell corporation taken public to fund an undetermined future acquisition (a Qualifying Acquisition). At the time of its IPO, a SPAC does not have an operating business. In 2007 alone, 66 SPACs raised over US$12-billion in aggregate, accounting for over 25% of the U.S. IPO market. This spike in SPAC activity can be attributed in part to the surge of bulge bracket investment banking firms and hedge funds that have entered this market and served to legitimize the product. Hedge funds view SPAC investments as interest bearing "options" in a potentially attractive investment with a favourable risk reward profile, while big investment banks see SPACs as an opportunity to bring a new product to an otherwise stagnant public market.
SPAC activity declined in the first half of 2008 in reaction, in part, to a saturated U.S. market, declining valuations and the resulting lack of attractive targets for Qualifying Acquisitions. As of April 30, 2008, 94 U.S. SPACs had completed their IPOs, raising an aggregate of US$18.6-billion, but had not yet completed their Qualifying Acquisition. Nevertheless, the average SPAC size has risen to approximately US$263-million per deal in 2008, compared to approximately US$183-million per deal in 2007.
Large-sized SPACs are not currently permitted to list in Canada (smaller entities called Capital Pool Companies, permitted to raise up to C$2-million, may be listed on the TSX Venture Exchange (TSXV)). However, the Toronto Stock Exchange (TSX) is cognizant of the burgeoning U.S. SPAC market and has been studying it for some time, taking note in particular of the participation of investment banking firms such as Goldman Sachs, Citi, UBS, Deutsche Bank, Merrill Lynch, JP Morgan and Morgan Stanley. On August 15, 2008, the TSX published for comment a proposed new rule "Part X – Special Purpose Acquisition Corporations" for the TSX Company Manual (the SPAC Rule). Once adopted, the SPAC Rule will permit U.S.-style SPAC listings on the TSX. The comment period for the SPAC Rule expires on September 15, 2008 and the rule will be effective following approval by the Ontario Securities Commission.
What is a SPAC?
A SPAC is a publicly-traded holding company with no operating business at the time of its IPO. Instead, SPACs are marketed on the strength of an experienced management team, generally a group of individuals with a track record of successful mergers and acquisitions. Such management teams may be, but are not always, focused on a particular industry, sector or geographical area. The proceeds of the IPO are held in trust while management seeks an appropriate target business to effect a Qualifying Acquisition. In the U.S., the deadline for completing a Qualifying Acquisition is usually 18 to 36 months from the date of the IPO, and such Qualifying Acquisition must be approved by a prescribed majority of the SPAC's shareholders. If a Qualifying Acquisition is not completed prior to the deadline, the SPAC is dissolved and its IPO proceeds returned to shareholders.
Formation and General Structure
A small group of founders, typically industry executives and sophisticated investors, will initially establish a SPAC (the Initial Investors) and comprise its management team. The Initial Investors purchase common shares of the SPAC at a nominal price and sometimes advance funds to finance the SPAC's start-up expenses.
The SPAC then files a registration statement (the U.S. equivalent of a Canadian prospectus) with the U.S. Securities and Exchange Commission to register the IPO securities. In its IPO, the SPAC typically issues units, each unit consisting of one common share and one warrant (or fraction of a warrant) to purchase an additional common share. The warrant is exerciseable by the holder upon the completion of a Qualifying Acquisition or at some other specified date, such as one year from the date of the registration statement. The Initial Investors generally retain 20% of the SPAC's common equity, and often purchase additional common shares or warrants in a private placement immediately prior to the IPO.
Typically, the IPO proceeds are held in trust in an escrow account and invested exclusively in short-term government securities. A portion of the proceeds (and often the interest earned on the escrowed proceeds) is used to fund the IPO expenses and for working capital purposes.
Minimum Requirements for Qualifying Acquisition and Shareholder Approval
According to self-imposed, and in some cases exchange-specific, rules, a SPAC's Qualifying Acquisition must meet the following requirements: (i) the target business, or businesses in aggregate, must have a fair market value of at least 80% of the SPAC's net assets at the time of the acquisition and (ii) the acquisition must be approved by a specific majority of shareholders ranging from 51% to 80% of the outstanding common shares.
Investors who do not vote in favour of a Qualifying Acquisition that is subsequently completed may elect to redeem their common shares for a pro rata portion of the SPAC's escrowed funds. If more than a specified percentage of investors, typically ranging from 20% to 40%, exercise this redemption right, the SPAC will not complete the acquisition.
Trading Markets and Listing Rules
In the U.S., SPACs have traditionally been listed on the American Stock Exchange (AMEX) and the Over the Counter Bulletin Board. However, the SEC recently approved a proposal from the New York Stock Exchange (NYSE) to add SPAC listings and its first SPAC, Heckmann Corporation, was listed in May 2008 after transferring from the AMEX. The National Association of Securities Dealers Automated Quotation System (NASDAQ) has also filed a proposal with the SEC to list SPACs, which is expected to be approved in the near future.
The AMEX listing rules require a SPAC to meet the minimum requirements for one of two listing standards: (i) a market capitalization of US$50-million, a US$15-million public float, a share price of US$2 and shareholder's equity of US$4-million, or (ii) a market capitalization of US$75-million, a US$20-million public float and a share price of US$3. The AMEX must also be satisfied with the quality of the SPAC's management team and the underwriters of the IPO.
The NYSE listing rules are more detailed and require a SPAC to, among other criteria: (i) have a US$250-million market capitalization and US$200-million public float, (ii) hold 90% of the IPO proceeds in trust, (iii) obtain majority shareholder approval for the Qualifying Acquisition, (iv) complete the Qualifying Acquisition within three years of the IPO and (v) provide dissenting shareholders a right to redemption. The NYSE evaluates SPAC listings on a case-by-case basis considering factors such as the quality of the SPAC's management and the nature and extent of management compensation. The NYSE also considers whether the continued listing of the SPAC's securities would be in the best interests of the NYSE after consummation of a shareholder approved Qualifying Transaction and the resulting issuer must otherwise meet the NYSE's minimum listing standards.
The proposed NASDAQ listing rules are virtually the same as those for the NYSE except that: (i) only a US$75-million market capitalization will be required, (ii) in addition to majority shareholder approval, each Qualifying Transaction will have to be approved by a majority of the SPACs independent directors, and (iii) the proposed NASDAQ rules do not state that the SPAC listing will be assessed based on qualitative factors; rather, the rules will only require the resulting issuer to meet the NASDAQ initial listing standards.
SPACs in Canada: Junior Capital Pool Companies
A smaller form of SPAC has been available in Canada since 1987 through the Capital Pool Company (CPC) Program on the TSXV. CPCs are permitted to raise between C$200,000 and C$1.9-million in share capital through an IPO for the purpose of completing a Qualifying Acquisition within 24 months of the IPO.
Under the CPC Program, a Qualifying Acquisition is one which will result in the CPC meeting the minimum listing requirements of the TSXV.
As with SPACs, a CPC is typically incorporated by a small group of Initial Investors. The TSXV minimum listing standards require that directors and senior officers of the CPC collectively possess the appropriate experience, qualifications and history to properly identify, investigate and consummate a Qualifying Acquisition. The Initial Investors collectively subscribe for a minimum of C$100,000 and maximum C$500,000 of equity shares in the CPC (the Seed Shares) which are subject to TSXV escrow and are released over a three-year period from the date of the Qualifying Acquisition. Following the IPO, only the lesser of 30% or C$210,000 of the gross proceeds may be used for specified permitted expenses relating to identifying and evaluating prospective acquisition targets. The remainder must be invested in short-term government securities.
Besides the lower capital raising limits, a significant difference between a CPC and a SPAC is the Qualifying Acquisition rules. The CPC Program does not require that the Qualifying Acquisition receive majority shareholder approval before proceeding. However, the Qualifying Acquisition must be approved by the TSXV.
U.S.-Style SPACs Coming to Canada
The SPAC Rule proposed by the TSX will permit SPAC listings with a deal size and structure comparable to those in the U.S. and is largely similar to the NYSE rules. There are, however, several notable differences:
1. Lower Minimum Market Cap. The proposed SPAC Rule requires a market capitalization of C$30-million, reflecting the smaller size of the Canadian marketplace and the average IPO size in Canada.
2. Equity Investment of Initial Investors. Under the proposed SPAC Rule, Initial Investors are required to hold an equity interest of at least 10% in a SPAC and are prohibited from owning an "excessive" interest, with 20% or more generally considered excessive. This is not a requirement in the U.S., although most U.S. SPACs are structured in a similar manner.
3. Portion of Underwriters' Commission Held in Trust. The proposed SPAC Rule will require 50% of the underwriters' IPO commissions to be held in trust, to be released upon completion of a SPAC's Qualifying Transaction. This is not a requirement under the NYSE rules, although some U.S. SPACs have imposed similar arrangements.
4. Rights Offerings and Debt/Equity Financings. Under the proposed SPAC Rule, a SPAC will only be permitted to issue additional securities prior to a Qualifying Acquisition by way of a rights offering to existing shareholders and may only complete other equity or debt financings contemporaneously with, or immediately following, the Qualifying Acquisition.
5. No Maximum Threshold for Redemption. The NYSE rules do not permit a Qualifying Acquisition to be consummated by a SPAC where shareholders owning in excess of a certain threshold amount (to be set no higher than 40%) exercise their redemption right in respect of that transaction. The proposed SPAC Rule does not set a maximum threshold amount for redemption rights. However, a SPAC may elect to set a limit so long as it is disclosed in the prospectus and information circular.
6. Non-Offering Prospectus for Qualifying Acquisition. The proposed SPAC Rule provides that a SPAC must file and obtain a receipt from the applicable securities regulators for a non-offering final prospectus that contains full, true and plain disclosure of the SPAC and the Qualifying Acquisition. This must occur before the SPAC pre-clears its information circular with the TSX for the shareholder meeting to approve the Qualifying Acquisition.
Despite a robust SPAC market in the U.S. in 2007, activity has slowed in 2008 and the decline has been attributed in part to a saturated U.S. market. With the introduction by the TSX of the SPAC Rule, and a fresh market for SPACs, Canada may see activity in this sector by both Canadian and foreign management teams, investment banking firms and hedge funds.
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