SPAC Market Overview
SPAC IPOs have surged in 2020, with 170 offerings raising $63 billion in just the first ten months of the year compared to 59 and $13.6 billion in all of 2019. At the same time, the interest of new market participants in SPAC transactions (either sponsoring a SPAC or merging with a SPAC for a liquidity or financing transaction) has increased. These developments have deepened and widened the SPAC landscape, leading new sponsors, investors, and advisors to enter the space. Variations on certain terms have arisen to meet SPAC, founder, investing public, or target objectives. For example, a number of recent SPACs have deviated from the typical formulation to be more public or target friendly (through the use of earn-outs, contingent equity, out-of-the-money warrants, or the like), and some SPACs have included tontine warrant structures to provide additional incentives for SPAC public investors not to redeem their shares in connection with a de-SPAC.
In contrast to the increasing variation in commercial terms in the SPAC market and regular evolution in other IPO contexts, the typical SPAC corporate structure has been relatively static. Prior to the IPO of Rice Acquisition Corp., discussed below, all SPACs were essentially formed as simple corporate IPOs, where investors and founders all invested in a single, corporate IPO vehicle.
Recognizing the potential benefit of alternative corporate structures, Vinson & Elkins LLP (“V&E”) has considered alternative structures that may provide incremental benefits to a SPAC at IPO and/or de-SPAC, including the “Up-SPAC”—a combination of the traditional SPAC with an Up-C structure at IPO. The Up-SPAC structure should feel very familiar to capital markets participants, with only slight deviations from the well-known SPAC and Up-C structures. Combining these well-tested structures in the SPAC context can create substantial tax benefits with little or no downside.
Up-SPAC as a Structural Evolution
The Up-SPAC is designed to provide added value by structuring the SPAC as an Up-C at the time of the SPAC IPO. The Up-C is a proven solution in regular IPOs for creating shareholder value that is well-known to investors. In the Up-SPAC structure, the SPAC is structured as two entities at IPO: (1) a SPAC “Pubco” classified as a corporation for tax purposes, which is the issuer of Class A shares to the public, and (2) an LLC “Opco” classified as a partnership for tax purposes, which is partially owned by the Pubco and partially owned by the SPAC founders. The Up-SPAC’s economics are essentially identical to those of a traditional SPAC at IPO. Each unit issued in the IPO consists of one share of common stock of the Pubco and a whole or fractional redeemable warrant, with each whole warrant entitling the holder to purchase one share of common stock in the Pubco.
The primary structural difference of the Up-SPAC is that the founder equity is issued beneath the SPAC at the Opco, with the right to exchange Opco equity into Pubco equity. The Pubco is generally expected to receive a tax basis step-up on exchanges of founder equity for shares of common stock of the Pubco, providing the Pubco with tax deductions from depreciation and reducing the overall tax burden in the future. For example, a Pubco that raised $400 million at IPO might expect the exchange of founder shares to net the Pubco $25 million in cumulative cash tax benefit at a $10 share price and much more at higher prices or if corporate tax rates increase. The Up-SPAC structure could be implemented with or without a tax receivable agreement to share this tax benefit with founders, depending on the willingness of investors to invest in an Up-SPAC IPO with that feature. For a yielding company without a tax receivable agreement, the market cap benefit could be multiples of the cash tax savings.
Up-SPAC as a Differentiating Factor
The Up-SPAC structure could enhance the SPAC’s attractiveness to investors and certain target companies by offering tax benefits to the Pubco that are not present in the traditional SPAC structure. Additionally, issuing founder equity at the Opco level allows founders to rely on well-settled and favorable profits interest valuation authority, which sponsors often prefer. In the event the Up-SPAC structure does not ultimately make sense for a de-SPAC acquisition, the structure could be unwound, much like a traditional Up-C structure.
A potential challenge of the Up-SPAC structure is the possibility that investors or regulators may perceive the structure as more complicated or unfamiliar, leading to delays in the execution of an IPO. However, V&E recently advised Rice Acquisition Corp. in its IPO in an Up-SPAC structure. Rice was able to close its IPO within its goal timeline and without any significant questions during the marketing of the IPO.
Assuming SPACs continue to represent a stable and significant path to public markets, additional SPAC structural evolution is possible. V&E expects other sponsors may consider further modifications to fit their circumstances (e.g., where the founder equity will be held in a fund or the SPAC intends to pursue foreign targets). In particular, many sponsors may want greater flexibility to pursue either a U.S. or foreign target without the drawbacks of the traditional Cayman or Delaware corporate form, and this may lead to yet another structural evolution.
For more information on the Up-SPAC structure or SPACs generally, visit V&E’s SPAC series page at https://www.velaw.com/series/special-purpose-acquisition-companies/ and download our SPAC primer at https://www.velaw.com/practices/special-purpose-acquisition-companies/.
About Vinson & Elkins:
Vinson & Elkins has expansive experience forming and representing SPACs in their IPOs and representing both SPACs and target companies in their business combinations and related financings. From the legal issues impacting SPACs to the business and industry issues that affect their advancement, our team possesses comprehensive knowledge regarding SPAC structures, IPOs and business combinations, and can widely assist parties considering the formation of a SPAC or a SPAC business combination.
Sarah Morgan is a corporate partner at V&E who represents public and private companies, investment banks, management teams and private equity firms in all forms of capital-raising transactions, including IPOs of SPACs, as well as general corporate and public company reporting matters. She also advises companies in mergers, acquisitions, disposition and separation transactions, including significant experience representing both SPACs and targets in de-SPAC business combinations.
Ramey Layne is a corporate partner at V&E whose principal areas of practice are capital markets, securities law, and mergers and acquisitions. He has a particular focus on transactions relating to SPACs and publicly traded MLPs. He represents both issuers and underwriters in public and private securities offerings, and advises clients on general corporate matters, public company reporting issues, restructuring of partnerships, and reporting obligations in connection with acquisition and disposition of partnership securities.
David Peck is a tax partner at V&E with more than 20 years of experience advising companies on tax planning and structuring related to complicated transactions, leveraging his deep understanding of tax law to develop smart strategies to save his clients tax dollars. David has significant experience in capital markets, including SPACs, public offerings and other financings.
Jason McIntosh is a tax partner at V&E who focuses on complex cross-border and domestic transactions. He regularly advises clients on the optimal tax structures for business transactions, including mergers and acquisitions, equity and debt financing transactions, IPOs, SPACs, formation of investment funds, and cross-border restructurings.