Planning With SPAC Securities

Capital markets statistics show it: The Special Purpose Acquisition Company (SPAC) is the new initial public offering.1 For advisors accustomed to pre-offering discounting opportunities in previous booms, that raises the obvious question—can the current rush to take companies public, albeit through a different route—also be turned into estate-planning gold? 

Not to spoil the rest of the article, but there are many opportunities, including for SPAC sponsors, investors and the original shareholders in the private company going public through the SPAC transaction. 

SPAC Facts

A typical SPAC deal begins when a sponsor, almost always a limited liability company (LLC), starts a new corporation (the SPAC) by purchasing its common stock for $25,000. The number of founder shares issued initially are intended to equal 20% of the SPAC at the end of the process, but often the percentage ends up being lower. 

Shortly thereafter, the SPAC goes public through a regular initial public offering (IPO), except this is a very simple offering because the company at this point has almost no assets, no operations and thus no accounting and other statements for the government to scrutinize. In the IPO, units are sold at $10 each. Each unit consists of one share of common stock and some fraction of a warrant struck at $11.25 per share.2 Contemporaneously with the IPO, the sponsor also purchases common stock warrants for $1 per warrant, thereby providing the SPAC with the cash required to pay the IPO underwriting fees3 and for a small amount of working capital.4 The cash from the investors in the IPO, on the other hand, isn’t used: It’s put in a trust account until the merger happens (or not). 

Finally, the SPAC finds its target, the perfect match: a private company intending to go public and, usually, raise some cash. A letter of intent is signed after initial due diligence on both sides, followed by further due diligence and negotiations, and then the merger is completed. Some portion of the trust account cash is now available for the growth and working capital needs of the target, and the target shareholders now hold publicly traded shares. In conjunction with the merger, the SPAC may also raise additional capital through a private offering (a private investment in public equity (PIPE)) to institutional investors. 

So far, so simple, right? Now, we have the following securities, all with interesting valuation aspects to them: 

1. The founder shares. These are held by the LLC set up by the actual, individual sponsors, along with their warrants. By convention, this is captioned “Class B” common stock. These shares aren’t publicly traded but are set to convert to Class A on completion of the merger. However, even after conversion, the shares are locked up from trading for some time. 
2. The regular shares purchased by investors in the IPO, usually called “Class A” shares. These shareholders get to vote on the merger, and any shareholder who for any reason wants out, pre-merger, can have their shares redeemed for $10 per share, plus interest. They get to keep the warrants, which is the shareholder’s compensation for parking cash with the SPAC for 12-to-18 months. 
3. The PIPE shares. These shares are unregistered and held as a concentrated position. Thus, they’re  illiquid. 
4. The shares in the private company. Prior to the merger, these shares have no public market and would be valued based on standard valuation metrics from comparables, prior investment rounds or an income approach. 

Thus, at various times during the life of the SPAC, in the ideal case, all of these very different shares are converging in value at $10 per share until the merger is announced (and at some share price higher than that once the merger is announced, and the market begins to take the specifics of the target and the deal into account). But, until each share is freely tradable at a public market price, each would be valued at a discount. And, what’s the discount? That varies over time, as well as with the specifics of each security and each deal. (See “SPAC Classes,” p. 59.)

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Valuation Discounts

The best way to think of the valuation of SPAC securities is as a discounting exercise. The IPO happens relatively early in the life of the entity, often as soon as a couple of months after inception. Thus, a market-based reference price exists from which other securities can be valued. Three market prices may exist contemporaneously: 

1. The price for each unit. While the warrants in each unit are detachable, the unit often trades on its own, at least initially. Ticker example: ABCU.
2. The share price. Once the warrants detach, the shares will start trading, initially always around the $10 price. Ticker example: ABC.
3. The warrant price. Because the warrants are out of the money, they trade at a fraction of the share price. A typical warrant price, initially, is often around $1. Ticker example: ABCW.5

Any discounts applicable to these publicly traded securities during the time between IPO and merger (also known as the “de-SPAC transaction”) would be modest and due to blockage issues. Note that the shares are not only freely tradable but also redeemable at $10 per share plus (a small amount of) interest since the IPO. Also, while the PIPE securities may be illiquid and discountable under certain circumstances, they represent few real planning opportunities. As such, I’ll focus on the founder shares and warrants and the private company shares that will become public after the de-SPAC transaction. 

The Founder Securities

These are often valued at deep discounts. Why? Unique among the securities considered here, all the cash contributed by the sponsors represents at-risk capital. This is critical: If the de-SPAC doesn’t happen, the founder shares and founder warrants are most likely worthless. Expressing the value of founder shares as a discount from the expected or traded stock price, we can discuss the founder shares discounts separately as of four different time periods: 

• From the inception of the entity until the IPO, the founder shares are valued at very deep discounts. On the other hand, a de minimis value or a value close to the $25,000 purchase price would be inappropriate.6 After all, the IPO generally isn’t a high risk event due to the “clean” status of the shell company and lack of operating and financial history. However, the IPO isn’t a riskless event: The bankers and professionals working on the SPAC must still raise the money, which depends on the perception of investors of the quality of the management team as well as the warrants and other deal terms offered. 
• From IPO to merger announcement, the market provides reference prices for the units, shares and warrants. The sponsor’s efforts in searching for, vetting, negotiating with and performing due diligence on various targets during this period generally aren’t public information (but should be considered by an appraiser valuing the founder’s shares, as the owners of those securities have access to that information). During this period, the market reference prices tend to be placid: shares and units trading close to $10 and warrants trading at a fraction of the share price.7 A starting point for the discounting during this period might be the discounts commonly found in pre-IPO (and other illiquidity) studies, often averaging around 30%-to-40%.8 Depending on circumstances, however, prior to the merger announcement, founder shares discounts should almost always be greater than pre-IPO study discounts, due to the greater risk.9 
• From merger announcement to de-SPAC transaction, the market price of the shares will adjust to all the news surrounding the merger, which will be disclosed in regular SEC filings.10 Depending on the progress of the transaction, and the attractiveness of the target company and its business, the shares may trade up or sideways in anticipation of the deal happening.11 In addition to an average discount, pre-IPO studies provide data on how the discounts trend downwards as the IPO date approaches. This data can be used as a benchmark or starting point for the analysis, as the SPAC approaches its consummation. Founder warrants, which by now have been issued, can also be valued at a discount from the trading price of the warrants in the market—albeit at an even higher discount than those applicable to the shares.12 As with the founder shares, there’s no reason to give significant weight to the issue prices when valuing these. 
• Post de-SPAC, the market price of the merged entity will adjust as the now public company progresses in its business, as regularly disclosed in filings and as the market itself moves.13 However, any remaining securities with lock-up provisions will still need to be discounted. Founder shares are typically restricted from trading until the earlier of: (1) one year after the completion of the merger, or (2) 150 days post-merger if the trading price of the common stock exceeds a certain threshold. During this period, the founder shares and warrants are still discountable, using standard marketability discount databases, including restricted stock studies. 

In addition to the discounts discussed above, it should be noted that individual clients don’t hold founder shares: The founder shares are held by an LLC, of which the individual sponsors are members. There are further discounting opportunities when transferring member interests in this entity (or other entities “upstream” from the sponsor LLC). 

Private Company Shares

For holders of common or preferred shares in the private company target during the SPAC IPO process, significant valuation discounts also apply due to the same factors: illiquidity and risk. Here’s what happens with these securities pre-merger and post-merger:  

• Pre-merger, the private company is, first, discussing the SPAC IPO with one or more sponsor groups—these negotiations will arrive at expected deal terms by the letter of intent stage. At this point, the private company shareholders have an expectation of what price their shares will be worth if all goes well (a certain number of SPAC shares, at $10 per share for each of the private company’s shares pre-deal). However, there are also many uncertainties, including what percentage of the IPO holders will redeem their shares (which will deplete the trust fund) and what the market reaction will be to the announcement and/or completion of the deal. Regular pre-IPO and restricted stock data discounts apply here as a benchmark but will need to be adjusted for a range of factors impacting the risk of the transaction. 
• Post-merger, the shareholders now just have common shares in a public company. And, if a registration statement has been issued covering their shares, the normal 1-year Rule 144 holding period doesn’t need to apply; however, standard issues of blockage and affiliate status affecting the marketability of the shares may impact the valuation of any given block of shares. 

Time to Plan

What to say when your client has significant SPAC securities holdings? After congratulations, it’s time to plan! Depending on the deal stage and securities held, many clients and their trusts will benefit from a swift transfer ahead of potentially value-transforming deal activity. 

Endnotes

1. No kidding: According to FactSet, “SPACs Dominated 2020 … In the third quarter, there were a whopping 116 SPACs that went public, representing 56% of all IPOs for the quarter. In the fourth quarter we saw 87 SPAC IPOs, making up 52% of the total number.” In a special purpose acquisition company (SPAC) initial public offering (IPO), a privately held company “reverse-merges” into a public shell specially designed for that purpose. Post-merger, the shareholders of the private company become owners of publicly traded shares. See Sara B. Potter, “U.S. IPO Market: SPACs Drive 2020 IPOs to a New Record,” FactSet Insights (Jan. 7, 2021). 

2. This isn’t just an illustrative example. While there are slight variations from deal to deal, almost all SPACs issue units for exactly $10 per share, and the warrants have an exercise price at $11.25 per share. The warrants purchased by the founders are also (again, almost always) purchased for exactly $1 per warrant. This allows for easier comparisons from deal to deal. 

3. A significant portion of the underwriting fees are typically deferred until after the merger. 

4. The sponsor also has the option to give the SPAC a loan during the ensuing process for additional working capital needs, if required. However, working capital requirements are generally relatively modest (for example, the principals of the sponsor, who are the main deal professionals, perform their work without any other compensation than their founder shares). 

5. Note that warrant terms are becoming steadily more complex, as well as more issuer friendly. A half or a full warrant (per unit) was common in prior years. However, recent deals have had one-quarter warrants and one-fifth warrants, and one deal with no warrants at all, according to a recent article. There are also deals in which the warrants may be redeemed for stock and “crescent terms,” when the warrants are adjusted for future share issuances. See“Update on Special Purpose Acquisition Companies,” Harvard Law School Forum on Corporate Governance (Aug. 17, 2020), https://corpgov.law.harvard.edu/2020/08/17/update-on-special-purpose-acquisition-companies/. 

6. Because the shares are intended to be compensatory (and the sponsors do in fact contribute their valuable skills and efforts during this whole period to earn the shares), the nominal purchase price for the shares doesn’t have any real economic significance. 

7. The relationship between warrant and share price can be used as a way to gauge the public market perception of the likelihood of the deal happening (otherwise, the warrants are worthless) and if it’s dilutive or accretive to the share price (if the shares trade down post-merger, the warrants are likewise out of the money). 

8. Pre-IPO studies may be the best starting point here, due to the data accounting for a combination of illiquidity and no-deal risk, but studies, for example, restricted stock studies, of lack of marketability discounts may provide additional support and should be considered as well. 

9. Not only the risk that founder shares are worthless if the de-SPAC doesn’t happen (whereas pre-IPO shares still have the same private company value if a proposed IPO doesn’t happen) but also the risk of forfeiture: SPAC sponsors often forfeit some of their shares (or transfer them to private investment in public equity (PIPE) investors) to “sweeten” the deal to the other investors involved and enhance the chances of the deal closing. The investors that may require such forfeiture include the public (the IPO) investors (to induce them to keep holding through the de-SPAC and not redeem), the PIPE investors (to induce them to invest their capital and accept some degree of illiquidity) and the private company owners (to make them choose this particular SPAC as opposed to any number of others vying for their business). 

10. The merger itself is preceded by a proxy statement, which may contain financial projections. This is one of the often-cited advantages of SPAC IPOs: the ability to take advantage of the general protection of the safe harbor for forward-looking statements afforded publicly traded companies (which isn’t available to private companies attempting to go public through an IPO). 

11. Due to the redemption rights, the publicly traded shares don’t tend to trade down, but this is another reason why the founder shares, which lack such rights, and therefore lack the $10 “floor,” must be valued at a significant discount. 

12. Because of the leverage implicit in the warrants (as opposed to the shares) due to their strike prices and the greater resulting risk, warrant discounts are much deeper, all else being equal. There’s also empirical support for this; see  Espen Robak, “Discounts for Illiquid Shares and Warrants: The LiquiStat Database of Transactions on the Restricted Securities Trading Network,” White Paper (Jan. 22, 2007). 

13. The de-SPAC itself is memorialized in the “Super 8-K” that all SPACs must file within four days of completion of their business combination. It contains financial and other information on the transaction and the now-public company, similar to what’s commonly found in a prospectus.