By now, most of you reading this will have witnessed the proliferation of special purpose acquisition companies (SPACs), both in financial circles as well as in popular culture. Shaquille O’Neal, Tony Hawk, Serena Williams, Alex Rodriguez, Jay-Z, Steph Curry and Colin Kaepernick are just some examples of celebrities mentioned in the media who’ve gotten in on the ground floor of SPACs, along with a number of private equity (PE) funds and other investors.1 Some recently launched SPACs are, indeed, reaching for the moon and beyond by focusing on space exploration.2 Whether the focus of a SPAC is on reaching for the moon and the stars or perhaps something more pedestrian, there’s no denying the excitement surrounding investments in SPACs, due to the perception that these investments have the potential to achieve stratospheric growth.
SPACs are referred to as “blank check companies” because they’re created before their acquisition target has been identified by the following process: (1) the sponsor forms the SPAC; (2) public investors seed the SPAC with cash through an initial public offering (IPO); (3) those funds are held for the purpose of consummating a merger with a target company (the Target) (the merger is referred to as “de-SPAC”). After the IPO, a SPAC has a limited period (typically 24 months) to find an acquisition candidate and close on the business combination. If, however, the SPAC is unable to close on a merger within the allotted time frame, the SPAC must return the funds to the holders of the Class A shares. On de-SPAC, in which the SPAC and the Target are combined, the sponsor, as the owner of the sponsor shares, will vest in its shares. These shares equal up to 20% of the value of the SPAC at the time of its IPO, which can be a small percentage of the combined entity post-de-SPAC.
The opportunity to invest a relatively small amount of capital in sponsor shares in a SPAC in exchange for an interest in a vehicle that potentially could have explosive growth in the future makes this asset a good candidate for wealth transfer. Sponsor shares are typically held through a sponsor vehicle. Because of the speculative nature of SPACs, the current value of an interest in the sponsor shares may be worth substantially less than the potential future value of that interest.
In addition to sponsor shares, there are other stakeholders in the SPAC ecosystem that own different types of equity interests with the potential for substantial growth. For example, owners of Targets to be acquired by a SPAC may have a greater opportunity for wealth transfer planning from a traditional pre-IPO or pre-appreciation standpoint. In addition, public investors in the SPAC on the IPO, as well as investors making private investments in public equity (PIPE), may be able to structure the ownership of their shares to benefit from the appreciation potential.
A SPAC structure involves different stakeholders, including:
- The sponsor, who will often own, or be an owner in, the sponsor vehicle (which owns the sponsor shares),
- Individual and perhaps PE fund owners of the sponsor vehicle,
- Public investors in the Public A shares of the SPAC,
- Investors in the PIPE, and,
- Owners of the Target, who may be individuals or perhaps PE funds, venture capital (VC) and possibly family offices.
Advisors will likely be representing different stakeholders in different situations. For example, on a 9 a.m. call, an advisor may be representing an individual owner of sponsor shares who’s inquiring about planning for family with the shares; on a 2:30 p.m. call, the owner of a potential Target being pursued by various SPACs may be interested in learning about how efficiently to structure a transaction; at 6 p.m., the sponsors of the general partnership (GP) of a PE fund invested in a sponsor vehicle could be interested in transferring carried interest before the “pop” occurs in the SPAC; and at 7:30 p.m., an investor in the Public A shares or the PIPE may be wondering where best to hold those investments. All these stakeholders in the SPAC ecosystem have an ownership interest in assets that have a potential upside, in some cases with exponential growth potential.
SPACs are increasingly becoming part of client discussions, much in the same manner that carried interest transfer became part of the collective vocabulary of advisors 10 or 15 years ago. It’s important for advisors to become familiar with the various roles that different investors play in a SPAC structure so that advisors can gain fluency in the terminology and, critically, the specialty issues, so as to properly advise these different stakeholders.3
The Stakeholders
The sponsor. The sponsor of the SPAC initially funds the sponsor vehicle that will form and promote the SPAC’s IPO with a small amount of capital (for example, $25,000) to cover the cost of operating expenses and forming the vehicle. Initially, the sponsor vehicle will be the sole owner of the SPAC. The IPO of the SPAC is the mechanism by which public investors purchase the Class A shares and warrants in the SPAC in exchange for seeding the so-called blank check company.
The sponsor vehicle is typically given 20% of the shares in the SPAC (sometimes called the “promote”) subject to the completion of a subsequent de-SPAC in which the SPAC acquires the Target company (the resulting company is often referred to as the “business combination”). The sponsor shares held by the sponsor vehicle are structured as Class B shares and subject to a lock-up so that the holder of the sponsor shares won’t be entitled to redeem its interests immediately after the merger is consummated. In addition, the sponsor shares are given warrants that the sponsor vehicle purchases for approximately $0.50 to $1.50 per warrant.
The owner(s) of the sponsor vehicle could be individuals and/or family entities or trusts. With increasing frequency, however, the owner of the sponsor vehicle interest may be a PE fund investing in the sponsor vehicle as one of its portfolio investments.
PIPE. A PIPE is another source of needed cash for the SPAC to be able to consummate a merger with the Target. As mentioned previously, the holders of the Public A shares will have a right of redemption, enabling them to be redeemed out of the SPAC and have their investment returned. A PIPE provides a source of additional capital available to the SPAC in the event, for instance, that the Class A shareholders exercise their rights to redeem, as well as provides a stream for additional needed capital. The holder of the PIPE will acquire common shares in the SPAC.
Public A shares. Public investors obtain
Class A shares in connection with the IPO of the SPAC, typically purchasing shares in the SPAC at $10 per share. Technically, the IPO is a sale of Class A units, which usually consist of one share of common stock and either a full or fractional warrant with a strike price at $11.50. After a short period, the units split, leaving the investors with separate holdings of stock and warrants.
The funds raised by the Class A shares are placed in a trust account until they’re needed to fund a merger with the Target. The IPO can be an attractive opportunity for investors due to a redemption right that comes with the purchase. Shareholders have the ability to vote on the proposed acquisition down the road and can redeem their units at cost (net of expenses) should they later view the proposed merger as unattractive. Investors can redeem their stock but retain the warrants, which is an often-employed strategy by professional investors to limit risk.
Target. Multiple SPACs are often competing in discussions with different Targets. The owners of the Targets may be individual family-held companies or PE or VC firms that are seeking an exit for one of their portfolio companies. Closely held business owners may find the SPAC route to a public listing more attractive than the traditional IPO process due to reductions in time and cost and the ability to negotiate the terms of the going-public transaction. This certainty on price doesn’t exist to nearly the same degree when bankers conduct the traditional IPO process.
Carried Interests vs. SPACs
The sponsor’s right, through ownership of sponsor shares (either outright or via a sponsor vehicle), to benefit from potentially substantial appreciation in connection with receiving a 20% promote of the SPAC pre-merger will no doubt draw some comparisons to the other type of vehicle with which many in the estate-planning community have become very familiar—the so-called “2 and 20” structure in connection with PE and hedge fund vehicles. While SPACs are much different animals than PE funds, nonetheless, there are some conceptual similarities in that both an investment in sponsor shares in a SPAC and an investment in the GP of a fund involve making a relatively small investment by the founder (or sponsor) that has the potential for supercharged appreciation. In the case of a SPAC, this is due to the fact that the sponsor puts up an initial “peppercorn” investment (typically $25,000) to form the SPAC and on de-SPAC would be entitled to 20% of the IPO SPAC value. In the case of a GP of a fund, the GP will typically be entitled to a 20% allocation of the profits of the underlying fund yet would have made a much smaller capital investment (for example, 1%).
From a wealth transfer standpoint, estate-freeze planning is generally agnostic as to selection of the asset to be transferred, as long as the asset has significant upside appreciation potential. Notwithstanding whatever unique issues may have to be carefully navigated, SPAC sponsor shares and carried interests in a fund both have the “diamond in the rough” characteristic, which make them strong potential candidates for wealth transfer. However, a SPAC structure has more players or stakeholders than a traditional fund structure, all of whom hold different equity interests, and sometimes a combination of different equity interests, which have different levels of appreciation potential.
In a typical fund structure, when focusing on wealth transfer, the analysis has more of a singular focus on trying to transfer the carried interest held within the GP vehicle as the primary asset to transfer. Because of the overly broad rules under Internal Revenue Code Section 2701, however, it’s often by necessity that other interests held by the fund principal, such as limited partner (LP) interests in the underlying fund or funds, and in certain cases, perhaps interests in the management company, will need to be “dragged along” to effectuate transfers by gift and/or sale (at least when relying on the so-called “vertical slice” to achieve the planning).
A Moving Target
SPACs are often structured in a bespoke manner, and the deal struck among the different stakeholders can take different forms and may even morph over time. Increasingly, variations from any kind of the basic structure are becoming less the exception and more the norm. Given the significant number of SPACs that are in the market and the limited period to de-SPAC, SPACs are competing for acquisitions of a limited pool of potential Targets. This competition could mean taking less equity or restructuring equity to include vesting based on stock price hurdles. This can present challenges in attempting to come up with some sort of elegant solution in the way that the vertical slice has, for many advisors, become the most favored approach, albeit far from the only approach, in carried interest wealth transfer structuring. While there are some cousin concepts with which we can start, once we begin to dissect different structures and distill the issues, the comparisons between these cousin structures soon diverge, and it appears that an obvious go-to approach may not necessarily exist in many cases. Thus, when considering SPAC wealth transfer, it’s important to be fluent in the rules typically applied in analyzing a carried interest transfer structure, but realize that applying these rules to SPAC transfers will inherently need to be more tailored and that different issues, triggering events and potential exceptions may be in play. Importantly, advisors must be aware of how seemingly small variations in different structures can result in quite different issues and solutions.
Because the types of interests held by the sponsor and/or family members may vary from deal to deal, and may even change during the course of negotiations between a SPAC and a Target, attempting to apply any kind of conventional carry-like approach can be challenging. Furthermore, as PE funds increasingly invest in SPACs in different capacities—for instance, as an owner of the sponsor vehicle in the Target, in the PIPE and/or in Public A shares—it’s critical when considering wealth transfer approaches with different SPAC interests not to disrupt planning that may have already been implemented for the PE fund principal “up top” at the fund level or is being contemplated going forward.
Perhaps wealth transfer structuring might be done in the same manner as practitioners have become accustomed, using vertical slice holding companies to hold all family owned stakeholder interests. Or perhaps variations on a holding company approach might be considered that split the economics of a holding company into a preferred “frozen” equity interest and a common “growth” equity interest. Perhaps other variations familiar to the carried interest wealth structuring industry, such as derivatives, might be considered.4 However, any such approaches would need to be undertaken in a bespoke manner taking into consideration a careful evaluation of the respective equity interests in the SPAC structure overall, and the advisor should be careful to resist the urge to presume that a vertical slice-type approach will necessarily be effective in a given situation.5
Some Section 2701 Considerations
As a general proposition, potential deemed gift tax issues can arise under Section 2701 when transferring different classes of equity interests to different generations of family members as well as to spouses, their entities and trusts for their benefit. There may be various exceptions providing different safe harbors that avoid triggering Section 2701. Because SPACs involve various equity interests, however, advisors structuring wealth transfer transactions with different types of SPAC assets in which family members are involved should evaluate if and to what extent any Section 2701 issues exist and how to best navigate them. There’s a lot of variation in the way SPACs are being structured and how different types of equity interests by a sponsor and/or family members (and their business entities and trusts) are held. Therefore, any evaluation of a proposed wealth transfer program involving different equity interests in a given SPAC structure will involve a bespoke evaluation of these issues.
We often hear in the carried interest wealth transfer space that Section 2701 wasn’t designed to apply to PE or hedge fund structures; rather, it was intended to prevent what Congress perceived as abuses with pre-1990 family-held discretionary preferred and common equity structures. However, because of the broad language of Section 2701, advisors expressed concern that transfers of carried interest by senior family members while retaining LP interests in a fund could implicate these rules, thus resulting in the type of vertical slice and other approaches to navigate through these issues to avoid unintentional consequences. If these rules were never intended to apply in the context of PE or hedge funds, they most certainly were never designed to capture the type of structures we’re seeing in the SPAC world, where the stakeholders, in addition to family, are a mixture of both public and private investors. Thus, from a policy standpoint, it would seem that
Section 2701 shouldn’t intersect with SPAC wealth transfer. Nonetheless, as in the case with carried interest wealth structuring, it’s important to be mindful of these highly mechanical and broad rules and evaluate any issues and implications that may present themselves in the context of wealth transfer with different stakeholders in a SPAC structure.
While a discussion of Section 2701 and the application of its rules is beyond the scope of this article, and while not intended to be an exhaustive list, what follows are some scenarios in which Section 2701 considerations may present themselves in the context of a SPAC structure. While there are certainly other variations that the advisor will encounter in connection with different individual SPAC structures, the scenarios below illustrate the range of possibilities in SPAC wealth transfer structuring that span from relatively straightforward to quite complex from a Section 2701 standpoint (however, note the valuation uncertainties discussed later in this article). In some cases, a structure may be determined to be relatively “safe”; in others, however, there may be some customization to address these issues. The analysis can quickly become complex as different variations in ownership by family in a SPAC structure evolve, which gives rise to many questions, but not such clear or obvious answers:
- Sponsor shares only. In the most straightforward structure, the Section 2701 analysis would appear to be relatively “clean” (at least from a Section 2701 standpoint). For example, when the only family-owned interests in the SPAC ecosystem consists of one class of equity; those being the sponsor shares that are being transferred and retained by way of transfer of shares in the sponsor vehicle. In such case, arguably either the same class6 exception or, if the warrants associated with the sponsor shares are considered different equity interests than the sponsor shares, then perhaps the vertical slice exception,⁷ would provide a relatively straightforward approach.
- Family ownership of sponsor shares and Public A shares. Suppose an individual sponsor owns an interest in the sponsor vehicle and gifts a 50% interest to a trust for their spouse and kids. However, Class A shares are offered to “friends and family” on the IPO of the SPAC, and the sponsor’s mother-in-law, father-in-law and children purchase Class A shares.
- Is either considered a distribution right for Section 2701 purposes?
- Is the SPAC a controlled entity, noting that a different standard applies for a corporation?
- Do any exceptions apply, such as proportionality⁸ or the marketable securities exception⁹?
- What’s the impact of the grantor or non-grantor status of the trust?
- Is either class senior or junior to the other?
- Are other “tainted” rights, such as extraordinary payment rights, attached to either interest?
- How are the warrants connected with both sponsor shares and Class A shares to be evaluated, and how will they impact the analysis?
- Impact on existing vertical slice planning up-top. PE fund principal (Principal) has previously implemented a vertical slice gifting program of their GP and LP interest in Fund I with a grantor trust for spouse and descendants. Fund I makes an investment in the sponsor vehicle in connection with the launch of a new SPAC. Principal is also a principal in Fund II, for which they haven’t implemented any wealth transfer planning. Fund II invests in the PIPE in connection with the SPAC:
- Will Principal’s ownership by way of a vertical slice of Fund I be impacted as a new
- Section 2701 transfer by virtue of Fund II’s investment in the PIPE in the underlying SPAC, when they also own an interest, by way of Fund I, in the sponsor shares (via the sponsor vehicle) in the SPAC?
- Is the Fund II investment into the PIPE considered a new transfer?
- Is the SPAC a controlled entity, noting that a different standard applies for a corporation?
- Is the interest in the sponsor vehicle investment in the SPAC or the PIPE a distribution right?
- Is the PIPE common or preferred?
- Do any exceptions apply?
- How do the warrants associated with the sponsor shares impact the analysis?
- PE double dip: PE fund owner of Target remaining invested in public shares and/or PIPE. In some instances, the Target may be owned by a PE fund that will sell the Target to the SPAC. However, the fund may still want to remain invested in the SPAC, so perhaps PE Fund II might invest in the Public A shares or in the PIPE. Or, perhaps the PE fund will transfer its shares in the Target in exchange for a combination of cash and Public A shares. Regardless of the variation involved, and there may be numerous ones (similar to the up-top planning), the advisor will likely want to analyze how different streams of equity ownership in the overall SPAC ecosystem, and proposed transfers of interests, may have implications under Section 2701.
- Up-SPAC variation.10Sometimes, a SPAC is structured as a so-called “up-SPAC” structure, which involves the creation of a limited liability company (LLC) that will hold the funds being used to merge with the eventual Target. Unlike in a traditional SPAC structure, however, the Public A shares combined with its associated warrants are owned through units in the corporation (Pubco), which, in turn, owns corresponding interests in the underlying LLC. The sponsor vehicle in the underlying LLC owns the sponsor shares with their associated warrants. The sponsor shares are subordinate to the Public A shares if there’s a liquidation in the event of a failure to de-SPAC. The sponsor vehicle will also own non-economic rights in Pubco. While there are certainly more nuances and variations to this type of structure, from a transfer-tax perspective, the ownership of the sponsor shares in the LLC will give rise to Section 2701 considerations if there are also family ownership interests existing or contemplated in the Public A shares and/or if the PIPE is to be owned by family members. Such a structure likely prompts questions to determine whether and to what extent Section 2701 issues may or may not exist, such as:
- Is the underlying LLC a controlled entity?
- Are there any distribution rights or extraordinary payment rights involved?
- How does the liquidation preference of the Public A shares impact the analysis?
- How are the warrants evaluated?
- Do any exceptions, such as proportionality or marketable securities exceptions, apply, and how would the existence of the LLC impact the analysis?
- Are other interests owned by family members in the structure, such as a PIPE?
- In the case of a PE fund owning interests in the sponsor vehicle or the Public A shares, how would any existing vertical slice or other estate-planning structure potentially impact or be impacted by the analysis?
The collision of the carried interest and SPAC worlds in the context of wealth transfer leads to many questions. The answer to these questions may not be so clear and depends on different variables (for example, retained rights, controlled entity, exceptions, trust and entity attribution rules).
Valuation Considerations
Valuation of the sponsor vehicle. When considering the transfer of interests in the sponsor vehicle, the interests in the Target or perhaps Public A shares, a proper valuation must be obtained to determine the fair market value (FMV), taking into consideration all of the relevant facts known at the time of the transfer. The owner of the interest might be tempted to take the view that the sponsor shares have nominal value if transferred close to, or even as a capital contribution in connection with, the funding of the sponsor vehicle (for example, equivalent to the $25,000 peppercorn investment). The $25,000, however, doesn’t likely represent a negotiated price (and therefore a bona fide sale) and may not align with how FMV must be determined for federal gift tax purposes. In this manner, the valuation question is eerily reminiscent of the issues often encountered in the carried interest space, with echoes of “why isn’t my carry worth zero?” reverberating and now evolving to “why isn’t my sponsor vehicle worth only $25,000?” for gift tax purposes. There have been thoughtful articles written by valuation appraisers on this topic positing that the Internal Revenue Service would likely argue that the sponsor vehicle may have significant value at inception based on a willing seller–willing buyer standard.11
By its very nature, a SPAC is created as a blank check entity whose sole purpose is to raise funds to find a Target with which to merge. Depending on when the estate planning is executed along the SPAC time continuum, there are significant implications on valuation. Estate planning is typically more effective the earlier it’s effectuated. With SPACs, numerous milestones occur between the date of formation and the IPO and between the IPO and the date the merger closes. There are also risks and costs associated with the sponsor. The sponsor vehicle is typically on the hook for a portion of the underwriter fees, frequently funded from the sale of warrants to the sponsor. Typically, 35% to 50% is due at the time of the IPO and is the responsibility of the sponsor vehicle, with the remainder being paid by the merged entity on closing of the acquisition. In addition, the sponsor vehicle often has to put up additional funds for working capital, which is a significant obligation of the sponsor vehicle and has ramifications on its valuation. The appraiser will need to demonstrate what the situation and outlook was on the transfer date given how quickly things can evolve with these interests.
Valuation of an interest in a closely held business is an inherently difficult task in any situation. For an interest in a sponsor vehicle of a SPAC in which a de minimis amount is contributed but that has the very real possibility of blossoming into value of hundreds of millions of dollars in a couple years’ time, what exactly that interest is worth at any given time along the relatively short lifespan of a SPAC is that much more challenging. Anyone tempted to simply make a gift of such an interest on the basis that the interest is worth no more, or not much more, than the initial capitalization of the sponsor vehicle will need to proceed with caution. Reasonable minds will agree that, while certainly the sponsor shares carry great risk, there’s tremendous upside potential. These securities can be likened to deeply out-of-the-money call options in that, while there may be no intrinsic value on formation, there’s time and volatility value. Along the same lines, think of the sponsor shares as the promote or carried interest in the structure, having nominal intrinsic value at formation but having potentially meaningful value on account of its option-like characteristics.
Valuation of the Target. The advisor may at times be working with the owner of a Target that’s being pursued by one or more SPACs to merge, so the owner may want to engage in wealth transfer structuring. Ideally, this would occur as early in the process as possible, while the prospects of a business combination are speculative. This will necessarily involve valuation issues. At its essence, the valuation challenge goes to the fact that the determination of FMV for federal gift tax purposes must take into account all relevant factors in existence at the time of the transaction, based on a hypothetical willing buyer and seller.12
Chief Counsel Advise (CCA) 201939002 provides some insight into how the IRS views pre-merger activity for federal gift tax purposes. The CCAconcerned an anticipated merger of a company listed on an exchange during the time leading up to the contribution of shares into a grantor-retained annuity trust (GRAT). Extensive merger negotiations occurred during the time of the GRAT planning that assumed a higher value per share than trading value. After the funding of the GRAT, the merger did occur, which ultimately raised the trading share value. The IRS concluded that the negotiations must be taken into consideration in valuing the stock (resulting in the IRS’ view that the stock value was different than the traded value). The IRS focused on Treasury Regulations Section 25.2512–1, indicating that: (1) FMV is what a willing buyer and seller would determine, neither being compelled to buy or sell “and both having reasonable knowledge of relevant facts” (emphasis added); (2) there was a presumption that a reasonable investigation would be made into relevant facts; and (3) a hypothetical buyer would ask and receive from a hypothetical seller during negotiations relevant facts, even if those facts weren’t otherwise publicly available. This goes to the general rule that post-transfer events may be considered to the extent relevant to the value as of the transfer date. In the CCA, the IRS indicated that as of the date of the GRAT, the hypothetical willing buyer could have “reasonably foreseen” the anticipated merger and the upward impact on share price.
Given the valuation uncertainty, and the potentially wide valuation range for Target shares and sponsor shares, certain types of valuation adjustment mechanisms might be considered, including GRATs or certain types of formula-adjustment or price-adjustment clauses.
Gifts of Interests in Sponsor Vehicle
A sponsor vehicle is often created to hold the sponsor shares in the SPAC. From a gifting standpoint, making transfers of interests in the sponsor vehicle, perhaps to trusts for the benefit of family members of the sponsor, can provide a relatively streamlined and administratively simple means to effectuate such transfers. However, in light of the evolution and perceived expansion of IRC Section 2036 in the wake of the Estate of Powell v. Commissioner and Estate of Cahill v. Comm’r cases,13 the use of a holding entity, such as a sponsor vehicle, presents issues to consider. The IRS has a history of challenging the funding and subsequent transfer of interests in family limited partnerships (FLPs) under different theories, including the reinvigorated IRC Section 2036(a)(2) argument as a transfer with retained control.
The IRS has generally challenged FLPs, which were formed for much different reasons than a sponsor vehicle in a SPAC. One might think that Section 2036 wouldn’t apply to sponsor vehicles because they’re created for reasons generally having nothing to do with gifting transactions. Nonetheless, in light of the recent expansion of the potential reach of Section 2036, prudence would dictate examining the creation of a sponsor vehicle in which transfers of interests are made. In many situations, the sponsor vehicle may have been created by unrelated sponsors who’ve collectively formed the sponsor vehicle. In such situations, it could be argued that Section 2036(a)(2) shouldn’t apply in light of the fiduciary duties that would exist among the partners of the sponsor vehicle, which should arguably enable them to enjoy the protections from Section 2036(a)(2) provided in United States v. Byrum.14 In such cases, it would appear that the sponsor vehicle should be distinguishable from the types of family vehicles with respect to which the Tax Court in both the Estate of Strangi v. Comm’r and Estate of Powell v. Comm’r cases dismissed the existence of fiduciary duties in the intra-family context as being “illusory.”15
The bona fide sale exception. In the context of creating a sponsor vehicle, Section 2036 doesn’t apply if the sponsor’s initial capital contribution into the vehicle is considered to be a bona fide sale for adequate and full consideration.16 If this exception is satisfied, then, as a technical matter, the retained control issue under Section 2036(a)(2), as well as any implied understanding issues under Section 2036(a)(1), may not be a problem because the application of Section 2036 to the transfer of assets into the entity would appear to be “off the table.” A legitimate and significant non-tax purpose is required to establish that a bona fide sale existed. On this point, while family transactions may satisfy this standard, they’re generally subject to a greater level of scrutiny.17
A sponsor vehicle created for purposes of investing into sponsor shares in a SPAC, which in turn is created for the sole purpose of doing an IPO to raise third-party capital to identify and merge with a Target, would appear to provide a very meaningful distinction from a garden-variety FLP. The determination of whether the bona fide sale exception has been satisfied in connection with the formation and capitalization of an entity is determined on a facts-and-circumstances basis rather than any kind of bright-line test. The creation of a sponsor vehicle in connection with the launching of a SPAC, which by definition is created for the sole purpose of raising capital from public investors by way of an IPO to ultimately consummate a merger, brings to mind Estate of Bongard v. Comm’r.18In Bongard, the Tax Court determined that the decedent’s transfer of shares of a closely held corporation into an LLC holding company was a “bona fide sale for adequate and full consideration,” which satisfied the exception to Section 2036(a). The court determined that the non-tax motivation for transferring closely held stock into an LLC was to position the underlying company to attract potential outside investors to provide liquidity to the company. The Tax Court determined that Section 2036(a) didn’t apply to include the contributed shares in the decedent’s estate.
Indeed, in many cases, it appears that the industry standard for holding the sponsor shares in a SPAC is by way of a sponsor vehicle.19 In many cases, there may be more than one member of a sponsor vehicle, who are often unrelated parties and, in some cases, PE funds. The business reality is that sponsor vehicles are typically created to provide an administratively efficient means for sponsors to own the sponsor shares, rather than any notion about wealth transfer. Indeed, the concept of gifting interests in a SPAC sponsor vehicle is in its infancy and is one that wealth advisors are just beginning to contemplate. As a general matter, owners of sponsor vehicles are unaware of the fact that such assets could be used in connection with wealth-transfer structures. Additionally, the relatively short shelf life of a SPAC, which is designed to exist, at least in its original form, for up to 24 months only before morphing into shares of the merged public company, would appear to make it quite different from a typical FLP. That said, the subject entity to which the bona fide sale exception standard would apply (the sponsor vehicle) would remain intact, even though the underlying assets would evolve with the sponsor vehicle ultimately owning shares in the merged company on de-SPAC.
Thus, while the bona fide sale exception is a facts-and-circumstances determination, it would appear that a good argument may exist in many cases that a sponsor vehicle was created for legitimate and significant, non-tax motivated reasons, consistent with industry standards. Of course, one of the downsides with attempting to rely on the bona fide sale exception is that there’s no way to actually determine with any degree of certainty whether this exception to Section 2036(a) has been satisfied; that is, until the sponsor has passed away and the estate is in the midst of an estate tax audit and is arguing that Section 2036(a) doesn’t apply because of the satisfaction of this exception.
— The views expressed are those of the author and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global Ernst & Young organization.
The author would like to thank Benetta Y. Park of JP Morgan Private Bank for her great insights and feedback on various issues discussed in this article, as well as Todd Povlich of Management Planning Inc., for his thoughtful comments on this article and valuation insights. The author also thanks his colleagues at Ernst & Young, LLP, Todd Stein, partner, David Herzig, partner/principal and Joseph Medina, managing director, for their insights and feedback in connection with various ideas discussed in this article.
Endnotes
1. Sarah Smith, “Celebrity SPAC Merger News: 10 Stars Jumping on the SPAC Bandwagon,” Investorplace (March 5, 2021).
2. Melissa Rowley, “How SPACs are changing the investment landscape for space exploration and beyond,” Forbes (Feb. 9, 2021).
3. See Benetta Y. Park, “An Overview of SPACs: What Are Special Purpose Acquisition Companies and What Are the Planning Opportunities?” ACTEC Annual Meeting—Business Planning Committee (March 3, 2021); Benetta Y. Park, “Hydraulic Spackling: The SPAC capital raising boom, and why Biden’s early stage energy policies are more likely to increase oil imports rather than reduce emissions,” J.P. Morgan (Feb. 8, 2021).
4. David A. Handler, Angelo Tiesi and Anna Salek, “Carry Derivatives: Using your Carried Interest In Your Estate Plan,” Venture Capital Review (2015).
5. For a detailed discussion of the possible application of Internal Revenue Code Section 2701 in the context of estate planning with carried interests, see generally N. Todd Angkatavanich and David A. Stein, “Going Non-Vertical With Fund Interests—Creative Carried Interest Transfer Planning: When The ‘Vertical Slice’ Won’t Cut It,” Trusts & Estates (November 2010).
6. Treasury Regulations Section 25.2701-1(c)(3).
7. Treas. Regs. Section 25.2701-1(c)(4).
8. See supra, note 6.
9. Treas. Regs. Section 25.2701-1(c)(1) and (2).
10. This scenario is based on the example included in Introducing the Up-SPAC Structure, Vinson & Elkins (Oct. 6, 2020), https://media.velaw.com/wp content/uploads/2020/10/07074808/Introducing-the-Up-SPAC-Structure-Vinson-Elkins-October-2020.pdf. Apparently, this structure is sometimes considered to attempt to address compensation issues as well as for basis step-up reasons. I include this scenario, not for purposes of opining on the merits of this type of structure, but to illustrate another type of structure variation with SPACs that may give rise to IRC Section 2701 implications given the creation of different classes of equity interests in an entity.
11. Bryce Geyer, Estate Planning with SPAC Founder Shares (August 2020); Todd Povlich, SPAC Primer for Wealth Advisors (March 2021); Espen Robak, “Planning with SPAC Securities,” Trusts & Estates (March 2021).
12. Revenue Ruling 59-60.
13. See N. Todd Angkatavanich and Justin Ransome,“Cahill, Powell and the Ongoing Evolution of IRC Section 2036(a)(2),” Trusts & Estates (September 2018); See also N. Todd Angkatavanich, James I. Dougherty and Eric Fischer, “Estate of Powell: Stranger than Strangi and Partially Fiction,” Trusts & Estates (September 2017).
14. United States v. Byrum, 408 U.S. 125 (1972).
15. Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, aff’d, 417 F.3d 468 (5th Cir. 2005); Estate of Powell v. Comm’r, 148 T.C. 18 (2017).
16. Thompson v. Comm’r, T.C. Memo. 2002-246 (Sept. 26, 2002), aff’d, 382 F.3d 367 (3d Cir. 2004); Strangi, ibid.
17. Stone v. Comm’r, T.C. Memo. 2003-309 (Nov. 7, 2003); Bongard v. Comm’r, 124 T.C. 95 (2005).
18. Bongard, ibid.
19. See Ramey Lane and Brenda Lenahan, Special Purpose Acquisitions Companies: An Introduction, Vinson & Elkins (July 6, 2018).