Happy new year! To complete the year- and term-end surge, just before Christmas, the Corp Fin staff issued CF Disclosure Guidance: Topic No. 11 regarding disclosure considerations for special purpose acquisition companies in connection with their IPOs and subsequent business combinations, often referred to as de-SPAC transactions. As usual, the staff provides some great questions to consider when crafting disclosure.
Very loosely, SPACs are companies with no real operations formed for the purpose of raising capital in an IPO and placing the offering proceeds into a trust or escrow account to be used to acquire an operating company. Essentially, they act as vehicles for the acquired operating companies to go public through the de-SPAC acquisition transactions.
The fundamental message that informs this guidance is to be on the alert for potential conflicts of interest—particularly the potentially competing or different economic interests (including compensation) of the SPAC sponsors, directors, officers and affiliates on the one hand and the public shareholders on the other—and be sure to provide clear disclosure about them. For example, conflicts may arise as sponsors, directors, officers and affiliates evaluate and decide whether to recommend a de-SPAC transaction to shareholders and as they negotiate the acquisition. In contrast to a traditional IPO, where the securities offered are valued through market-based price discovery, in a de-SPAC transaction, “these individuals are solely responsible for deciding how to value the private operating company and how much the SPAC will pay for it.”
In October, at the CNBC Financial Advisor Summit, then SEC Chair Jay Clayton was interviewed on CNBC by Bob Pisani and addressed SPACs, among other issues. In that regard, Clayton noted that, while he liked the concept of more competition in the distribution of stock, it was important that investors understand that SPACs are a different animal than an IPO, especially with regard to price discovery, diligence and motivations:
“I think what investors need to understand and what the professionals who are involved need to help them understand, is that it’s not the same as an IPO. The motivations of the SPAC sponsors, the motivations of the company that they’re purchasing and the de-SPACing transaction are different from the motivations of your traditional owners and management teams in an IPO. Not saying that’s right or wrong, but they’re different; investors should understand that. Also, there’s something that happens in the IPO process that doesn’t happen as much in the de-SPACing process, and that is institutional investors on your traditional road show kick the tires on the company. That doesn’t happen to the same extent in the de-SPACing transaction.”
In another interview on CNBC with Andrew Ross Sorkin conducted in September, Clayton had also addressed the recent SPAC frenzy, including the importance of good disclosure about the incentives and motivations of those involved. Right now, he said, the SEC is particularly focused on the compensation and incentives that go to the sponsors of the SPAC. (SPAC sponsors typically receive a portion of the SPAC’s equity to provide compensation and incentives for their work in creating the SPAC, soliciting investors, identifying acquisition targets and, sometimes, assisting the surviving public company to meet its corporate objectives and goals post-merger.) For example, how much equity do they have initially? How much do they receive at the time of the acquisition transaction? The SEC wants to be sure that the investors understand the incentives involved and that, at the time of the investor vote on the acquisition transaction, the disclosure to investors is as rigorous as in an IPO.
Sorkin commented that it can be especially difficult to understand the SPAC compensation schemes. How did Clayton envision that it should look? Should there be full hypothetical examples provided showing the SPAC sponsor’s compensation? Clayton responded that, if hypotheticals are necessary to explain the compensation and incentives, then the SPAC should provide them. Again he emphasized that the public needs to understand the motivations both at the point of initial distribution of the SPAC into the market and also when the acquisition transaction takes place with the operating company. The SEC can’t dictate what the compensation structures should be, but it can require that they be fully disclosed. (See this PubCo post.)
IPO disclosure considerations. In this category, the staff have identified five topics with related questions (copied below) to consider for disclosure:
- One conflict of interest that may arise is that the SPAC sponsors, directors and officers may not work exclusively on behalf of the SPAC to identify acquisition targets for the de-SPAC transaction and may have fiduciary or contractual obligations to other entities, even entities that compete with the SPAC for business combination opportunities.
“Have you clearly described the sponsors’, directors’ and officers’ potential conflicts of interest? Have you described whether any conflicts relating to other business activities include fiduciary or contractual obligations to other entities; how these activities may affect the sponsors’, directors’ and officers’ ability to evaluate and present a potential business combination opportunity to the SPAC and its shareholders; and how any potential conflicts will be addressed?
Is it possible that you will pursue a business combination with a target in which your sponsors, directors, officers or their affiliates have an interest? If so, have you disclosed how you will consider potential conflicts of interest?“
- Typically, under the SPAC’s governing documents, if the SPAC does not complete a de-SPAC (business combination) transaction with an operating company within by a specified time, it must liquidate and make a pro rata distribution to its public shareholders of the net offering proceeds that are held in trust. As a result, toward the end of that time period, acquisition targets have more leverage in negotiations.
“Have you clearly described the financial incentives of SPAC sponsors, directors and officers to complete a business combination transaction? Have you disclosed how these incentives may differ from the interests of public shareholders? Have you quantified, to the extent practicable, information about the losses the sponsors, directors and officers could incur if the SPAC does not complete a business combination transaction?
Have you disclosed the amount of control that SPAC sponsors, directors and officers and their affiliates will have over approval of a business combination transaction?-Have you disclosed whether the SPAC may amend provisions in its governing instruments to facilitate the completion of a business combination transaction? Have you described how the SPAC may amend such provisions, whether shareholder approval is required, and, if so, the requisite voting standard for approval and whether the sponsors have sufficient voting power to approve it?
Have you disclosed whether, and if so how, the SPAC may extend the time it has to complete a business combination transaction? If the SPAC may extend the time period, have you disclosed whether shareholders may redeem their shares in connection with any proposal to extend it?
If the sponsors, directors, officers or their affiliates have prior SPAC experience, have you provided balanced disclosure about the prior experience and the outcome of presented and completed business combination transactions and liquidations?”
- The underwriter of the SPAC IPO may agree to defer its compensation until the de-SPAC transaction has closed.
“If the underwriter of your IPO may provide additional services such as identifying potential targets, providing financial advisory services, acting as a placement agent in a private offering or underwriting or arranging debt financing, have you described those potential services and disclosed the fees you may pay for those services and whether you may pay those fees in other than cash? Will you condition payment for these additional services on the completion of a business combination transaction? Have you disclosed any conflict of interest the underwriter may have in providing such services given any deferred IPO underwriting compensation?”
- A SPAC’s sponsors, directors, officers and their affiliates have investments in the SPAC and, as a result of securities ownership, compensation arrangements or relationships with affiliated entities, have financial incentives that differ from those of the public shareholders, which could result in conflicts when evaluating potential opportunities for de-SPAC transactions.
“Have you clearly disclosed the securities owned by sponsors, directors, officers and their affiliates including the price paid for the securities? Have you included a discussion of any concurrent offering of securities to the sponsors and their affiliates, the amount of those securities and the price to be paid? How does the price of securities previously sold and currently offered to sponsors, directors, officers and their affiliates compare to the public offering price in the IPO?
Do you clearly describe the conflicts of interest that result from sponsors’, directors’, officers’ or their affiliates’ securities ownership, compensation arrangements or relationships with affiliated entities that may create financial incentives to complete a business combination transaction even if the transaction may not be in the best interest of other shareholders? For example, do you clearly disclose that if the SPAC fails to complete a business combination transaction, some or all of the sponsors’, directors’, officers’ and their affiliates’ securities would have no value and the sponsors, directors, officers and their affiliates may incur a substantial loss on their investment?
Have you disclosed whether and how you may compensate your sponsors, directors, officers and their affiliates for services to the SPAC? Will any payments be contingent on the completion of the business combination transaction? Have you quantified known amounts?”
- Unlike the securities the SPAC sells to the public, the securities the SPAC issues to its sponsors often give the sponsors “substantial control” over the SPAC. In addition, if the SPAC conducts private offerings, those securities may also have different negotiated terms.
“Have you clearly disclosed the terms of securities held by sponsors, directors, officers, and their affiliates and discussed how the rights of those classes of securities compare to and differ from the rights and terms of securities offered in the IPO, as well as the resulting risks to public shareholders? If the sponsors, directors, officers, and their affiliates hold convertible debt, have you disclosed the material terms for conversion, such as when the debt is convertible, the maximum number of securities they may acquire through conversion and any contingencies on conversion?
Have you disclosed whether you plan to seek, or have obtained, additional funding and how the terms of securities issued or to be issued in private offerings compare to the terms of securities offered in the IPO? Have you disclosed whether the sponsors, directors, officers or their affiliates may participate in or have an interest with respect to such financing?
If the SPAC enters into a forward purchase agreement allowing the purchaser to invest in the SPAC at the time of a business combination transaction, have you clearly described the terms of the agreement and any potential dilutive impact on other shareholders? Is it clear whether the forward purchaser’s commitment to purchase the securities is irrevocable?”
Disclosure Considerations—De-SPAC Transaction (Business Combination)
In this category, the staff have identified three topics with related questions (copied below) to consider for disclosure:
- In the course of negotiations, the SPAC may seek additional financing.
“Do you disclose clearly any additional financing necessary to complete the business combination transaction and how the terms of such financing may impact public shareholders? If the terms of additional financing involve the issuance of securities, have you described how the price and terms of those securities compare to and differ from the price and terms of the securities sold in the IPO? Are sponsors, directors, officers, or affiliates participating in additional financing?
If you will issue convertible securities, do you describe the material terms for conversion and any material impact on the beneficial ownership of the combined company?”
- In selecting the target (among alternatives) for the de-SPAC, the SPAC sponsors, directors and officers may have interests and incentives that conflict with those of the public shareholders.
“Have you provided detailed information about how you evaluated and decided to propose the identified transaction? Have you explained how and why you selected the target company? Who initiated contact? Why did you select this target over other alternative candidates? Have you explained the material terms of the transaction? How did you determine the nature and amount of consideration the SPAC will pay to acquire the private operating company? Have you clearly described the negotiations regarding the nature and amount of consideration?
What material factors did the board of directors consider in its determination to approve the identified transaction? How did the board of directors evaluate the interests of sponsors, directors, officers and affiliates?
Have you clearly described any conflicts of interest of the sponsors, directors, officers and their affiliates in presenting this opportunity to the SPAC and how the SPAC addressed these conflicts of interest? If the SPAC had a policy to address conflicts of interest and waived any provisions of that policy, have you disclosed the waiver and the reasons therefor? Have you described any interest the sponsors, directors, officers or their affiliates have in the target operating company, including, if material, the approximate dollar value of the interest, when the interest was acquired and the price paid?
Have you provided detailed information on how the sponsors, directors, officers or their affiliates will benefit from this transaction? Have you quantified any material payments that they will receive as compensation, the return they will receive on their initial investment and any continuing relationship they will have with the combined company?
Have you disclosed the total percentage ownership interest the SPAC sponsors, directors, officers and affiliates may hold in the combined company, including through the exercise of warrants and conversion of convertible debt?”
The IPO underwriter may have provided other services and may have deferred a portion of its underwriting compensation until the closing of the de-SPAC transaction.
“Have you disclosed the fees that the underwriter of your IPO will receive upon completion of the business combination transaction, including the amount of fees that is contingent upon completion of a business combination transaction?
Have you clearly described any additional services the underwriter provided, the cost of those services and how you compensated the underwriter and/or its affiliates for those services? Were those services conditioned on the completion of the business combination transaction? Have you disclosed any conflict of interest the underwriter may have had in providing such services given any deferred IPO underwriting compensation?”