What is a SPAC?
A Special Purpose Acquisition Company (“SPAC”) is a publicly traded company that has no formal commercial operations. A SPAC usually has a lifespan of about 2 years and is formed with the sole purpose of effecting a merger with another company.
Since the 1990’s, Special Purpose Acquisition Companies have been successful in raising hundreds of billions of dollars. The money raised in its IPO is deposited into an interest-bearing trust account that cannot be disbursed except to consummate a business combination. To start, a SPAC must supply its own capital when issuing its IPO. This is ultimately provided by the SPAC’s sponsors. The sponsors receive founder shares in return for providing capital to the company for its operations. This includes the SPAC’s professional fees and due diligence it undertakes when identifying and acquiring a target company. After the SPAC successfully completes its IPO, the sponsor begins searching for a target company to merge with. SPACs have a specified time to complete its special purpose, generally around 2 years, or it must return the capital raised in its IPO to investors.
In short, a SPAC is a freely trading public company that’s seeking a company to merge with to continue its existence. Since a SPAC itself is a publicly traded company that’s subject to strict federal securities laws and exchange listing requirements, SPAC sponsors take into consideration the target’s ability to abide by these requirements since their goal is to ensure they deliver as much value as possible to the SPAC and its shareholders.
What Makes a Company a Good Target for a SPAC?
A publicly traded company makes for a powerful SPAC acquisition candidate. Typically, a SPAC will target a private company. A conventional IPO process could take the target company more than a year, while the route to public offering using a SPAC may take a mere few months. Traditionally, the target company is a third party, such as a start-up firm.
There are a few key factors the SPAC will often look at when evaluating a target company: A strong management team, financial systems and reporting in place, corporate governance familiarity and alignment, a mature company lifecycle, and growth opportunities.
A strong management team and prior company experience will be more attractive SPAC targets. A strong, experienced CFO is necessary to implement and meet the financial and reporting requirements of a publicly traded company. A mature company lifecycle is reflected in a company’s history of healthy growth coupled with plans for a sustainable future. Ultimately and arguably the most important factor, is the potential growth of the target company. The success of a SPAC transaction will depend on the growth of the acquired company.
Lastly, one of the biggest hurdles when consummating a merger for any public company is the registration statement that needs to be filed with the SEC which is called Form S-4. Form S-4 is required to disclose material information with respect to a merger or acquisition upon the registration of a company’s securities. It consists of information regarding the terms of the transaction, risk factors, ratios, pro-forma financial information, and material contracts with the company being acquired. Most importantly, in order to file Form S-4 both companies need 2 years’ worth of audited financials. This poses a problem for private companies targeted by SPACs because they need to undergo the audit process and incur additional expenses. This could make the transaction timelier and more expensive. Thus, if a company is audited, it significantly enhances the likelihood of the completion of the transaction because it decreases time and costs.
With these key factors in mind, what kind of company seems like a perfect fit? That's right, a publicly traded company.
How can an OTC Company Get Targeted by a SPAC?
Of course, a public company can always become the target of a SPAC through the traditional due diligence process where the sponsors take a liking to a company, the sponsors target the company, they begin due diligence and, eventually, close the deal. Of course, the chances of this are rather slim simply because the number of OTC companies far outweigh the number of SPACs looking for targets. Luckily, this isn’t the only way an OTC company can get targeted and eventually merge with a SPAC.
Another route for a company to merge with a SPAC is by a company stepping into the shoes of the sponsor where it will appoint independent leadership for the SPAC. The SPAC then targets the OTC company for a business combination.
While a merger with a SPAC may cost more than an uplist, it’ll likely be quicker and decrease the chances of a company getting delisted for failing to meet certain exchange requirements. The entire process can take a mere few months, risk is minimized, and the potential benefits that come with becoming listed on a national exchange are tenfold. With a typical reverse merger, a lot of due diligence is required to combat potential liabilities.
It ends with an OTC company landing itself on NASDAQ. Since the sponsor-and-target company has already had experience being on the OTC markets, management will be prepared to handle the demanding regulatory and compliance requirements that go along with being a public company.
OTC to NASDAQ
OTC companies are commonly smaller companies which makes it difficult to meet the listing requirements of national exchanges. Investors face greater risk when investing in more speculative OTC securities. Further, stocks trading on OTC markets are, generally, not known for their large volume of trades, therefore the OTC marketplace is an alternative for small companies or those who would have trouble listing national exchanges due to their financial capabilities. It’s incredibly possible to outgrow the OTC. The quicker the process, the better. For example, on the other hand, stocks listed on NASDAQ experience less volatility, tighter spreads, and more depth. Tighter spreads and more depth at the inside quote decrease costs to investors. In addition to tighter spreads making it cheaper to trade, this also makes it easier for investors to get larger trades done.
Conclusion
The familiar risks associated with SPAC mergers and the obvious inexperience of a private target company seemingly melt away when the sponsor-and-target is an established, publicly traded company. This method provides microcap companies another option to grow. The popularity and use of SPACs will continue to find success as faster merger speeds benefit companies involved in this seamless transaction.
Eric P. Benzenberg, Esq. is a Partner at The Basile Law Firm P.C. Gus can be reached at eric@thebasilelawfirm.com. To learn more about what we can do for you, please call us today at 516.455.1500 ext. 112 for a free initial consultation. With offices in New York, Texas, and Florida, we serve public companies nationwide.