In the last couple of years, special purpose acquisition companies (SPACs) have become a viable listing alternative in the U.S. for traditional initial public offerings as a result of the changes in market environment and shifts in investor appetite. The Singapore Stock Exchange (SGX) has also announced new rules that enable SPAC to list on its mainboard which became effective on 3 September 2021.
This article provides an overview of the SPAC structure and its key features in the U.S. and Singapore, the benefits and disadvantages of SPAC listing, the latest consultation published by The Stock Exchange of Hong Kong Limited (HKEX) on 17 September 2021 regarding a proposed SPAC listing regime and what this means for the Hong Kong capital market.
What are SPACs?
A SPAC is a blank check company with no existing commercial operations "created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe". The target business(es) is unidentified at the time of the initial public offering (IPO). Prior to the consummation of business combination, or "de-SPAC" transaction, the proceeds of IPO are placed in an interest-bearing trust account. The uses of proceeds are limited to certain purposes, mainly for the acquisition and operation of the target business(es), as well as shareholder redemption in connection with the business combination or liquidation. A SPAC is typically required to complete the business combination through merger, share exchange, asset acquisition, share purchase, reorganisation or similar business combination within a specified time period upon its IPO, although such timeframe is extendable by way of shareholders' approval. If a SPAC fails to acquire the target business(es) within the specified timeframe, it must liquidate and refund the IPO proceeds raised to the public shareholders.
Features of SPACs
The following highlights the key features to note in a SPAC listing in the U.S. and Singapore, including:
The size of the target business(es) for the purpose of the de-SPAC transaction shall have an aggregate fair market value no less than 80% of the amount held in the trust account at the time of the signing of the de-SPAC agreement. Once the sponsors identify the target business(es), the SPAC is required to obtain shareholders' approval to complete the proposed business combination. The shareholders may elect to continue their investments or redeem their shares based on their assessment on the profitability and potential return of the potential acquisition. Under the U.S. regime, the minimum market capitalisation of a SPAC to be listed on the New York Stock Exchange (NYSE) or NASDAQ is between US$50 million and US$100 million; while under the Singapore regime, the minimum market capitalisation of a SPAC is S$150 million.
The business combination is usually structured as a "cash-out" or "reverse IPO" transaction, or the combination of both. In a "cash-out" transaction, existing owners of the target business(es) receive significant cash consideration in exchange of their equity holdings. In a "reverse IPO" deal, the target business(es) effectively gains public listing status through merging with the SPAC and the existing owners of the target business(es) exchange their shares in the target business(es) for the shares in the SPAC.
A SPAC issues public units to public shareholders, which comprises one share of common stock and a whole or fractional warrant. The warrant holders are entitled to acquire public shares at the strike price in the future. Following the IPO, the units, shares and warrants are listed separately on the securities exchange and can be traded separately. Public shares and promote shares have similar voting rights but warrant holders are not entitled to voting rights. The public shareholders have the right to vote in favour of or against the business combination proposal. In the event that the public shareholders intend to exit before the business combination, they are entitled to dispose their units in the market or redeem their shares on a pro-rata basis. This flexibility allows investors to mitigate their investment risk if they do not have sufficient confidence in the target business(es) proposed by the sponsors.
The sponsors' shares are non-redeemable and subject to certain lock-up arrangements upon completion of the business combination. Under the U.S. regime, the lock-up period is 12 months upon completion of the de-SPAC transaction and early termination is possible if the trading prices of the shares exceed a pre-determined price for a number of consecutive trading days after the closing of de-SPAC transaction. Under the Singapore regime, the lock-up period is at least six months and up to 12 months upon completion of the de-SPAC transaction. The purpose of the lock-up arrangement is to ensure alignment of interests between the sponsors and the public shareholders. In most circumstances, the sponsors' shares automatically convert into ordinary public shares after certain period following the completion of the de-SPAC transaction.
Private investment in public equity
As the redemption by the shareholders during the de-SPAC process may deplete the funds in the trust account, the SPAC may need to raise additional capital through various vehicles to complete the business combination or pay for the operating expenses. Private investment in public equity ("PIPE") is one of the most popular fund-raising means. PIPE financing allows the SPAC to raise additional capital for the de-SPAC transaction as well as working capital for the post-merger company. Also, it signals to potential future public investors that the PIPE investors are confident in the potential return of the post-merger company.
Advantages and disadvantages of SPAC listing
Advantages of SPAC listing
1. Time and cost efficiency
SPAC listing is more time and cost efficient than traditional IPOs as the SPAC has no commercial operation at the time of listing. It follows that the financial statements of the SPAC are shorter and less complicated given there is no historical financial results or substantive assets to be disclosed. The process of SPAC listing is more streamlined where a SPAC can be listed in six months compared with 12-24 months for a traditional IPO. Also, a SPAC usually receives fewer and less challenging comments from the authorities regarding the listing. However, one point to note is the de-SPAC transaction entails negotiation of a merger and acquisition agreement where shareholders' approval is required and the process could be time consuming.
2. Greater flexibility for investors
The unique structure of the SPAC allows the investors to enjoy greater flexibility. During the de-SPAC process, the 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(es). Since the units, shares and warrants are traded separately in the market, the shareholders can retain the warrants even if they elect to redeem the shares.
3. Price certainty and flexible deal terms
Business owners of the target business(es) can benefit from the price certainty and flexible deal terms by merging with the SPAC. As the negotiation of the de-SPAC transaction takes place between the sponsors and the business owners of the target business(es), the valuation is based on the direct communication prior to the business combination compared to traditional IPOs where underwriters set a price range and valuation is derived from roadshow meetings with potential investors and investment banks. The de-SPAC transaction allows sponsors and the business owners of the target business(es) to negotiate and determine the value of the target business(es) at an early stage. As such, the upfront determination of pricing protects the SPAC from last-minute price fluctuation and thus minimises market volatility risks. Also, the business owners of the target business(es) can bargain for more flexible deal terms in order to retain a stake in the business while gaining access to a greater pool of public capital.
Disadvantages of SPAC listing
1. Uncertainty on the quality of the target company
As a SPAC is subject to less rigorous regulatory requirements during the IPO stage, it may result in a higher chance of misinformation or even fraud. In a traditional IPO, a listing applicant is required to provide in-depth information such as financial statements, potential risks and historical business performance of the listing applicant. However, there is no such information disclosure by a SPAC as it does not have commercial operation at the time of listing. Also, the faster and simpler route to listing for SPACs may incentivise companies that have not reached market standards and quality to take advantage of this quick access to public funding by circumventing the stringent approval process normally required in a traditional IPO. This issue is coupled with the time pressure faced by the sponsors to complete the acquisition within specified timeframe. The sponsors may be financially motivated to proceed with the business combination regardless of the quality of the target business(es) as they are entitled to stake in the SPAC with a minimal investment upon the de-SPAC transaction. This potential misalignment of interests between the sponsors and the shareholders, as well as the uncertainty on the quality of the target business(es) raise concern on the influx of poorly managed or operated companies merging with the SPACs.
2. Problems associated with disclosure
As the SPAC is a blank check company with no operating history and financial record, the disclosure in the IPO stage is relatively simple and generic in nature, as compared to the complete and accurate disclosure in all material aspects of the company in a traditional IPO. The disclosure on the investment strategy of the SPAC is more general than that of the traditional IPOs where the SPAC only discloses the industry, sector and geographic area that it intends to operate in. Since the SPAC has yet to identify a specific target business at the time of listing, investors are not able to make full assessment on their investment as they are restricted by the limited information and broadly defined acquisition strategy and criteria. After the SPAC has identified a target business, substantive disclosure on the business operation, market growth and financial statements of the target business is required. Sponsors are required to conduct due diligence by applying a standard which is as stringent as the one in traditional IPO and the process may be time consuming and costly.
3. Inherent risks associated with the redemption feature
The redemption feature of the SPAC 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 highly depend on the market and economic conditions and it may have a dilution effect on the shareholding structure of the SPAC. As the sponsors may need to renegotiate the deal terms regarding the merger and acquisition agreement after the redemption, the business owners of the target business(es) may lose certain degree of control to the PIPE investors as it is usual for the PIPE investors to request significant representation in the SPAC. The renegotiation process may take considerable time and thus hinder the process of the de-SPAC transaction. Furthermore, there is concern on the liquidity of the combined company after the de-SPAC transaction due to the lack of underwriting by the investment banks as compared to traditional IPOs.
Latest developments in Hong Kong
Hong Kong is currently adopting a robust disclosure-based listing regime where the HKEX requires accurate and complete disclosure in all material respect of a listing applicant before listing. On 17 September 2021, the HKEX published a consultation paper seeking market feedback on proposals to create a listing regime for SPAC in Hong Kong (SPAC Proposal). Key points of the SPAC Proposal are as follows:-
The subscription for and trading of a SPAC's shares would be restricted to professional investors only. A SPAC shall distribute each of its SPAC shares and SPAC warrants to a minimum of 75 professional investors, of which 30 must be institutional professional investors. This restriction would not apply to the trading of the shares of the listed issuer following the completion of a de-SPAC transaction (Successor Company).
Similar to the sponsor role of a SPAC transaction in the U.S., SPAC promoter (SPAC Promoter) is professional manager, usually with private equity, corporate finance and/or industry experience, who establishs and manages a SPAC. SPAC Promoter shall meet suitability and eligibility requirements. Particularly, a SPAC must have at least one SPAC Promoter, which is a firm licensed by the Securities and Futures Commission (SFC) for Type 6 (advising on corporate finance) and/or Type 9 (asset management) regulated activities and holds at least 10% of the promoter shares.
Promoter shares are proposed to be capped at 20% of the SPAC's total number of all shares in issue at the SPAC IPO, with further issuances of additional promoter shares up to 10% ; and a 30% cap on dilution from the exercise of all warrants is also proposed.
Fund raising size
For the SPAC IPO, the gross proceeds expected to be raised must be at least HK$1 billion.
Application of new listing requirements
A Successor Company must meet all new listing requirements under the Listing Rules, such as minimum market capitalisation requirements and financial eligibility tests. In addition, at least one independent sponsor shall be appointed for the de-SPAC transaction.
Independent third party investment
Independent PIPE would be mandatory and must constitute at least 15% to 25% of the expected market capitalisation of the Successor Company, validating the valuation of the Successor Company.
Shareholders' approval for de-SPAC transaction
A de-SPAC transaction must be approved by SPAC shareholders at a general meeting, which would exclude the SPAC Promoter and other shareholders with a material interest in the de-SPAC transaction.
SPAC shareholders must be given the option to redeem their shares prior to (i) a de-SPAC transaction, (ii) a change in SPAC Promoter; and (iii) any extension to the deadline for finding a suitable target business for de-SPAC transaction. Shareholders who elect to redeem should receive a pro rata amount of 100% of the funds raised by the SPAC IPO, at the price at which such shares were issued, plus accrued interests.
Public float requirement
The Successor Company must maintain a public float of 25% and at least 100 shareholders.
Return of funds to shareholders
If a SPAC is unable to announce a de-SPAC transaction within 24 months of its IPO, or complete such transaction within 36 months of its IPO, the SPAC must liquidate and return 100% of the funds it raised plus accrued interest to its shareholders. The HKEX will then de-list the SPAC.
What the SPAC Proposal means for the Hong Kong capital market
Compared to the U.S. and Singapore regime, the criteria for a SPAC listing under the SPAC Proposal were considered to have put much emphasis on safeguarding the interests of the public investors, including:
- the proposals where retail investors will only be able to trade the SPAC's shares after completion of the de-SPAC transaction, and only allowing professional investors who have at least HK$8 million in assets and investment experience to trade SPAC's shares before the de-SPAC transaction;
- each SPAC must have at least one SPAC Promoter which is a SFC licensed firm;
- mandatory independent PIPE investors,
- no redemption right if the relevant shareholder voted for the de-SPAC transaction at the general meeting; and
- the appointment of sponsor for the de-SPAC transaction and the associated procedural and substantive requirements under the Hong Kong IPO sponsor regime.
Under the SPAC Proposal, a SPAC must raise at least HK$1 billion and the target business will need a minimum market capitalisation of HK$500 million. By comparison, SGX set a minimum market capitalisation of S$150 million; while the NASDAQ and NYSE require a minimum market capitalisation between US$50 million and US$100 million depending on the stock exchange and its boards.
While Hong Kong has been the world's biggest IPO market seven times in the past 12 years, adding SPACs to the Hong Kong capital market would be valuable and worthwhile as the SPAC listing has its advantages of providing an alternative listing method for issuers and reducing book building time seen in the traditional IPO process. However, SPAC IPOs in Hong Kong are not expected to replace the traditional regime of listing. The HKEX is seeking market feedback on the SPAC Proposal and the consultation will end on 31 October 2021.