The TSX has proposed rule changes to permit US-style SPAC listings in Canada. A SPAC is a 'special purpose acquisition corporation' formed to raise a minimum of $30 million to pursue an 'as yet to be identified' acquisition opportunity. If the new TSX rules are implemented, they may help rejuvenate the currently moribund Canadian IPO market.
Internationally, SPACs accounted for 25% of the IPOs in the US market in 2007, with the NYSE and NASDAQ recently following the lead of AMEX In accommodating SPAC listings. Although US SPAC activity has slowed recently due to a large backlog of SPACs that have not yet completed an acquisition, SPAC action has shifted to Europe where London's AIM and Euronext are now competing for SPAC listings. A quick approval of the TSX's SPAC proposal by Canadian securities regulators is critical to maintaining the TSX's competitive position internationally.
Three structural elements are key to setting up a TSX SPAC. First, at least 90% of the gross proceeds from the SPAC's IPO must be segregated in a trust fund and used solely for a qualifying acquisition; second, the acquisition must be approved by a majority of shareholders, with shareholders who vote 'no' having the right to 'cash out' by converting their SPAC shares into a pro-rata share of the cash in the trust fund; and third, the SPAC must complete an acquisition with a value of at least 80% of the value of its trust fund within 36 months of its IPO, or otherwise liquidate and distribute the cash in the trust fund to investors at the expiry of the 36-month period.
While the basic SPAC structure is easy enough to describe, it can give rise to relatively complex trading strategies in the IPO after-market. Consequently, SPAC IPO offerings will be attractive principally to technically-focused hedge funds. A typical SPAC IPO is an offering of units consisting of one common share and a separable warrant exercisable subsequent to the closing of the SPAC's qualifying acquisition. The common shares trade as a yield instrument, with an embedded option consisting of the right to participate in the acquisition of a business or to put the shares to the SPAC for cash in the event that the investor chooses to vote against the proposed acquisition. The warrant is a pure play on the SPAC's prospects of consummating an acquisition, since it expires and is worthless if the SPAC fails to complete a qualifying acquisition.
In today's tight credit markets, SPACs represent a potentially significant pool of cash managed by promoters who are highly incentivized to consummate an acquisition transaction. The SPAC's founders receive cheap shares, usually representing 20% of the SPAC's post-IPO equity, which are forfeited if the SPAC does not complete an acquisition on a timely basis. The success of the TSX's SPAC model will depend on the ability of SPAC management to source attractive acquisition targets. Good governance will be important to ensure that 'high grade' acquisition opportunities are not diverted to other investment vehicles.
It will also be important to ensure that SPACs have sufficient start-up funding to pay their deal search and compliance costs. Under the proposed TSX model, it is contemplated that the 10% of the gross IPO proceeds that, as a regulatory matter, need not be dedicated to the trust fund, will be available to fund these costs. In practice, however, as SPACs have evolved in the US market, investors have come to expect that most, if not 100%, of the IPO proceeds will be deposited in the trust fund. This means that the SPAC's start-up costs must be funded by pre-IPO private placements.
SPAC M&A is different in many ways from conventional M&A, and a vendor selling a business to a SPAC faces several unique risks that reduce transaction certainty relative to a conventional transaction. First, a SPAC transaction is subject to a prolonged regulatory review process. Once a deal has been signed, the SPAC must clear a non-offering prospectus through provincial securities regulators, a process that can easily take a month or more; and which cannot commence until pro-forma financial statements for the transaction have been prepared. Next, the SPAC must also prepare a proxy information circular (again containing prospectus-level disclosure) in respect of the qualifying acquisition and have it pre-cleared by the TSX.
The hiatus created by this extended regulatory review process is an arbitrageur's dream come true. Under the proposed TSX rules, the SPAC's shares will continue to trade after the announcement of a possible acquisition, even though a prospectus and information circular have not yet been published. Such trading is essentially an arbitrage play on the prospects of a deal closing and on whatever limited information is in the market about the target's financial prospects and future performance.
Second, a SPAC acquisition must be approved by a majority of the SPAC's independent shareholders. Ensuring SPAC shareholder support requires significant underwriter involvement to ensure that the SPAC's investor base is migrated away from the hedge fund investors who participated in the IPO towards more 'fundamentalist' investors interested in holding an equity investment in the public operating company following the acquisition. The involvement of underwriters in the solicitation of 'yes' votes raises selective disclosure and insider trading concerns.
Third, the closing of a SPAC acquisition will invariably be subject to a condition that not more than a specified percentage of the SPAC shareholders exercise their conversion rights. Although the TSX, unlike the NYSE and NASDAQ, is not proposing to impose this as a regulatory requirement, most SPACs will condition any offer to ensure that the amount of the trust fund available for funding the acquisition is not eroded by a high proportion of shareholders voting no and invoking their conversion rights. In the US experience, the earlier deals were conditioned on 20% or less of shareholders exercising their conversion rights, but over time this threshold has drifted higher, and currently a 40% threshold is typical.
Fourth, again based on the US experience, SPAC transactions attract aggressive hedge funds deploying trading strategies designed to work against closing of the acquisition transaction; for example, accumulating voting share positions in the SPAC at a discount and shorting the warrants, betting that an acquisition transaction will not be approved and that the SPAC's trust funds will be returned to investors. Another tactic is to accumulate a blocking position and to then extract a payment from the founders or from the acquisition target in return for voting in favour of the transaction.
In the US, some SPACs incorporate so-called 'bull dog' provisions into their articles. These provisions, named after Bulldog Investors, a well known SPAC investor, prohibit any investor that accumulates more than 10% of a SPAC from exercising conversion rights. The new NASDAQ rules governing SPACs permit this, but the proposed TSX rules exclude only insiders who are insiders both before and after the IPO from exercising a conversion right.
Fifth, it is generally not possible to incorporate a 'reverse termination fee' provision as a deal protection mechanism in a SPAC transaction to compensate the seller in the event that the buyer walks from the transaction in breach of the purchase agreement. The problem is that the underwriters generally require the seller to give a waiver in the purchase agreement committing that it will not seek monetary recourse against the trust fund for any claim.
If a SPAC does not complete an acquisition within 36 months of its IPO, it must be liquidated and its trust fund distributed to investors. Although in theory this seems like a long time, today most Canadian businesses are sold in controlled auction processes. The participants in these auctions must devote considerable effort and expense to prepare a bid, even though their prospects of winning the auction may be small. It is likely that many SPACs will spend a lot of time and money unsuccessfully pursing three or four opportunities before they execute a definitive purchase agreement.
In contrast to the US rules, it appears that the TSX will permit SPACs to get a head start on the search for an acquisition target. Under the proposed TSX rules, a SPAC may be in the process of reviewing a potential qualifying acquisition at the time of its IPO so long as it has not entered into a binding or non-binding agreement. In the US, the SEC takes a more conservative approach, insisting that the SPAC confirm to the staff of the SEC that it has not identified specific targets, and that it has not been in discussions with prospective vendors.
TSX SPACs represent a possible bright spot in an otherwise gloomy Canadian IPO market. Generally, it can be expected that most SPAC acquisitions will be significantly larger than the SPAC itself since, In addition to the cash in the trust fund, most SPACs are likely to issue further equity as an acquisition currency and to use debt to help fund a leveraged acquisition. Whether or not SPACs realize their full potential depends on the quality of the promoters attracted to the SPAC market and on the quality of the acquisition prospects that they generate for the first generation of Canadian SPACs.
About Al Hudec
Al Hudec is a senior securities practitioner with 25 years of experience in all legal aspects of securities and corporate finance, including mergers and acquisitions, public and privatefinancings of equity and debt, corporate governance and related party transactions, regulation of listed companies, income trusts, banking and restructurings; with emphasis on the North American resource and technology industries.
© 2008 Farris, Vaughan, Wills & Murphy LLP
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