De-SPAC Playbook: 8 Considerations for Potential Targets
SPAC investable cash is at record highs and target company valuations remain robust. Yet fewer mergers are getting done. Blame regulatory intervention, increasing inflation, the uneven success of past deals, and an unnerved investor base. For potential SPAC targets, this article provides a playbook to help drive to a more favorable outcome.
There is an old yarn first told to me by my grandmother about why the spider has such a tiny middle. Way back when, Spider welcomed banquet invitations from three neighboring villages, for feasts on the same day but at presumably different times. Spider was never one to miss a free meal. He tied three long pieces of twine around his waist, handed the other end of the ropes to each of his sons, and dispatched them to the different villages — with explicit instructions to give a gentle tug on the ropes at mealtime. He could then make the rounds from one feast to the next. Unfortunately for Spider, the feasts all happened at once. Each son pulled, gently at first and then harder to get their father’s attention. Spider squealed in agony. Pain, without gain.
Of the plethora of companies still waiting to go through the De-SPAC gauntlet, many are reminiscent of Spider. They are pulled and squeezed by competing and potentially misplaced priorities. Each eager to feast on a trifold of promises: a faster path to liquidity, at a higher valuation benchmarked off promised future growth, and tapping into a larger pool of capital (vs. traditional IPOs or private raises). Faster, higher, stronger — or so the Olympic mantra goes. However, if not careful, the target company ends up a skinny shadow of their erstwhile ambitions.
True that the supply of capital appears to be resilient, if not resurgent, in weathering recent blips. Uncertainty regarding accounting treatment of SPAC warrants in Q2 slowed down SPAC IPOs and subsequent De-SPAC mergers. Less-than-ready targets have resulted in weak post-deal performance, consequently increasing shareholder redemptions for subsequent deals. And current inflation concerns have increased the opportunity cost of capital, eroding the potential for tack-on equity private placements (PIPEs).
Yet even as more SPACs are chasing targets and at robust valuations, there are fewer deals getting done and at a slower pace. See Figure 1 below. And those that are done, increasingly perform poorly in the post-market. Deals are now taking longer to announce as Sponsors seek to more fully diligence potential investor concerns before signing. Fewer deals are proceeding to close as parties second-guess the merits of taking less mature companies public.
Amidst the clutter, there remains a coherent playbook for companies looking for a successful liquidity event — one that prioritizes preparation over speed, cash-on-hand over Sponsor cash-in-trust, and driving the process instead of being driven by it. I’ve never met a credible insider advocate for a public exit by any means necessary — some investors might, but there is more often the desire to reach the best deal terms possible and secure a stable currency for sustained future growth. This is what I’ve learned from over a decade as an M&A advisor, and another decade as a corporate executive and CFO at growth-stage companies. As CEOs and CFOs of target companies evaluate a potential SPAC path, and consult with their Boards on overall strategy, here are 8 legs to stand on:
1. Rationale
Before going down this path, decide why a SPAC makes sense for you. For some entities, it might be the desire to raise significantly more cash (than is available to private markets) to accelerate growth. For others, it may provide valuation certainty while maintaining control (vs. an outright sale). And for still others, it is a desire to bring on board a strategic and experienced Sponsor team. Whatever the reasons, if you are clear on the intent — you can design a process that cuts through the noise. More importantly, it may also help identify other avenues for achieving the same objectives or open the aperture into related considerations. For example, if price certainty is the primary objective, CFOs and CEOs need to also focus on considerations (including high SPAC redemptions) that could exert downward pressure on the share price prior the expiration of a potentially more restrictive lockup period (vs. traditional IPOs).
2. Roadmap
There has already been a lot written about process steps leading up to a De-SPAC event, so I won’t dwell here. Be sure to hire great financial and legal advisors to help inform valuation and prospective deal terms, and to navigate the SEC process. While advisors can help, you (as the client) are ultimately responsible for ensuring an integrated process balanced against strategic priorities. A comprehensive timetable, with specified milestone dates and clear lines of accountability, works well as a forcing function. Consistent and recurring engagement between key internal stakeholders and external advisors ensures that misses don’t remain hidden. Simultaneously, good counsel will ensure the company avoids making commitments that it cannot objectively track or progress with a high degree of confidence.
3. Runway
Build up a strong balance sheet prior to commencing any SPAC process. It affords you the opportunity to negotiate from a position of strength and avoid settling for any deal. Have a cash runway of at least 12–18 months. CFOs should push to secure a runway that matches or outlasts that of the liquidation horizon of the Sponsor candidates they are in negotiations with. A healthy cash cushion also mitigates the impact of any subsequent regulatory delay, minimizes distraction along the way, and reduces volatility of Sponsor shares prior to close. Alternatives for raising cash post-SPAC announcement often come at a cost and reinforce the absence of strategic preparation.
4. Suitors
Harnessing the competitive tension amongst multiple suitors is critical and remains viable in the current market. There are almost 2.5x the number of SPACs that have not closed on a deal as there are completed deals for 2021. Don’t grant exclusivity prematurely unless the offer on the table achieves your most important objectives. Far more prudent would be to continue diligence with at least two parties and provide the opportunity for each to “sharpen their pencils” following a brief period of diligence. If only one LOI is received and agreed to, with no basis for comparison, then this will no doubt create an uncertain footing for subsequent negotiations. Boards have a fiduciary obligation to ensure a market check. Furthermore, a robust process, conducted with integrity and discipline, provides the opportunity to contrast different Sponsors for the best fit.
5. Sponsor
The Sponsor is typically selected based on an LOI that is closest to the target’s expectations on valuation and key terms, including governance, minimum cash to close, and any potential changes to the Sponsor promote structure. Granting exclusivity at this point makes sense, providing the Sponsor an opportunity to conduct confirmatory diligence and negotiation of definitive agreements. Targets are simultaneously afforded the opportunity to assess a savvy Sponsor’s ecosystem of potential PIPE investors and strategic partners. As important, the shroud of exclusivity affords the opportunity for the senior management team and the Sponsor to further develop a working relationship and coalesce around a shared vision for the company post-closing.
6. Structure
Definitive agreements should focus on ensuring deal certainty. Done artfully, agreements should secure incremental commitments for mutual benefit. For example, would the Sponsor be open to best efforts in seeking redemption waivers from its major investors, or securing side agreements with investors to seed the PIPE? This limits risks related to high redemptions or a stillborn PIPE. Neither outcome is great for either party. Higher redemptions damage the credibility of the Sponsor. PIPE investments from marquee institutions help secure research coverage and stabilize aftermarket trading. Harder to negotiate, but important if high redemptions are anticipated, is a pro rata reduction in the Sponsor promote (which further aligns interests between the target and Sponsor).
7. Catalyst
How do you clear the muck of endless diligence and negotiation? Every process does benefit from a bit of good news that provides enough of a catalyst to get to signing and to weather the patches between signing and close. As the Sponsor contemplates how to sell the target story to investors, reassuring news of progress ahead of schedule or better than budget further bolsters confidence. This is where your earlier under commitment can shine through in management’s ability overdeliver, and provides some insulation against the inevitable bumps along the way. That said, tread carefully to avoid any potential inadvertent disclosure prior to consummating the deal.
8. Consistency
With definitive agreements done and the S-4 filed, the arduous back-end of a process conducted under public scrutiny could last six months or more before close, and is prone to unforced errors. The S-4/proxy statement will include audited historical and pro forma financial statements as well as related disclosures, and trigger the necessary back-and-forth of the SEC review period and ongoing reporting of interim financials. The scrutiny does not end with the shareholder vote. Maintain that disciplined cadence as the commitment to operational excellence continues beyond close.
Companies usually spend only brief portion of their lifecycle transitioning through to an IPO event and will spend a much longer duration as a public company, bound by SEC reporting obligations. Don’t rush it. Before going public, be ready with a clear rationale, detailed roadmap, and enough of a cash runway to go the distance. Steady your gaze as you engage with multiple suitors, select one that’s a good fit, and secure an ironclad deal. Go forward with a catalyzing wind at your sails, and a consistent post-close performance. I’ve provided comprehensive views to Boards in the past on potential liquidity paths — while every situation is different, my advice has remained consistent. To bend towards Olympian ideals, the mantra for the current environment should hearkens back instead to the schoolyard race — ready, steady, go!
