Legal Briefs: A SPACtacular Trend

Without question, SPACs are the M&A flavor du jour. Special-purpose acquisition companies accounted last year for more than a fifth of the money raised on the U.S. IPO market. At one point in early March, SPACs comprised 11 of the 19 IPOs filed in 2008.

Need further evidence of a frothy market? Former Notre Dame football coach Lou Holtz has gotten into the SPAC business, having teamed up with former Vice President Dan Quayle and the CEO of a sporting goods company to launch a vehicle with more than $400 million of buying power.

SPACs, for the uninitiated, used to be called blank-check companies. They’re public shells in search of operating companies to acquire through a reverse merger. A ton of money is sloshing around in the SPAC market, and because the vehicles must make an acquisition within a fixed amount of time—18 months to 24 months—or face liquidation, they’re typically motivated buyers.

Increasingly, buyout firms see SPACs as exit opportunities. Sponsor-to-sponsor deals gained legitimacy in the last few years, but at the moment credit-starved LBO shops don’t have the wherewithal to be acquirers, at least not at the same pace and at the same size as in recent years.

But before buyout firms rush into the blank-check embrace, they should be aware of a few SPAC idiosyncrasies, according to Sachin Kohli, an attorney at law firm Weil, Gotshal & Manges.

As public companies, SPACs need approval from half of the stockholders before completing an acquisition. This means that after negotiating a deal in the boardroom, the SPAC and LBO firm must then sell the idea to shareholders. To seal the deal, the two parties also occasionally must offer what’s called “contingent value rights” to a SPAC’s more influential shareholders.

Essentially, contingent value rights offer shareholders downside risk protection. If, a year after the acquisition closes, the public company is trading for less than the IPO price, the SPAC owes those shareholders the difference between the current trading price and the initial IPO price. That sum usually can’t exceed $1 per share, according to Kohli. Madison Dearborn Partners agreed to this when it sold Boise Cascade earlier this year to a SPAC managed by Terrapin Partners.

SPACs also give a good deal of weight to minority shareholders, who can block a deal by exercising their stockholder conversion rights. In fact, it only takes 20 percent to 40 percent of shareholders to block a deal by invoking these rights, according to Kohli.

On the positive side, SPACs can allow buyout firms to quickly cash out their stakes in portfolio companies while also affording the opportunity to keep highly liquid equity positions after the sale. Madison Dearborn, for instance, retained a 49 percent post-sale stake in Boise Cascade, according to Kohli.