SPARCs: An Attractive Alternative to Traditional SPACs?

Mike Nordtvedt and Rezwan Pavri are Partners and Austin March is an Associate at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Mr. Nordtvedt, Mr. Pavri, Mr. March, Bryan King, Heath DeJean, and Sally Yin. Related research from the Program on Corporate Governance includes SPAC Law and Myths (discussed on the Forum here) by John C. Coates, IV.

On September 29, 2023, the U.S. Securities and Exchange Commission (SEC) declared effective a registration statement for Pershing Square SPARC Holdings, Ltd., which is contemplating a unique variation on the traditional special purpose acquisition company (SPAC) structure. This variation, called a SPARC—or special purpose acquisition rights company—was spearheaded by billionaire investor Bill Ackman through his investment fund, Pershing Square Capital Management, L.P., and was designed to address several pain points for SPACs, which have lost popularity after frenzied activities in 2020 and 2021.

Ackman’s SPAC, Pershing Square Tontine Holdings, previously gained notoriety in 2020 as the largest ever SPAC with $4 billion raised, but that capital was ultimately returned to investors in 2022 after the SPAC failed to consummate a business combination within the prescribed time period.

What Is a SPARC?

Like a traditional SPAC, a SPARC is a shell company that is seeking to identify and combine with a private company, with the post-combination entity being a capitalized public company. Unlike a traditional SPAC, a SPARC does not raise any public capital at its onset.

More specifically, pursuant to its effective registration statement, the Pershing Square SPARC is distributing special purpose acquisition rights at no cost to former investors in Ackman’s dissolved SPAC. These acquisition rights will provide the holder, among other things, the opportunity to purchase securities in connection with a future business combination by the SPARC at the same price as the SPARC sponsor.

Although the SPARC retains the fundamental nature of a traditional SPAC as an acquisition vehicle, it also departs from a SPAC structure in some notable ways:

  • Deal Visibility and Funding: With a traditional SPAC, public investors invest in the SPAC’s IPO without knowing the business combination target’s identity and generally only an expectation of the industry that the SPAC sponsor will focus on in searching for a target. The proceeds from the IPO are placed into trust while the SPAC searches for a potential business combination target. After a business combination agreement is signed with the potential target and the business combination proxy statement or registration statement clears SEC review, the SPAC’s stockholders vote on the proposed business combination and have the opportunity to have their shares redeemed for their pro rata portion of the amount in trust. Prior to that point, the SPAC investors’ invested capital is tied up for what can be an extended period. Also, unless a SPAC stockholder affirmatively elects to have its shares redeemed, the stockholder will invest in the post-closing combined company.On the other hand, the SPARC doesn’t seek money from public investors until it has secured a deal, at which point the holders of the rights will have the option to invest in the combined company. Inaction by a rights holder will not result in the holder investing in the combined company.
  • Sponsor Promote: Traditional SPACs typically include a sponsor promote, which is a percentage of the SPAC’s stock acquired by the SPAC sponsor at a nominal price. Because of the promote, a sponsor stands to gain money even where the post-combination company loses value, which creates an incentive for sponsors to complete a transaction even when it may not be favorable for other investors. The Pershing Square SPARC sponsor still has an interest in the business combination, but its primary economic interest is in the form of warrants, which are only exercisable when the share price of the post-combination company is 20 percent above the exercise price paid by the rights holders in the business combination. Because the warrants are underwater unless the initial business combination public investors have profited, the Pershing Square SPARC structure better aligns the interests of the sponsor and the rights holders. The SPARC underwater warrant structure aligns with a similar structure Ackman used in his traditional SPAC.
  • Committed Capital: The Pershing Square SPARC also promises additional deal certainty compared to SPACs by providing for a minimum level of committed capital. The SPARC sponsor and certain of its affiliates entered into Forward Purchase Agreements pursuant to which they committed to purchase at least $250 million of public shares if the exercise price for the acquisition rights is $10.00 per share, which commitment amount increases proportionally as the exercise price increases, up to $40.00 per share, or up to $1.0 billion of aggregate committed capital. This committed capital gives potential targets additional certainty that there will be sufficient post-combination cash, regardless of valuation shifts. The shares issuable under the Forward Purchase Agreement will be subject to lock-up restrictions, which ensures that the sponsor has an interest in the overall health of the company beyond the combination. Unless the SPAC sponsor agrees to invest at closing, traditional SPACs face the risk that holders will redeem their shares and leave the SPAC with insufficient capital to complete the business combination, therefore requiring additional financing to inject cash into the company, often through a private investment in public equity (PIPE) transaction. Particularly during times when the PIPE market is less active, traditional SPAC acquisition targets have little certainty that there will be sufficient cash to complete the business combination and meet its post-closing capital needs.
  • Flexibility and Potential for Dilution: The amount of money to be raised by the SPARC will vary depending on the size of the business combination, providing the SPARC with the flexibility to pursue a wider variety of possible transactions. A traditional SPAC, on the other hand, raises a set amount of capital in its IPO and generally aims to combine with a target company at a multiple of the amount in trust (often two to three times the amount in the SPAC’s trust)—the higher the multiple, the lower the dilutive impact of the SPAC’s equity structure. To the extent it wants to combine with a target company with a valuation outside of the desired valuation range, it must either return excess funds or find additional financing opportunities to right-size the business combination. Furthermore, a traditional SPAC typically issues warrants in its IPO to encourage participation, but the introduction of warrants into the company’s capital structure increases the likelihood that an investor’s interest may be diluted, a risk that is reduced in the SPARC structure where the only warrants are the sponsor’s warrants.
  • Opportunity Cost and Time to Locate a Target: Because traditional SPAC investors’ capital is held in trust until a business combination is consummated, SPAC investors bear the opportunity cost of not being able to invest their funds. As a result, a SPAC is typically required to dissolve and return the money if it has failed to complete a deal after two or three years. The SPARC, on the other hand, has 10 years to locate a suitable target, during which time no investor capital is being held by the shell company. This longer deadline is expected to reduce pressure to locate a target as well as to allow the SPARC sufficient time to conduct thorough due diligence on potential targets, a process that is typically compressed in a SPAC context, particularly if the SPAC’s deadline is approaching.
  • Underwriting Expense: Because the acquisition rights are being distributed to former investors in Ackman’s dissolved SPAC, the Pershing Square SPARC is not engaging an investment bank for the distribution. This will avoid the SPARC incurring IPO underwriting fees, which fees typically average 5.5 percent of the gross IPO proceeds.
  • Deal Approval Certainty: Because the holders of acquisition rights in the SPARC do not hold shares until they have opted in, the sponsor is the sole stockholder of the SPARC prior to the business combination. This results in greater deal certainty by eliminating the risk that the shell’s shareholders might not vote in favor of the business combination, which is largely theoretical given SPAC stockholders are incentivized to vote in favor of the business combination regardless of whether they elect to have their shares redeemed given they continue to have upside in the post-combination public company through their warrants.
  • Application of Blue Sky Laws: In contrast to a traditional SPAC structure, the acquisition rights distributed by the Pershing Square SPARC will not be listed on a national securities exchange. As a result, the SPARC will be subject to the “Blue Sky” laws of each state. The Pershing Square SPARC’s rights agreement requires the SPARC to use commercially reasonable efforts to register its securities in every state in accordance with Blue Sky laws; however, the application of state securities laws introduces additional regulatory uncertainty compared to a traditional SPAC.

Initial Takeaways

Although the SPARC structure appears to solve many the issues for investors in SPAC IPOs, it is a novel and unique structure, so the investment community will need time to fully digest its benefits and drawbacks, which will likely depend on the success of the Pershing Square SPARC. Furthermore, the terms of the Pershing Square SPARC may differ materially from future SPARCs. The time required for potential market acceptance and the establishment of standard market terms will likely be extended due to the precipitous drop in investor interest in traditional SPACs and the uncertainty regarding the timing and scope of the final SEC rules for SPACs, including how those rules may apply to the SPARC structure.

Additionally, while the Pershing Square SPARC structure provides some assurances as to the minimum amount of post-closing cash, many of the issues that target companies face when considering a business combination with a traditional SPAC will continue to be issues when considering a combination with a SPARC. Those issues include limited certainty on the amount of post-closing cash, competing interests in setting the target’s pre-combination valuation, potential dilution from the sponsor warrants, uncertainty as to the timing and likelihood of closing the business combination from other closing conditions (e.g., the scope and duration of SEC review), limited post-closing public float prior to the target company’s lock-up expiring and onerous post-closing disclosure requirements.

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