Introduction to De-SPACs

A de-SPAC transaction refers to the process where a privately held company becomes a publicly traded firm by merging with a special purpose acquisition company (SPAC). These SPACs, also known as check companies, raise funds via initial public offerings (IPO) to acquire existing private companies. Once the de-SPAC transaction occurs, the private operating company becomes publicly traded without taking the IPO route.

In recent years, de-SPAC transactions have gained popularity for emerging companies to enter public markets. The number of SPAC IPOs reached highs in 2020 and 2021 as companies and investors saw benefits in choosing de-SPAC transactions over traditional IPOs. For companies, de-SPACs offer a potentially less risky path to becoming a public firm while allowing SPAC investors to gain exposure to a growth company and its potential returns.

Although the de-SPAC structure was initially introduced in the 1990s, adoption happened gradually. Its popularity peaked after DraftKings completed an SPAC transaction in 2020, showcasing the advantages of this model. This led to a surge of interest from both companies seeking to go public and investors providing funding for new SPACs. De-SPAC transactions quickly transformed from a niche strategy into a mainstream phenomenon.

With the surge in IPOs and completed mergers, de-SPAC transactions have become a hot discussion topic in the financial community. Despite markets cooling due to uncertainty around regulations, de-SPACs remain an intriguing alternative for private companies seeking access to public markets compared to the traditional IPO route.

Understanding De-SPAC Transactions

The process of de-SPAC involves steps that enable a private company to become a public company through business integration in a merger with a SPAC. These special purpose companies are shell corporations specifically listed on the stock exchange to buy a private firm.

SPAC IPO and Fundraising

• The journey starts when a SPAC launches an IPO to secure funds that will be used to purchase a company. It's important to mention that the SPAC doesn't handle any tasks itself.
• Typically, sponsors such as equity firms or investment banks form SPACs. They receive founder shares and warrants as part of the deal's organization.
• The funds raised from investors during the IPO are held in a trust account while the SPAC looks for an acquisition target.

Identifying a Target Company

• With the IPO proceeds secured in trust, the SPAC sponsors evaluate private companies as potential acquisition targets.
• The target company should be poised for growth and benefit from access to public markets. The SPAC looks for a company that can utilize the funds from the merger to expand.
• SPAC sponsors leverage their industry expertise and connections to identify attractive targets. Negotiations take place once a potential match is found.

Merger Deal and Shareholder Vote

• If a SPAC reaches a merger agreement with a target, the deal terms are announced publicly. This includes valuation, ownership breakdown, etc.
• Subsequently, shareholders of the SPAC vote on whether or not to approve the proposed merger at a meeting.
• Once approved, the target company merges with the SPAC adopting its name as it becomes publicly listed.

SEC Review and Public Trading

• After completing the merger, a review process is typically conducted by bodies such as the U.S. Securities and Exchange Commission (SEC). This ensures compliance with regulations before allowing the trading of shares.
• After receiving approval from shareholders, the SEC carefully examines the merger's filings, including registration statements.
• After receiving approval from the SEC, the company's stocks get listed on a stock market under the target stock symbol.
• Subsequently, the owned firm transitions to being traded through a merger with a SPAC shell corporation.

De-SPAC vs Traditional IPO process

A de-SPAC transaction offers advantages compared to a traditional IPO when taking a company public.

Speed

The process of de-SPAC is usually faster than an IPO. Unlike an IPO that can last 12 to 18 months a de-SPAC deal is typically completed within 6 to 12 months. This quicker timeline is achievable as the SPAC has already gone through an IPO process and obtained funding. The target company only needs to negotiate the merger and fulfill requirements before commencing trading.

Costs

Regarding fees and underwriting costs, de-SPAC transactions can be more cost-effective than an IPO. The burden of covering IPO costs falls on SPAC sponsors searching for an acquisition target. Estimations indicate that de-SPAC transactions typically costs that are 20% to 40% discounted compared to initial public offerings (IPOs) factoring in expenses like underwriter fees, roadshow expenses and other associated outlays.

Control

When a business decides to go public via an IPO, it gives up some authority to investment banks and underwriters who manage the process. This also involves the company sharing statements, disclosures, and projections which could be scrutinized by the public. Conversely, de-SPAC transactions enable companies to directly discuss merger terms with SPAC sponsors tailoring agreements to suit the needs of both parties closely.

Risks

Although de-SPACs have benefits in terms of efficiency and expenses, they also pose risks. It is crucial for companies to extensively evaluate the SPAC sponsors and meticulously review the terms of the deals. The regulatory complexities surrounding de-SPACs also expose companies to compliance issues. However, many private companies find de-SPAC deals appealing due to their timeline and lower costs than IPOs.

De-SPAC Timeline

The entire de-SPAC process usually spans from 12 to 24 months. Here are the key stages involved during this period:

SPAC IPO and Fundraising

• The first stage entails the SPAC conducting its IPO to raise funds from investors in the public market. The SPAC aims to secure significant capital to acquire a private company.
• In general, it usually takes about 6 to 24 months for a SPAC initial public offering (IPO) process to be completed. The fouders behind a SPAC must handle the paperwork with the SEC, market the IPO to investors, and make final decisions on pricing before concluding the offering.

SPAC Searches for Acquisition Target

• Once the SPAC completes its IPO, it typically has a window of 12 to 24 months to identify and complete the acquisition of a company.
• The management team of the SPAC utilizes its knowledge and connections within the industry to discover acquisition targets. They seek mature, late-stage private companies ready to transition to a public listing.
• The target search process typically takes 6-24 months as the SPAC evaluates multiple candidates before selecting the best fit.

Merger Negotiations and Deal

• Once they identify a target negotiation, the SPAC management team and the target company agree on merger terms.
• Key elements of these terms cover valuation, sharing of ownership rights related to governance, and potential earnouts. Throughout this phase, both sides conduct thorough due diligence.
• Usually, it takes 3 to 6 months to discuss and finalize a merger deal post the SPAC process.

Shareholder Vote and SEC Review

• Before a de-SPAC deal can proceed, it must receive approval through shareholder voting from the SPAC and the target company. A majority vote is required.
• The SEC will also review the deal documentation and filings for regulatory issues.
• The shareholder vote and SEC review process takes approximately 2-4 months.

Public Listing of New Company

• Once all necessary approvals have been secured, the merger deal is closed. The combined entity starts trading on the New York Stock Exchange (NYSE) or Nasdaq.
• The de-SPAC procedure has now been finalized where a privately held company is converted into a traded entity.
• It typically takes 1-2 months after close until public trading commences.

Advantages of De-SPACs

De-SPAC transactions offer advantages compared to IPO processes for private companies seeking public listing. Here are some:

Faster Path to Public Markets

De-SPAC transactions offer an advantage by expediting the process for private companies to become traded entities. Typically, a de-SPAC transaction can be completed within 6 to 12 months whereas a traditional IPO commonly spans from 12 to 18 months. This timeline is because the SPAC has already completed its IPO and secured funding, which allows negotiations with the target company to commence promptly. For private companies eager to enter the markets, being able to go public in months than waiting for a year or longer can be highly lucrative.

Less Risk and Uncertainty

Opting for an IPO exposes companies to uncertain processes with exposure to risks. IPOs face obstacles like poor market conditions, regulatory delays, or investor interest. On the other hand, de-SPAC transactions provide certainty since the SPAC is committed to acquiring a target. Once a de-SPAC deal is signed, the combined company is guaranteed to become publicly traded without any regulatory blockade. The definitive acquisition agreement removes much of the risk and uncertainty associated with a traditional IPO.

SPAC Sponsor Expertise

Experienced leadership teams sponsor SPACs and possess expertise in identifying appealing acquisition targets, negotiating deals, and transitioning companies into the public markets. Target companies benefit greatly from accessing the knowledge and guidance these SPAC sponsors offer throughout the de-SPAC process.

Disadvantages of De-SPACs

Despite the benefits, de-SPAC transactions also have notable drawbacks that private companies should carefully weigh.

The De-SPAC Process is Complex with Strict Compliance Requirements

Completing a SPAC deal involves adhering to a comprehensive set of regulations and compliance requirements. Navigating through filings becomes necessary, and transaction costs can quickly accumulate due to fees associated with legal work, accounting services, and advisory assistance. The process can become cumbersome for private companies without prior exposure to public markets. From the initial merger agreement to completing the de-SPAC, the deal requires coordinating many moving parts quickly. Having an experienced team is key.

Target Companies Cede Some Control and Influence on the SPAC

In exchange for the SPAC providing the path for a private company to go public, the target private company trades off some control and influence. SPAC sponsors typically get an upsized equity stake, board seats, voting power, and other rights. While the target company gets access to the SPAC's expertise and capital, it does give up decision-making authority. SPAC’s interests may not always align completely with the long-term goals of the target firm, which poses a risk.

Pressure to Close Deals Can Lead to Poor M&A Outcomes

The time constraint of 24 months for SPACs to complete an acquisition often leads to pressure in finding a target and closing a deal. This urgency can sometimes result in a mindset of prioritizing any deal over no deal, potentially leading to overpaying for targets or acquiring companies that may not be the fit. Rather than having the patience to wait for an ideal target, SPACs may rush into bad M&A just to beat the clock. This risk can work against private companies being acquired via de-SPAC.

SEC Regulation of De-SPACs

The SEC has introduced SPAC transaction regulations to enhance transparency and safeguard investor interests. These rules specifically target issues that arise in deals.

One important rule focuses on disclosing any conflicts of interest among the target company, SPAC sponsors, and related parties. The SEC recognized that more transparency was necessary regarding incentives and compensation structures received by sponsors and affiliates of shell companies as part of SPAC transactions. This requirement will enable investors to assess any biases in these deals.

The SEC is also enforcing more accountability and clarity around any historical financial statements or projections published concerning a proposed de-SPAC transaction. SPACs must now explain the specific basis and underlying assumptions for any such financial reporting or projections rather than presenting them as facts. Projections can only cover short-term periods rather than many years into the future.

In addition, the new rules require some key changes to the structure of de-SPAC transactions. For example, SPAC sponsors are restricted from redeeming their shares associated with the deal, which the SEC sees as a conflict of interest. Targets of de-SPAC deals will need to meet initial listing standards on public exchanges in contrast to the previously more lenient requirements.

These new regulations impose more rigorous disclosure requirements and standards around de-SPAC deals to strengthen protections for everyday investors. While they may create some new procedural hurdles, increased transparency and accountability are necessary to further investor protection and prevent misleading claims or conflicts of interest in the rapidly growing market.

Outlook for De-SPACs

In the future SPAC transactions show promise as they are becoming increasingly popular as a path to going public, instead of the traditional IPO route. Here are some predictions for the de-SPAC landscape:

Deal Volume

The growth in SPAC deals witnessed in 2020-2021 is expected to continue, albeit slower. SPAC sponsors still have funds estimated at over $200 billion that can be utilized for mergers with private companies. While deal volume may moderate from the historic highs, de-SPACs are projected to represent a meaningful portion of overall IPO activity.

Investor Appetite

Despite some high-profile failed deals, investor interest in de-SPACs remains strong. These transactions allow public market investors access and exposure to disruptive private companies earlier in their lifecycle than IPOs. With proper due diligence and accountability, de-SPACs offer an attractive investment opportunity.

SPAC Structures

In response to criticism over rushed deals and misaligned incentives, expect structural changes in SPACs, including smaller IPO proceeds, increased sponsor investment, and enhanced shareholder rights. New SEC regulations will also force greater transparency and diligence in de-SPAC deals.

Target Industries

De-SPACs have been concentrated in sectors like tech, EV/mobility, and energy transition. These hot areas of innovation and growth will likely remain prime targets for SPACs seeking acquisition opportunities. However, some new industries may gain SPAC interest as well.

International Expansion

While predominantly focused on US targets, SPACs are expanding globally with recent overseas deals and more foreign listings. The de-SPAC model could gain adoption in Europe and Asia as an alternative path for private companies in those markets to access public capital.

In summary, de-SPACs have momentum and are here to stay as a new means for companies to go public. With proper oversight and improved structures, de-SPACs will continue offering market benefits to private companies and investors for years to come. The outlook is bright despite some needed evolution in the model.

How to Invest in De-SPACs

Here are a few options for investors looking to gain exposure to the de-SPAC ecosystem:

SPAC ETFs

One approach is investing in exchange-traded funds (ETFs) that focus on SPACs. For instance, ETFs like Defiance Next Gen SPAC Derived ETF (SPAK) and Morgan Creek Exos SPAC Originated ETF (SPXZ) offer exposure to premerger SPACS as well as companies that have completed the de SPAC process. These ETFs provide a selection of stocks related to SPACs in a fund.

Individual Stocks

Investors can also focus on companies that have either already gone public or are in the process of going public through a SPAC transaction. Notable examples of de SPACs include DraftKings (DKNG), Virgin Galactic (SPCE), and Opendoor Technologies (OPEN). Researching these companies to understand their status and evaluate their business operations and growth prospects is crucial.

Risks

While de-SPAC transactions offer opportunities, they also involve risks. Due to operating history, it is important to analyze forecasts and projections provided by SPAC sponsors. Additionally, regulatory risk should be considered in the investment thesis, as seen with the SEC's efforts to increase transparency and disclosures regarding de-SPAC deals. Conducting diligence and implementing effective risk management strategies are essential when investing in this sector.

‍