SPACs in Canada: A New Participant in the M&A Market
Should special purpose acquisition corporations be part of your strategy?
By Kristina Vranjkovic
Associate, Stikeman Elliot LLP
When the TSX adopted new rule changes in 2008, it permitted special purpose acquisition corporations (or SPACs), which had existed in various forms in U.S. since the 1990s. While the first SPAC wasn’t listed until 2015, five others soon followed, with total capital raised standing at over $1 billion. SPACs represent a potentially significant new asset class in the Canadian marketplace.
What are SPACs?
A SPAC is a publicly-traded shell company whose primary purpose is to identify and acquire a business or businesses using the proceeds of its own initial public offering (IPO). Here’s a look at the timeline of a SPAC:
From Initial Investment to IPO:
A SPAC begins life with an initial equity investment from its sponsor and/or certain directors and officers, simultaneously with its IPO. Those funds are typically used to pay for ordinary public company expenses and to fund the IPO costs. During the IPO, the SPAC seeks the majority of its capital from public investors (by way of issuance of units consisting of common shares and warrants). The SPAC is then required to escrow at least 90 per cent of its IPO proceeds (market practice to date is 100 per cent), and such escrowed funds, which are typically invested in short-term Canadian government securities with a maturity of 180 days or less, may be used for the following purposes only:
- to satisfy permitted shareholder redemptions
- to pay taxes and certain permitted expenses
- to pay deferred underwriting fees (which are only payable at the closing of a qualifying acquisition)
- to fund the closing of a qualifying acquisition
This 90 per cent escrow requirement, which is typically backstopped by the SPAC’s sponsor and other founders, effectively assures shareholders of at least the return of an amount approximately equal to their original investment (plus interest and less any expenses and potential tax leakage), with the potential of further upside on their equity participation if a qualifying acquisition is completed.
Once the IPO has closed and the SPAC has listed its securities on the TSX, it has a statutory timeline of 36 months to complete its “qualifying acquisition”—otherwise, it will be liquidated and forced to redeem its publicly traded shares in exchange for a pro rata portion of the escrowed funds. Market practice, however, has settled on a shorter timeline—typically 21 to 24 months—with the possibility to extend, subject to board, shareholder and TSX approval. Prior to proceeding with its qualifying acquisition, a SPAC must obtain approval of a majority of its directors unrelated to the transaction and a majority of its shareholders at a duly called meeting. Regardless of whether they vote for or against, or do not vote on, the qualifying acquisition, public shareholders can then elect to redeem their public shares, subject to certain limitations, for their pro rata portion of the escrowed funds, minus certain taxes and specified minor expenses. Depending on the structure of a qualifying acquisition, additional shareholder approvals or other approvals may be required.
SPACs are a way for investors to invest—free of private equity fund management fees—in similar kinds of companies and sectors that PE funds target, but without the same diversification. A common consideration of an investor may be determining which SPAC to invest in, given that at the time of the initial investment there is no way to identify the specific businesses in which the SPAC will ultimately invest (or if there will actually be an acquisition at all).
To date, Canadian SPACs have been marketed mainly on the strength of their management teams and sponsors, who have included some of the most distinguished business leaders in Canada. Immediately prior to the time of the shareholders’ meeting to vote on the proposed qualifying acquisition (and once the target company or companies have already been selected), an investor can then elect to redeem its shares (while retaining its warrants), thereby affording it the opportunity, based on comprehensive public disclosure provided by the SPAC, to decide to take back its initial investment or continue investing in the resulting issuer.
The fact that investors may choose to redeem their shares if they do not wish to participate in the qualifying acquisition provides some degree of comfort given that the underlying business is not known at the time of the IPO.
From the perspective of a typical target, a SPAC acquisition offers a number of attractive features that may make it preferable to a traditional IPO:
- A SPAC will have capital readily available, so sellers may receive more cash and fewer shares than in a traditional IPO (depending on the level of shareholder redemptions).
- The target will effectively become public as soon as the qualifying acquisition is completed, while a traditional IPO is contingent on the underwriters’ ability to complete the offering as well as being subject to general market conditions.
- A SPAC can complete its qualifying acquisition using its cash, debt or equity securities, or a combination thereof, thereby providing it with the flexibility to tailor the consideration to be paid to the target business.
- Given its fixed timeline as well as the restrictions imposed on its escrowed funds, the SPAC will be highly motivated to complete a qualifying acquisition, especially throughout the negotiation and at the exclusivity stage.
On the negative side of the ledger, there is some uncertainty in dealing with a SPAC given that, if an excessive number of public shareholders elect to redeem their shares, the SPAC may be unable to meet a potential closing condition of having a minimum net worth or a minimum amount of cash to complete the transaction. Generally, SPACs are likely to look for businesses that have a value that is more than double their IPO value.
Future of SPACs
Our firm, Stikeman Elliott LLP, has had the distinct privilege of acting as legal counsel in all six Canadian SPAC offerings to date, and designing the SPAC structure in Canada.
As of July 2016, each of Canada’s six listed SPACs was still in the process of seeking to source and negotiate its qualifying acquisition. Investors and market participants alike anxiously await the announcement and completion of these transactions, in part because the long-term success of SPACs will inevitably be influenced by the ability of these early entrants to complete their qualifying acquisitions (and will ultimately be measured against the long-term trajectories of the businesses they acquire).
The state of the market at present is one of anticipation, with new SPAC IPOs less likely to emerge until the existing SPACs begin to announce and complete their qualifying acquisitions. If the success rate of these pioneering SPACs is high, investors are likely to see increased and sustained activity in the Canadian SPAC market.
Editor’s Note: Stay tuned to the CVCA blog for updates on the status of SPACs mentioned in this article.
*Kristina Vranjkovic is an Associate in the Toronto office of Stikeman Elliott LLP, whose practice focuses on securities, banking, mergers and acquisitions, as well as general corporate and commercial law. Stikeman Elliott LLP is recognized internationally for the sophistication of its business law practice. The firm is a Canadian leader in each of its core practice areas – private equity, M&A, corporate finance, banking, corporate-commercial, real estate, tax, insolvency, structured finance, competition, and business litigation.