The Capital Structure of a SPAC

EPISODE 68: The capital structure of a Special Purpose Acquisition Company (SPAC) is complex. DHG Valuation Group’s Brian Steen and Tim Smith join this week’s Growthcast to discuss the structure, investment considerations and private investments in public property. Brian and Tim also share what they have seen while working with clients looking to invest in SPACs.



[0:00:09.7] JL: Welcome to today’s edition of DHG’s GrowthCast. I’m your host, John Locke. At DHG, our strength relies on our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser-focused on company goals. In this ever-changing world, DHG’s GrowthCast provides insights and thought-provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace.

Thanks for joining us as we discuss tomorrow's needs today.

[0:00:42.3] ANNOUNCER: The views and concepts expressed by today's panelists are their own and not those of Dixon Hughes Goodman LLP. Always consult the advice of your legal and financial professional before taking any action.


[00:00:57] JL: Our topic today surrounds the acquisition of private companies, through the execution of a SPAC, a Special Purpose Acquisition Companies. Our guests are Brian Steen and Tim Smith, both principals and DHG's Valuation Services Group. Welcome, Tim and Brian.

[00:01:16] BS: Thank you, John. Great to be here.

[00:01:18] JL: All right, let's go ahead and just start at the basic foundational concept here. What is a SPAC? Tim, help us with that.

[00:01:28] TS: Thank you, John. A SPAC is essentially, a publicly traded shell company. It was formed by a sponsor and a sponsor is someone like an asset manager, a hedge fund manager, a private equity group that has built the SPAC with the sole purpose of getting fresh capital to make an acquisition of a private company. The SPAC goes public around $10 a share, and then has a couple of years to find that private company to basically merge with the SPAC to effect what's called a De-SPAC transaction.

When the investor is looking to invest in SPACs, they really need to understand not only the SPAC itself, but who's the sponsor? What's the investment thesis? Are they in tech? Are they industrials? There's a lot more to the SPAC than just, it's a fresh piece of capital and a trust fund waiting to make an acquisition. A sponsor has to drive the value.

[00:02:37] JL: Well, it sounds like this can get pretty complex pretty quickly. Brian, can you help us understand how these are structured?

[00:02:45] BS: Sure. There's an end game of getting an acquisition and a target and then becoming a public company that just like every other public company. What is it in the meantime? The in-between, becoming a SPAC in making a target, you basically have cash and shares and a different capital structure.

The capital structure is simply complex. It's simple in that, it's just equity, and some warrants. Those warrants have various provisions that make them complicated. There's redemption provisions, there's public warrants and private warrants have different provisions, that have been in the public eye recently with some of the SEC comments about how they're classified for accounting purposes. The water, the clearness of getting cash investing in a company has become a little bit muddy a bit and it's caused some challenges for the SPACs, during the SPAC period, and ones that have recently been what's called, De-SPAC, which we'll go in in a minute and to discuss. We've been working with clients to help them through that.

[00:04:05] TS: What I would add to that is that there's an evolution of a SPAC, from IPO to where you've got the cash in the trust fund, and then you go through the transaction. As part of the transaction, not just what Brian said around warrants. You have to think about warrants and units and shares. There's also usually a pipe that's involved in that transaction as well to raise more capital. Things don't get less complex as the evolution of the SPAC goes through De-SPACing, if you will.

[00:04:38] JL: Well, those are a couple of terms, I think we need to unpack even a little further. De-SPACing and PIPE. Tim, tell us really, what is a PIPE?

[00:04:48] TS: A PIPE is a Private Investment in Public Equity. P-I-P-E. PIPE. Private Investment in Public Equity. When a SPAC is formed, it's usually comes up with somewhere between a 100 and 300 million dollars of capital. Actually, just in the past year that the level of capital raised by SPACS has really increased. In the past decade, it's really been a 100 to 3 – I think, it's been 100 to call it, 300 million in capital. Just in 2020, we're over 300 million in average capital raised by a SPAC.

When you think about the SPAC is going to invest in a billion-dollar company, 300 million dollars, I'm going to do it. They have to get more capital. They get it through debt and they get it through a PIPE. A PIPE is a transaction that's been around for many – for at least two decades, if not more, where there's a private – there's public equity out there; it’s a SPAC equity, and there's another equity sponsor that comes in and buys a big block of that public equity in a private transaction.

This is a critical piece to De-SPACing. De-SPACing is when the SPAC which is, essentially a trust fund of cash, actually buys the private company. In order to buy the private company, it's got the cash in a trust fund, and he's got some cash from a PIPE, and it probably gets some debt as well. The De-SPAC transaction has its own complexities as well. As a capital holder in a SPAC, these are all things that that you have to have going through your mind to understand if you're going to be a capital holder before De-SPACing, or after De-SPACing. Because these are the pieces of your capital structure that you're investing into.

[00:06:40] JL: What does this really matter to the capital holders?

[00:06:45] TS: Well, from a capital holder perspective, what I would say, and Brian brought this up. Warrants are a big deal, because the disclosures can be fuzzy and the SEC is just getting into wanting more disclosure. Understanding what the callback on those warrants are, or what the strike price on those warrants are, is very, very important in understanding the capital structure of the SPAC and how things are going to move forward as the price, as the stock price of that SPAC continues to be volatile.

[00:07:22] JL: Brian, I know you mentioned earlier, when you were talking about the capital structure, you shared the fact that warrants and units, all of these really needed to be considered. Help us understand the various securities in the capital structure.

[00:07:39] BS: Sure. Tim has mentioned, it is important to capital holders. Some of our clients which are CFOs for SPACs, or for the companies that are targets, it can be somewhat of a headache, for lack of a better word, dealing with some of these – in the complexities of these capital structures.

From what we've seen, like I indicated earlier, the pain has been in the public eye from SEC perspective, has been the warrants and the valuation of the warrants. To help understand that a little bit, basically, previously, they were recording these for accounting purposes as equity instruments, rather than liability instruments, which basically, equity instruments, you book them when they were granted, and you did – set it and forget it, if you will, from an accounting perspective.

The SEC has come out and said, these need to be classified as liability awards, or liability treatment from an accounting perspective. That means you have to value them. That means, every restriction, every redemption provision, whether they're public versus private, as far as warrants go, all have valuation issues that you have to deal with. Dealing with those are very complicated. It's something that everyone in the valuation and accounting world that deals with SPACs is dealing with right now.

They're having to restate financials. Going back to, in some cases, even if they're De-SPACed, so to speak, that before when they were just a SPAC holding cash and equity and warrants. Then, if you move to the after the De-SPACing period, the target shareholders may get restricted shares that are restricted for six months to a year. As Tim mentioned, the PIPE, investors may get a discount on the shares that they invest in. All those have those valuation and considerations in the transaction that have to be dealt with, either from an accounting perspective, or as an investor to understand what it means for their investment.

[00:10:08] TS: I might add to that. When you think about the things that Brian just talked about, liability versus equity reporting, that has an effect on your income statement. When you think about the idea that Brian just said, that you have to go back and restate your financial statements, that could have an impact on being a timely filer, which as an investor, that brings up a red flag.

Even more than that, if you're not a timely filer, you can't file – You can use short-form filing status, which may truncate your timeframe to be reactive to the next M&A deal. Then you start losing deals. Especially when we think about how hot the markets are right now. The M&A markets right now are very hot. Timeliness in terms of execution of transaction is a critical piece of value creation.

There are some unexpected consequences of these accounting complexities that are just started – we’re just starting to scratch the surface on these. The interesting thing, and Brian probably can comment on this a little bit more. The interesting thing is, we've seen these warrant securities, they're very much the same across different SPACs. I mean, Brian, you've seen a number of these. Tell us a little bit more about that, because that's one of the interesting things I thought when we started looking at these things.

[00:11:47] BS: Sure. I can't say that every agreement is exactly the same, but there are very common, that there must have a certain provision that allows the SPAC to redeem the shares, once it hits a certain price target. A common number, the SPACs usually are about a $10 a share, or per unit. They have a retention provision at $18 a share, or $19 a share. That's very common across a number of the agreements we've seen so far. Some have provisions lower than that, that have a more complex average retention, but it's more complex than that.

Then, in talking to some of our valuation – other valuation firms, they've seen where they have actually make whole provisions in the agreement. There's a lot of complexity in – the Warren agreements that are beneath the surface, and they're different for what's called public warrants, which are publicly traded and private warrants, which are given to sponsors that are not – and others, that are not publicly traded.

Yeah, from my perspective as a valuation person, those present theoretical valuation issues. From actual investor, it does impact, have a direct or indirect impact on the actual unit holders that are none-warrant holders. It does have an impact on multiple parties to the transaction.

[00:13:32] JL: Tim, I think you mentioned just a few minutes ago about the challenges relating to financial reporting. Can you share with our audience, just some of your thoughts on these challenges for the SPAC and the acquisition target going through the De-SPAC transaction, I guess?

[00:13:52] TS: Absolutely. Actually, you bring something up that we've talked a lot about the SPAC and financial reporting for the SPAC and during the De-SPAC transaction. There's also another entire line of work that goes around with the target. I mean, we're talking about a private company that's actually going to become public. The level of governance and financial reporting in most private companies is not ready to be a public company, because of the level of financial reporting has to go around filing your case in queues and everything else.

The financial reporting at the SPAC level is hard, and can have these problems that we talked about. The financial reporting at a target company that's going to be – going to be merged into a SPAC, to the De-SPAC transaction also has to be looked at. We see it from a valuation standpoint, there's actually different elections for private companies around financial reporting, that if that private company has chosen those elections, that company is going to retrospectively back and restate their financial statements as if they were a public company.

The work effort and the amount of diligence that a private company has to go through in order to get itself ready to get involved in a SPAC transaction is very high as well. We've had a number of clients that have needed that help, both from a valuation standpoint, but from just a corporate governance standpoint, where we have an outsourced team of professionals helping them put together the right level of corporate governance that will stand up to public company scrutiny, and get that company into a place where it can be public and it can thrive in that new regulatory world of being a public company.

What I would say is that there are challenges, just like in an IPO. Because this is what this is. This is taking a private company and making it public. It's just a different way to do it. Instead of paying the underwriter, you're paying the sponsor. I'm not sure the fees are that terribly different. Maybe it'll change as the SPACs get more and more prevalent, you get more competition. From just looking at grass roots, there's a lot of work to do. The complexities of the SPAC are new to the market. SPACs have been around for a while, but this level of SPACs are new to a lot of people. Getting it right is definitely a heavy lift on both sides of the transaction.

[00:16:40] JL: Yup. I think, one of the focuses that we've always tried to take here in our GrowthCast is giving people really new ideas and presenting new challenges to help them grow. You've got the private group and you've got the target group. This is really a different approach. There might be some different risks that are associated with this. As we wrap up here today, I guess, my question for both of you is, what should really both the target and the investor group be looking at to really ensure a high percentage outcome for this endeavor? Because it's all about growth for both parties, right? What can they do to make sure that this is successful, moving forward?

[00:17:30] BS: Basically, for the target, or the company that wants to enter a SPAC, or get bought by a SPAC, or go public, because sometimes they are looking at an IPO versus going to a SPAC transaction. Basically, they need to grow up early, as early as possible, so to speak, as far as their financial reporting, how they handle valuation issues, how they handle their just accounting and getting maybe a higher level of audit, or just doing the things that they need to do to prepare themselves to be private. Because once they get into this realm, the scrutiny as Tim mentioned, is higher. The standards are higher. They do not want to be delayed and impacted; their prospects impacted for going IPO, or through a SPAC, because they not do their homework and do the work right.

The old Pennywise and pound foolish comes to play here, because you can try to do things cheaply. It can hurt you in the end, because you're not ready. Yet, you can actually lose an opportunity, because if a SPAC is looking at you and your records are not in order and you haven't done things properly in the past, they could move to the next target. That could be a negative and it could dry things. The sooner you can start that process, the better.

[00:19:13] JL: Tim, I think what I've understood about this, is this process usually moves pretty quickly. Brian's comments about really having your act together and preparing are very sound of, is there risk in moving too quick through the SPAC process?

[00:19:32] BS: There's risk in every corporate finance transaction process. I'm going to take this in a different direction. The key here is the players that are going through the process; having the right management at the target company, having the right sponsor at the SPAC, doing a process and having the right advisors to get you through that process. Every process takes time. Some of them can be accelerated and in SPACs, a lot of times they are. In all investing, whether I think of institutional investing, personal investing, it's about the character of your management and the character of your advisors.

From my perspective, the risk mitigant in all of these transactions is who's the sponsor in the SPAC? How much experience do they have? Have they done this before? Do they understand what they're doing? Who's the management of your target company? You're basically investing your target company. You're investing in a management team. How good is that management team and how good are the people surrounding them? Which is the advisors they're using to get through this complicated process.

If you have the right people at the table, you're able to mitigate risk and you can do it effectively in a timely manner and make it happen. That also leads to a company that is primed and ready to take in that new equity, to take in that new public equity and take off from a growth perspective and really put that equity to grow, into growth initiatives and become a much bigger company and a much more impactful company, hopefully not only from a profit perspective, but from a social perspective as well.

[00:21:20] JL: Wow. Great advice. Brian, Tim, thank you so much for sharing this time with us and just your insights on the SPAC and what's involved in this very valuable information. Appreciate you both today.

[00:21:34] BS: Hey, thanks. Good to see you, John.

[00:21:36] TS: Yeah, thank you.

End of Interview

[00:21:39] JL: Thank you for joining us today on GrowthCast, with Brian Steen and Tim Smith, Principals of DHG’s Valuation Services Group. We hope that you now have a better understanding of the benefits of a SPAC strategy when acquiring a private company.

I'm your host, John Locke, and I look forward to reconnecting with you soon on another episode of DHG GrowthCast. Until then, be sure to rate, review and subscribe to DHG GrowthCast on Apple Podcast, Spotify, or Podbean.

End of Episode
About DHG's GrowthCast

At DHG, our strength lies in our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser focused on company goals. In this ever-changing world, DHG’s Growthcast, provides insights and thought -provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace. Join us in discussing tomorrow’s needs today.

Disclaimer: The views and concepts expressed by today’s guests are their own and not those of Dixon Hughes Goodman LLP. Always consult with your legal and financial professional before taking any action.


Brian Steen
Principal, DHG Valuation Services


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