Special Purpose Acquisition Companies: What Directors Should Know and Why
By Karim Anani and Alex Zuluaga

The use of special purpose acquisition companies (SPACs) has become an increasingly popular route to the public markets, and there appears to be no sign this will slow down. In 2020, SPACs netted record-breaking IPO proceeds of over $50 billion, and the more than 60 completed and announced SPAC mergers dwarfed the 21 and 22 seen in 2018 and 2019, respectively, based on public filings and assumed transaction sizes. If this trend continues, active and filed SPACs could result in more than 200 new public companies worth over $300 billion.

Numbers of this magnitude demonstrate that SPACs have been gaining favor with private companies that want to go public as well as with prospective investors. Private board directors must understand the ins and outs of this strategic option if they’re serving a private company exploring this path. Public directors should be similarly prepared if they’re approached to join the board of a SPAC.

The role of a SPAC

Sometimes referred to as “blank check companies,” SPACs are investment vehicles that raise capital from investors via an IPO to use at a later date in an acquisition of a target that is still undetermined as of the listing. Investors in SPACs are essentially backing sponsors with the belief that they’ll be able to effectively deploy the capital in an attractive asset that will provide a good return.

Functionally, SPACs serve as a temporary cashbox used to identify a merger target and facilitate its access to public markets. Proceeds from a SPAC listing are typically set aside in an escrow account until a target is identified, at which time investors can either approve the transaction or receive their money back plus pro rata interest in the trust account if they participated in the IPO. Sponsors typically have 18 to 24 months to identify a suitable investment.

That defined time frame is one reason why SPACs have attracted interest from a wide range of players, including hedge funds, private equity (PE) and retail investors. Another factor is the typical $10 share price, which avoids the seemingly inevitable IPO “pop” of an undervalued stock. More importantly, players appreciate the ability to generate returns and liquid currency in the form of stock faster than the normal holding period of PE or hedge funds. In addition, PE investors are able to generate gains via founder shares, and retail investors have the chance to invest earlier in companies that previously would have followed the private equity path.

This greater certainty around price and execution appeals to private companies as well. For them, taking the SPAC route offers all the benefits of the public markets with enhanced flexibility and versatility, including access to greater amounts of capital and the ability to offer more cash to existing shareholders.

Companies that become public via this route leverage a SPAC’s ability to include projections of future earnings to help market the deal, a practice that is constrained in the traditional IPO process. Since the SPAC is already a public entity, it avails itself of safe harbor provisions. Upon completion of the merger, the acquired company becomes public.

Board considerations

As SPACs grow in popularity and number, there will be an increasing demand for directors to fill their boards and help develop strategy. Potential directors should understand the goals of the sponsor group and the sponsors’ fund-raising capability.

As they consider joining a SPAC board, potential directors need to gauge their expected level of involvement. For example, some sponsor groups will hold the primary responsibility for selecting potential operating companies to acquire, while others will expect the SPAC board to participate in filtering these targets. This can require frequent communications with the sponsor group to better understand what type of operating company is an appropriate target.

It’s important to remember that a SPAC director’s involvement may be short-lived, as most SPACs have an average shelf life of less than two years. Following a merger with an operating company, the SPAC’s board will be reshuffled, with some directors replaced on the newly combined board. Other scenarios entail working with either a serial SPAC sponsor or an entity that is launching multiple SPACs. A director could sit on the board of each SPAC that launches in the case of a serial sponsor or choose the SPAC that’s the best fit if a sponsor is running multiple SPACs simultaneously.

A final consideration is whether the directors and officers (D&O) insurance being carried is in line with expectations. While insurance amounts have grown significantly over the past year, from around $1 million per deal to over $10 million, that increase is not universal. Directors who are accustomed to a certain level of D&O insurance should make sure they are comfortable with what the SPAC they are considering joining is carrying.

There’s little question that SPACs are here to stay for the foreseeable future. They offer an alternative form of capital that can be structured in many ways to offer liquidity so companies can grow. The past year has been very dynamic, and that pattern is likely to continue over the next several years.

Karim Anani and Alex Zuluaga are Americas Financial Accounting Advisory Services Transactions Leaders and SPAC Co-Leaders at Ernst & Young LLP.

The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.

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