SEC issues disclosure guidance for SPAC IPOs and business combinations
Guidance signals SEC concern with disclosure of conflicts of interest in connection with SPACs
Capping off a year that saw the proliferation of IPOs and acquisition activity by special purpose acquisition companies (“SPACs”), the U.S. Securities and Exchange Commission (the “SEC”) staff recently issued its first significant disclosure guidance (the “Guidance”) for SPAC IPOs and business combination transactions.
CF Disclosure Guidance: Topic No. 11 (Special Purpose Acquisition Companies) provides a list of questions, focusing predominantly on conflicts of interest, that a SPAC should consider when drafting disclosure in connection with its IPOs and subsequent business combination transaction(s).
A SPAC is a company that raises capital from investors in an IPO for the purpose of identifying and negotiating a transaction to acquire a business after the IPO is completed. They are commonly formed by private equity firms, and rely on teams of managers and directors with various areas of expertise to identify and implement the business combination transaction for the SPAC.
A SPAC is required to file a registration statement with the SEC and prepare a prospectus for its IPO using the customary SEC registration forms. However, because the SPAC does not have an operating business at the time of its IPO, much of the prospectus disclosure tends to be somewhat generic in nature, describing the SPAC governance and capital structure, the reputations of the sponsors and management team and the business combination strategy.
A SPAC generally commits to finding a target and completing the business combination within a certain timeframe. If it is unable to do so, the SPAC’s governing documents usually require the SPAC to liquidate and make a pro rata distribution of the net offering proceeds to its public shareholders.
The business combination transaction will typically involve preparation of a proxy statement or a proxy/registration statement. The narrative disclosure and financial statement requirements, as well as the SEC review process, for the business combination transaction are usually similar to those in a traditional IPO.
The Guidance sets out a series of questions SPACs should consider when drafting disclosure for their IPOs and business combination transactions. The SEC staff’s key concern appears to be about the disclosure of the conflicts of interest of sponsors, directors, officers, their affiliates (together, the “insiders”) and the underwriting banks.
With respect to the IPO, the Guidance directs SPACs to consider whether they have disclosed:
- Insiders’ potential conflicts of interest, such as insiders’ fiduciary or contractual obligations to other entities and the possibility that the SPAC will pursue a target in which an insider has an interest;
- Business combination mechanics, such as the financial incentives of insiders to complete a business combination transaction; their control over its approval; and whether the SPAC may amend its governing instruments to facilitate the completion of a business combination transaction; and
- Securities ownership by insiders, such as insiders’ securities ownership in the SPAC (including the price paid); conflicts of interest that could result from their securities ownership; how the terms and rights of these securities differ from those offered in the IPO; whether the SPAC plans to seek additional funding; how the terms of securities issued or to be issued in private offerings compare to the terms of the IPO securities; and the terms of any forward purchase agreement allowing the purchaser to invest in the SPAC at the time of the business combination, along with the potential dilutive impact on other shareholders.
The Guidance also sets out a series of questions in connection with the business combination transaction, including whether disclosures have been made in the relevant Forms 8-K, proxy and/or registration statement about:
- Additional financing, including whether additional financing is necessary to complete the business transaction; the price and terms; the impact on public shareholders; and whether insiders are participating in the additional financing; and
- The process for identifying the target, including how the target was selected and evaluated; how the amount of consideration was determined; the material factors the board of directors considered in evaluating the transaction; any material conflicts insiders had in presenting the opportunity; and the total percentage ownership interest that insiders may hold in the combined company.
The SEC staff is also concerned with conflicts of interest on the part of underwriting banks. In particular, the Guidance focuses on whether the SPAC has disclosed, in both IPO documents and documents filed after announcement of the business combination, if payments of fees to the underwriter are conditioned on completion of the business combination (as they typically are).
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While the Guidance is not intended to create any new or additional disclosure obligation, it clearly signals the areas of likely SEC staff comment that would need to be resolved before a registration statement is declared effective or a proxy statement is circulated. Consequently, any company considering a SPAC IPO or business combination should pay close attention to the questions raised by the Guidance.
We will continue to monitor developments in this area and welcome any queries you may have.