SPAC Mania: Considerations for Sponsors and Targets

Whether you are forming a SPAC, or your business may be acquired by one, understanding the unique wealth planning considerations that arise with SPACs enables you to plan accordingly.

What is a SPAC?

A special purpose acquisition company (SPAC), or “blank check company,” raises funds through an initial public offering (IPO) in order to acquire a private company or a series of companies in the same business. After the funding is in place, the team that formed the SPAC (the “sponsors”) typically has up to 24 months to identify a company to acquire.

Individuals who invest in a SPAC IPO have their funds placed into a trust account and the funds are invested – in fairly liquid assets like treasuries, for instance – until the sponsors have identified an acquisition target. SPAC investors usually have the right to redeem their shares if they ultimately decide not to participate in the acquisition once the specifics are known.

In return for setting up the SPAC, identifying the acquisition target, negotiating the deal, and providing ongoing oversight and expertise post-acquisition, the SPAC sponsors are often issued “founder shares” for a nominal fee (for example, $1.00 per share). The founder shares are typically convertible into 20% of the publicly traded shares of the acquired company at the time the SPAC acquires the business. The public investors who take part in the SPAC IPO own the remaining 80% of the shares. Founder shares are often subject to lock-up restrictions even after converting into publicly traded shares. For instance, sponsors may be restricted from selling their shares for up to one year after completion of the acquisition.

The SPAC typically “acquires” the target company by merging into the private company, providing the company with capital, and ultimately receiving a portion, usually a minority stake, in the merged company. The acquisition becomes effective and is considered consummated when the company is publicly listed as the merged company.

Wealth Planning Considerations

If you are considering setting up a SPAC

SPAC sponsors have the potential to realize considerable upside when their founder shares, which they received for a nominal fee, ultimately convert into publicly traded shares of the acquired company. Sponsors should evaluate various estate planning techniques that will allow them to remove some of this price appreciation from their taxable estate at the appropriate time. For instance, transferring founder shares pre-IPO to a GRAT at the shares’ nominal value, is one strategy to consider.

Sponsors may also be able to apply certain valuation discounts to the value of their shares when transferring them outside of their estate. For example, your advisor may consider applying discounts for lack of marketability prior to the initial public offering of the SPAC, or even post-IPO, during the sponsor’s lock-up period when you are still restricted from selling the shares. Further, given that sponsors typically are not able to redeem their founder shares and are required to vote the shares in favor of the business combination, a discount for lack of control may also be appropriate until after the lock-up period expires post-IPO. It may also be possible to apply additional discounts to founder shares pre-IPO, as well as post-IPO – but prior to the business combination – to account for the risk-weighted probability that the IPO and business combination are actually consummated, respectively.

Separately, sponsors should also engage with their advisors in post-transaction planning to address the potentially large concentration they will hold in SPAC shares after the business combination occurs. Again, given the lock-up period, this may present more challenges than a traditional IPO.

If you are considering selling your business to a SPAC

If shares of your business fit the definition of QSBS² and you sell your business to a SPAC, the structure of the transaction may determine whether or not you retain your QSBS exemption post-sale. Selling your shares to a SPAC for cash may trigger a capital gain if you have not held the shares for the statutory five-year holding period. Under Internal Revenue Code (IRC) Section 1202(h), however, if you exchange your QSBS for non-QSBS (for example, shares of a SPAC) in a tax-free transaction under IRC Section 368, your tax basis would carry over to the SPAC shares you receive, and the SPAC shares may be treated as QSBS to the extent of your built-in gain on the effective date of the acquisition (public listing of the merged company).³

There are also timing implications to account for if you are contemplating estate planning in connection with the sale of your business to a SPAC. Given the significant amount of capital invested in SPACs recently, the price at which a SPAC offers to acquire your shares could possibly be significantly higher than even a relatively recent valuation of your business. Transferring shares out of your estate is likely to be less problematic the earlier you do so in the transaction timeline. For example, transfers prior to signing a letter of intent with the SPAC are likely to carry a significant valuation discount to the ultimate value. Valuation discounts for transfers after you have signed the letter of intent, but prior to the shareholders of the SPAC and target company voting to approve the transaction, may also be defensible given that the transaction is still contingent upon such approvals.

If your business is contemplating becoming involved in a SPAC transaction, contact your Northern Trust advisor for guidance in considering each of the wealth planning opportunities available to you pre- and post-IPO.