What are Special Purpose Acquisition Companies?
Special purpose acquisition companies (SPACs) are enjoying something of a renaissance. Unlike the traditional private equity model, SPACs raise funds through an initial public offering (IPO) with the proceeds subsequently being invested in the acquisition of, or merger into, certain existing target companies. SPACs are raising increasing levels of capital and the proportion of the overall IPO market they represent is at a record high. The NASDAQ stock exchange has had more than 100 SPAC IPO listings since 2011 with the momentum not expected to abate.
SPACs are typically incorporated in the Cayman Islands (Cayman) as an exempted company with a small group of initial investors, and a management team. Cayman companies are a popular listing vehicle with for instance more than 36% of all companies listed on the Hong Kong Stock Exchange being Cayman companies. The management team is comprised of professionals with experience in the sector into which the SPAC will invest. The management team will typically sit on the SPAC's board of directors and be authorised via the listing and constitutional documents to identify certain target companies post-IPO. The constitutional documents of the SPAC will ensure that the management team is prevented from acquiring, or merging with, target companies without the prior approval of the investors (typically a super-majority requirement).
By taking this approach, SPACs provide investors with access to speculative transactions in one or more specified sectors and industries, in particular where there is an unknown element of risk, or specific geographic regions in which they might not otherwise be able to take advantage of. There is also no diversification objective: a SPAC may engage in only one single business combination. Investors also enjoy greater control over investments, potentially increased liquidity (given their capital is not locked-up for a number of years as with a traditional private equity fund) and reduced management fees, rather than annual fees, as the management team members are compensated via their initial shareholding in the SPAC.
If the management team fails to identify such targets within a certain timeframe (usually around 1 to 2 years) the SPAC is dissolved and any remaining funds are distributed back to investors. It is a SPAC's "money back" feature which enhances liquidity.
Why are STAR Trusts required?
Given the SPAC, at the time of its IPO, has no track record or operating history, investors will understandably want to see their funds protected and managed in a responsible fashion. It is therefore customary that once the IPO has been completed, between 80-90% of the net proceeds of the listing, particularly for NASDAQ listed SPACs (not for LSE listings), are placed into a third party custodian trust account.
The terms of the trust (as mirrored in the constitutional and listing documents of the SPAC) will provide essential investor and asset protection provisions, including restrictions on when the management team can utilize the trust funds for investment purposes, the amount of such funds and for what purposes those funds may be used.
Further, the investors will be included within the trust's class of beneficiaries. Trust funds will typically only be released by the trustee, acting as custodian, once a target company has been identified and investors have approved such proposed investments, or may redeem their shares if they decline approval in respect of the proposed investment, or if there is a failure to complete a business combination within a permitted investment period. Investors who sell their shares in the SPAC will also be entitled to the return of his/her remaining investment at the time of such sale.
Separately, in connection with an IPO, founders and substantial shareholders (as settlors of the trust) have also been prompted to establish pre-IPO family discretionary trusts as an enduring platform to hold their shares and interests for estate planning purposes and also to give a measure of stability and concentration of their holding to ride through the IPO listing process.
Types of Cayman Trusts
In the context of SPACs, the trust of choice in Cayman is one established under Part VIII of the Cayman's Trusts Law (2018 Revision) – otherwise known as a 'STAR Trust'.
STAR Trusts provide a great deal of flexibility, primarily because:
- the trust may be established for beneficiaries and/or purposes only, or a combination of the two;
- there is no limit to the number of beneficiaries of a STAR Trust, which is essential in the context of an IPO; and
- the rule against perpetuities does not apply to STAR Trusts, meaning it can be established for an unlimited duration – a useful feature in the on-going cycle of the SPAC's mergers and acquisitions.
- STAR Trusts remove the ability of a beneficiary from suing the trustee or obtaining information concerning the trust. This is a useful administrative separation between the right to benefit under a trust and the right to enforce its terms. Only the person(s) appointed as the "enforcer" (acting in a fiduciary capacity) can enforce the terms of the trust.
- A STAR IPO-Trust provides important wealth succession planning, avoids probate, and provides asset protection by way of limiting the risk of adverse events which may affect the business owners, such as divorce or death which in turn may adversely impact the IPO process or cause fluctuations in the price of shares.
The trustees of a STAR trust must be (or include) a trust corporation (or its controlled subsidiary) licensed under the Banks and Trust Companies Law (2018 Revision) or a private trust company registered under the Private Trust Companies Regulations (2013 Revision). This statutory requirement aims at ensuring the proper administration of STAR trusts by suitably qualified and experienced trustees. Conyers affiliated licenced trust company can provide professional trustee services or registered office services and support to a private trust company.
These features are also beneficial to setting up a separate discretionary family trust to hold founder's/substantial shareholder's shares in the listing vehicle.
- Cayman's firewall legislation contained in the Trusts Law protects Cayman trusts from attack by forced heirs and those claiming against the trust assets by reason of a personal relationship with a beneficiary, and also protection from foreign orders made without reference to the operation of Cayman's Trusts Law.
- Cayman company laws are flexible and adaptable to the rules of most relevant stock exchanges.
- Sophisticated and reliable judicial system.
- Global recognition and familiarity.
- Tax neutrality.
- International compliance standards.
- Cost efficiency and ease of incorporation of companies and trust establishment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.