SPAC IPOs vs Traditional IPOs

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Special Purpose Acquisition Companies ("SPACs") have taken Wall Street by storm this year.  2021 has seen an unprecedented number being used as an alternative route for companies to go public.  In just the first quarter of 2021, a record US$96 billion was raised from 295 newly formed SPACs[1].  As at 20 December 2021, approximately US$162 billion has been raised from 609newly formed SPACs with the average SPAC IPO size being US$266million.

The Cayman Islands and the British Virgin Islands ("BVI") have been popular jurisdictions of choice for the launch of a SPAC owing to the suitability of their respective company laws to SPACs; their flexibility; tax neutrality; market familiarity; and the ability to redomicile to another jurisdiction (such as Delaware) upon a business combination (if required); and straightforward statutory merger regimes which is commonly used as a means of effecting a business combination, i.e. the acquisition or merger with the identified target business.

SPACs are led by an experienced management team, are backed by a sponsor and raise cash in an IPO specifically for the purposes of acquiring, or merging with, a target company in a specific sector or industry.

For US listings, both SPAC IPOs and traditional IPOs engage in an approval process with the United States Securities and Exchange Commission ("SEC").  The major differences between the listing process for a SPAC IPO and a traditional IPO revolve around the securities, the transaction documentation, the length of the process, the amount of disclosure in the offering document and the valuation of the fund offering.  We consider these and other points below.

Securities

In a SPAC IPO, units sold to investors generally comprise a Class A share and a fraction of a warrant to purchase a class A share. These separate securities comprising each unit can trade separately 52 days after the IPO but not before. The Class A shares are not subject to transfer restrictions and investors can choose to either redeem their investment prior to the business combination or continue with the investment after assessing the potential return of the target business.  In contrast, Class B shares are issued to the sponsor and comprise the 'promote' (see below for further details) and typically convert into Class A shares at the time of the business combination on a 1-for-1 basis. The Class B shares include the right to appoint and remove directors of the SPAC prior to the closing of a business combination.

In a traditional IPO, many Cayman Islands / BVI companies listing on a US stock exchange choose to list American Depositary Receipts ("ADRs") rather than making a direct equity listing. Each ADR evidences an ownership interest in American Depositary Shares which, in turn, represent an interest in the shares of the IPO company held by the applicable depository.

Transaction Documentation

The key legal documents applicable to a traditional IPO process from a Cayman Islands / BVI perspective are the listing document, including the prospectus, the amended and restated memorandum and articles of association of the company (the "IPO M&A"), any Cayman Islands / BVI legal opinions required by regulators, exchanges, depositories, registrar and transfer agents, or brokers or underwriters and requisite corporate approvals. In addition, documentation may be required to effect any pre-listing restructuring of the business group for the purposes of the listing.  Applicable underwriting agreements and depository or custody agreements would also be required.

The key legal documents applicable to a SPAC IPO process from a Cayman Islands / BVI perspective are similar.  These include the registration statement (for a listing on a US stock exchange), the amended and restated memorandum and articles of association of the SPAC (the "SPAC IPO M&A"), legal opinions at the time of the public filing regarding, among other things, the validity of the shares being issued in the offering, and those required by each of the underwriters and the registrar and transfer agent and requisite corporate approvals. Material contracts including the underwriting agreement, private and public warrant agreements, investment management trust agreement, transfer agency and registrar services agreement and registration rights agreement would be reviewed at the appropriate stage.

The IPO M&A / SPAC IPO M&A will need to follow a form which meets the requirements of the applicable U.S. stock exchange upon which the company / SPAC is to be listed, as well as the legal requirements of the Cayman Islands / BVI.

Cost and Timing

SPACs can be incorporated and go public in 8-12 weeks whereas an operating company may take anywhere from 6 to 12 months (or more) to go public when including the required preparations during a traditional IPO. The reason for the shorter timeline is that SPACs are not operating companies, thereby avoiding the need for lengthy due diligence, and there is a limited amount of information to disclose in a SPAC's registration statement.  As a result, there are clear cost and time benefits to the sponsor of a SPAC IPO when compared with a traditional IPO.

Acquisition Window

On a SPAC IPO, there is a defined timeframe (typically 18 to 24 months) within which the SPAC must complete the acquisition of a target business.  Further, a SPAC can move quickly to secure an acquisition target and 'de-SPAC' – which is the name given to the acquisition process - relatively quickly due to its large cash reserves held in trust.  If the SPAC fails to acquire a business within this defined timeframe, the SPAC must liquidate and return all funds raised in the SPAC IPO to their investors.

Compensation

SPAC sponsors receive what's known as the "promote", which is usually 20% of the SPAC post-IPO issued share capital. This compensates the sponsors for the risk they take in putting up their at-risk capital to form and operate the SPAC between the time of its IPO and the de-SPAC, but effectively dilutes the public shareholders' ownership of the IPO.

Less Scrutiny

Going through a traditional IPO exposes a company to enormous scrutiny over the months leading up to the IPO and can result in uncertainty around valuation methods up to the pricing of the IPO. SPACs are selling a management team rather than a product and company with an operating history and are, therefore, usually not subject to the same level of examination.

Redemptions and Private investment in public equity ("PIPEs")

The ability of investors in a SPAC IPO to redeem their Class A shares creates uncertainty on the amount of funds available to the SPAC to complete an acquisition and also whether the sponsors can secure additional funds from the PIPE or other investors to complete the acquisition. The availability and costs of such additional funds are highly dependent on the market and economic conditions and it may have a dilutive effect on the shareholding structure of the SPAC.  This issue does not arise in a traditional IPO since investors cannot redeem shares to get their money back from the company.

Underwriting Fee

One of the appealing features of a SPAC is that the underwriting fee for a SPAC IPO tends to be lower, at approximately 5.5 per cent, than the approximate 7 per cent investment banks charge in a traditional IPO.

Looking ahead

While some of the heat has come out of the SPAC IPO market since the beginning of 2021 amid increasing regulatory scrutiny (for example, the tightening of accounting guidance by the SEC) and a "wait-and-see" approach in the market, the main draw to the U.S. SPAC IPO market, namely liquidity and trading volume, is likely set to continue in the medium term.

Of course challenges lie ahead in both camps.  As they go through their initial public offering and subsequent de-SPAC process, SPACs face many regulatory, legal, and business hurdles, including obtaining the appropriate amount and type of insurance.  For traditional IPOs, the choice of listing venue will be an ever more pressing concern taking into consideration the company’s activities and factors like the level of shareholder approval, disclosure and minimum profitability requirements imposed by the rules of a particular listing venue, together with the wider geo-political considerations such as data security and data privacy.

Despite these challenges, opportunities abound for those companies, fund managers and sponsors seeking to raise capital in 2022 using either the traditional IPO or SPAC IPO route, provided they are prepared to navigate and an increasingly complex regulatory landscape in a world where uncertainty is becoming the norm.  Recent developments including the ability to list SPACs on Singapore Exchange's Mainboard since 3 September 2021 and Hong Kong's new listing regime for SPACs which launches on 1 January 2022 will mean participants in Asia will have alternative options to the busy U.S. SPAC market and a better chance of being heard on "home turf".