Over the last two years, there have been a significant increase in the use of special purpose acquisition companies (SPACs). SPACs, also sometimes known as ‘blank check’ companies, are a way for private investors to take a company public without the wild price swings that may occur during an initial public offering.
Even though SPACs have been around in one form or another since the 1990s, they have recently become a popular tool for private equity investors, including celebrities, who are looking for a place to invest their significant cash stockpiles.
How Do SPACs work?
The most common method by which a SPAC is formed is when a sponsor group creates a newly organized company and takes it public without that company having any existing operations. A SPAC often exists solely to receive investments to fund the acquisition of a private operating company that the SPAC’s management has purchased. These investments are placed in a trust fund and can only be used for said purchase of the operating company.
SPAC investors, therefore, are technically investing in the capacity of the SPAC management team to find and close a deal on a suitable private company. Most SPAC governing documents declare that the SPAC has a deadline of 18-24 months to find and purchase such a company with its investors’ money.
If it fails to meet this deadline, the SPAC is usually forced to return all money in the trust to its investors. So, as a person selling their private business, there are several advantages and disadvantages when you’re deciding whether or not to sell to a SPAC.
The Pros of Selling to a SPAC
On the positive side, the valuations that were paid out by SPACs in 2020 and 2021 tended to be significantly higher than the valuations paid by equity funds and strategic buyers.
Evaluations paid by SPACs have been so high, in fact, that in February 2021, Berkshire Hathaway’s Vice chairman Charlie Munger said, “Crazy speculation in enterprises not even found or picked out yet is the sign of an irritating bubble.”
It goes without saying most private business owners are fine with the thought of being bought out for an unreasonably high valuation.
The Cons of Selling to a SPAC
On the negative side, business owners who sell to a SPAC need to be immediately ready to meet the requirements of operating as a publicly traded business.
These requirements include audited financial statements that meet public company GAAP and SEC rules, interim financial statements, form S-4 proxy statements, form 8-K disclosures, and compliance with insider trading rules.
In addition, private business owners will generally be required to sign a lock-up agreement preventing them from selling their stock in the newly public company, typically for a 6-month period. This tends to be a real issue as most business owners who sell their companies in a more conventional manner tend to prefer that a significant portion of the purchase price be paid in cash at closing.
There are upsides and downsides to selling your business to a SPAC but it’s definitely a process that business owners need to go into with both eyes open. If you’re considering selling your company to a SPAC, Richards Rodriguez & Skeith’s expert team of business transactional attorneys can analyze your situation and advise your next steps. Contact us today to get started!