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Mergers and Acquisitions Journal: 1 May, 2007
By Partner Paul Broude, Foley & Lardner

Should You Sell To a SPAC?

SPACs may lack assets and a business plan, but a growing number of mid-size companies are choosing to merge with or be acquired by such companies

Would you sell your company to a buyer with no assets, led by part-time management that may know little about your business? In a deal that will likely take longer than a sale to a typical financial buyer, and require detailed regulatory review? And, in a deal in which you must be ready as of the closing date to comply with Sarbanes-Oxley and all of the other regulations governing publicly traded companies? Strike three, or sign you up?

Perhaps surprisingly, a growing number of successful, mid-size companies are signing up for such a sale to a special purpose acquisition company ( SPAC) - essentially a shell or "blank check" company that has no operations but that goes public with the intention of merging with or acquiring a company with the proceeds of its IPO.

So, no assets, no product, no business plan. A SPAC exists for the sole purpose of raising money in an IPO so it can acquire some sort of a company, within a specified time frame. Although some SPACs target a specific industry or country, many exist without a general business plan, let alone a well-defined acquisition strategy.

Nonetheless, last year smoothie maker Jamba Juice cemented a $265 million merger with a SPAC named Services Acquisition Corp., and construction consulting firm Hill International completed a merger with Arpeggio Acquisition Corp. In a deal that's still in the works, Endeavor Acquisition announced plans to buy American Apparel for $384.5 million in restricted stock, cash, and debt.

Deep-pocketed investment firms looking for places to put their money coupled with the current deals wave have created fertile ground for SPACs.

Where Do They Get The Money?

Most SPACs raise $30 million to $100 million in an IPO, although some recent SPAC offerings have surpassed $300 million. The largest SPACs to date have acquired asset-intensive businesses, such as shipping companies, or have been led by recognizable names: Apple Computer co-founder Steve Wozniak formed a SPAC called Acquicor Technology, which will acquire and develop technology companies, and Steven Berrard, the former CEO of Blockbuster Entertainment, now heads Services Acquisition. Investors who buy in are betting that the companies will pull off lucrative deals.

Smaller underwriters do most of the deals, butDeutsche Bank and Citigroup have gotten into the business as well, lured by the attractive fees that can be earned on both the underwriting and acquisition transactions.

Last December's IPO of Freedom Acquisition Holdings raised $520 million and was underwritten by Citigroup, which is also the lead underwriter of Marathon Acquisition Corp., co-managed by Ladenburg Thalmann and UBS Securities. In late 2005, Deutsche Bank backed an offering for a real estate-focused Cold Spring Capital, which raked in $120 million. In a less-successful attempt to get in on the SPAC action, last year Merrill Lynch failed to raise enough money to complete a planned $125 million offering.

How Do They Work?

Most of the proceeds from the IPO - 85% to 100%, depending on the deal structure, which has been evolving - is held in a trust account and is only released when an acquisition is completed. A smaller portion of the proceeds, after the IPO expenses are paid, is held outside of the trust to fund the costs of investigating and negotiating a deal. SPAC shareholders don't want to wait too long for something to happen, so an acquisition generally must be completed within 18 to 24 months. Otherwise, the funds it has amassed are returned to shareholders. To date, five SPACs did not complete an acquisition in time, and are returning their trust funds to their shareholders.

From August 2003 through early March 2007, there had been more than 85 IPOs by SPACs, based on publicly available information, and just over one-quarter of the companies had completed acquisitions, while another quarter had announced deal but had not yet completed them.

Recent estimates are that approximately 38 SPACs currently have more than $3.5 billion in trust funds and are looking for companies to buy; the 50 or so pending IPOs filed with the SEC could double that amount.

SPAC founders are generally experienced fund managers, private equity investors, investment bankers, or business executives. They put up a small amount of money to cover organizational and pre-IPO expenses, and are required by underwriters to purchase additional shares or warrants to purchase shares of the SPAC as a condition to completing the IPO. The proceeds from management's investment are added to the trust fund. This puts the managers at risk and demonstrates to investors their confidence that an acquisition will be completed, since the founders stand to lose their entire investment if no acquisition is completed within the specified time frame following the IPO.

SPAC management gets no current compensation for finding or completing the acquisition, other than some reimbursement for office space and administrative support. After the IPO, however, the SPAC managers end up with 20% of the company - as founders' shares purchased at a nominal price - plus the securities they purchase in connection with the offering. SPAC managers generally devote only part of their business time to searching for an acquisition target, and are often involved in managing other investment funds, operating other businesses, or leading acquisition searches for other SPACs. They may, but are not required to, stay involved with the company after a deal is competed.

SPACs typically leverage their IPO funds to enable them to buy bigger companies. Like private equity firms and other financial buyers, SPACs will utilize senior and/or mezzanine debt to increase the potential return to their equity investors. A SPAC may also complete a PIPE or other equity financing in conjunction with an acquisition. Some acquisitions are structured as cash mergers while in other cases, shareholders of the target company retain an equity interest in the combined company. As a result, a SPAC generally looks to acquire a company that has a purchase price substantially greater than the proceeds of its IPO.

Is Timing Everything?

Prior to completing its IPO, a SPAC cannot take any steps to identify an acquisition target. This limitation is designed to avoid having to disclose information about the target business in the prospectus for the SPAC's IPO. Once the IPO is complete, the SPAC management team, through their own contacts or use of an investment bank, begins the search for potential acquisitions.

From a target company's perspective, it will generally take longer to sell to a SPAC than to a financial buyer because the SPAC must gain deal approval at a special meeting of its shareholders. As a public company, the SPAC must file a proxy statement for review by the SEC. In effect, the proxy statement provides the same level of information that the target would be required to provide in a registration statement for an IPO, including three years of audited financial statements. The SEC comment process may require the SPAC to amend the proxy statement several times before it's cleared for mailing to the SPAC's shareholders. Since most of the substantive information in the proxy statement relates to the target company, this can involve a substantial commitment of management time and expense on the part of the target.

Breaking Up Is Hard to Do

Any acquisition by a SPAC requires the approval of a majority of the shares held by the SPAC's public shareholders. In addition, holders of up to 20% of the shares sold in the SPAC's IPO can vote against the deal and choose to have their share of the trust funds returned to them to redeem their stock. This provision can create some uncertainty about the ultimate capital structure of the combined company. Depending on the rest of the financing sources for the acquisition, the target's shareholders may need to agree, if necessary, to take some portion of the purchase price in SPAC stock if some SPAC shareholders "opt out," even if the acquisition would otherwise be an all-cash deal.

In the event that more than 20% of the SPAC's shareholders vote against the deal and choose to have their shares redeemed from the trust fund, the acquisition cannot be completed. The target company may have incurred substantial expense, disclosed extensive information about its business in the SPAC's publicly filed proxy statement, and lost other opportunities during the acquisition process. SPACs generally enter into agreements with acquisition targets that prevent the target from seeking damages that would exceed the SPAC's non-trust assets. Since most of the SPAC's assets are in the trust fund and cannot be drawn upon until the acquisition closes, there is generally no effective way to provide a breakup fee or reimbursement of expenses for the target if the SPAC fails to complete the deal.

3-2-1...Now We're Public!

As discussed earlier, the proxy statement for the SPAC shareholder meeting provides essentially the same information that the target would include in a registration statement for a traditional IPO. Since the SPAC is essentially a shell company with only part-time management whose sole responsibility is to identify and complete an acquisition, the target must have the infrastructure in place to handle SEC and stock exchange filings, Sarbanes-Oxley compliance, and related matters.

There is no "grace period" for the newly public company after the acquisition is complete. The company must immediately begin filing annual, quarterly, and interim reports with the SEC under the Securities Exchange Act of 1934. It must comply with the SEC's proxy rules, with Sarbanes-Oxley provisions, and any stock exchange on which the company's shares will be traded.

For example, the company must have independent audit and compensation committees, a code of ethics, and "whistleblower" procedures in place. It will also need an insider trading policy - about which it will need to educate its employees - and internal communication guidelines that ensure that the company will be able to comply with Regulation FD - the SEC's fair disclosure requirements. Finally, the company's officers and directors will be subject to the reporting obligations and short-swing trading limitations of Section 16 of the Securities Exchange Act.

Does Anyone Even Know Me?

Unlike a traditional IPO, a company that merges into a SPAC doesn't have the benefit of the underwriters' analysts starting research coverage of the company shortly after the IPO. As a result, the target will have to spend time and money to create interest in the company's stock, which can be a management distraction and can be hard to achieve for small companies.

SPACs are not followed by traditional analysts, since, to borrow a phrase from Gertrude Stein, "there is no there there." As a result, the company must start from scratch to build investor and analyst interest after the acquisition. In this respect, a simultaneous PIPE transaction as part of the acquisition financing can be helpful, since it will introduce one or more investment bankers and their analysts and investors to the company.

Why Sell to a SPAC?

Given some of the complications of selling to a SPAC, why do targets consider them viable acquirers? Some of the reasons include:

* Merging with a SPAC can be an effective way for a company that may not be a viable IPO candidate in the current market - due to size, industry, or other factors - to raise additional capital. A SPAC must acquire a company that has a value equal to at least 80% of the SPAC's net assets. However, the SPAC's cash does not need to be used in the acquisition; the SPAC can issue stock to the target's shareholders and preserve the cash from its IPO to use for the combined company's growth plans.

* The target may also be seeking the perceived benefits of being a public company: liquidity for existing shareholders, attractive equity compensation plans for employees, better access to capital markets, and a currency for future acquisitions.

* As a public company, the combined entity should, in theory, yield a higher valuation than a similar privately held company, reflecting the liquidity afforded to the company's shareholders. This may allow the SPAC to pay a higher price than other financial buyers, depending on current market conditions.

* For companies in an industry that is ripe for a "rollup" by a SPAC management team with substantial industry experience, selling to a SPAC may give the target's shareholders and management the chance to get in on the ground floor of an industry consolidation.

It's All About Choices

Selling to a SPAC may not make sense for every company looking to sell, or may not be a good alternative way to become a publicly traded company. But for the moment, the market for SPACs continues to grow, and for some companies, merging with a SPAC might be the best available alternative.

Like financial buyers, SPACs have a growing pile of money that is earmarked for acquisitions, and they have a need to put that money to work quickly. Target companies should recognize these opportunities, but also keep in mind some of the inherent limitations and complexities that the SPAC structure imposes on buyers.

Paul Broude is a Partner in the Boston office of Foley & Lardner, where he is a member of the firm's Transactional & Securities and Private Equity & Venture Capital Practices.

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