SPAC Mergers with Public Companies: A New Trend?

Bull Horn Holdings Corp., a special purpose acquisition company (SPAC), merged with Coeptis Therapeutics, Inc., a publicly traded biopharmaceutical company developing cell therapy platforms for cancer, in October 2022. In January 2023, TKB Critical Technologies 1, a SPAC focused on investing in critical technologies, announced a merger with an already public company, Wejo, which had gone public via an earlier merger with another SPAC.

The fact that some SPACs are acquiring public companies is a topic that comes with interesting and timely questions. To sort out some of these legal, financial, and insurance issues, we sat down with two experts in the industry: James Hu, a partner in White & Case's Global Mergers & Acquisitions Practice, and Mark Deters, an audit partner and SPAC team leader in Withum's Financial Services Group.

Below are some highlights from our conversation. You can also listen to the full discussion below.

What Are the Legal Concerns?

I first asked James Hu about any legal conundrums that may come from these unusual situations.

James Hu: A SPAC is a financing product, and the merger between a public company and the SPAC is just another application of a SPAC serving the function of a fundraising vehicle for publicly listed companies that are looking for funding options in today's high interest rate environment. SPACs could present, in some instances, a possible source of equity funding for these companies.

Yelena Dunaevsky: And the SPAC may be willing to complete the transaction at a premium to the public company’s current valuation, which is the reasoning behind the TKB/Wejo deal. So, there’s a valuation element here as well.

James Hu: One of the main questions for a public company board contemplating the merger with a SPAC will be the cost of capital raised. The cost here includes not only the sponsor shares but also other transaction expenses to be inherited from the SPAC, such as underwriter discount and advisory fees, for example.

The extent of redemptions, which have been high lately, will play a major role. As an extreme example, it would not make sense for a public company to complete a merger with a SPAC if there is a 99% redemption rate—that's not enough to cover the transaction expenses.

Two factors to consider are getting the public company's shareholders to vote favorably on the deal and the typical risk of shareholder lawsuits that any public company can face.

What About the Audit Side?

Yelena Dunaevsky: What kind of issues do companies merging with already public companies pose from the standpoint of their financial statements and the related audits? And how are these kinds of mergers different from a traditional SPAC-to-private-company merger?

Mark Deters: From the audit side, it is usually easier for everyone involved. It is definitely a quicker process. As auditors, we laugh during the entire business combination process because nobody cares about the accounting until it's the hold-up. But in every SPAC transaction I've been involved with, the long pole in the tent is the audited financials of the target company.

There are a couple of reasons why:

• Typically, the financials have not been audited under PCAOB (Public Company Accounting Oversight Board) standards. There are different independence requirements and it is more complicated, so many companies do not have PCAOB audited financials. If it is a public company, however, the PCAOB audit is already done. So it's not a problem for a public company and speeds up the timeline quite a bit.
• Lack of public company readiness is the other problem. Many of these companies are very young-stage companies that don’t yet have the structure to be a public company. So, there are a lot of growing pains when they merge with a SPAC and suddenly, they’re a public company and require a public company level of disclosure, which is often difficult for them.

What Are Insurance Considerations?

Yelena Dunaevsky: One of the reasons for a public-to-public merger is the benefit of adding the funds in the SPAC’s trust account to the public company the SPAC is acquiring. Essentially, it's a way for the target company to obtain financing in an environment where financing may be very hard to get.

For traditional SPACs, the question of public company readiness is a stumbling block that quite a few SPACs have tripped over in the last couple of years. This lack of readiness is very relevant on the insurance side.

An insurance underwriter would look favorably on a deal where the target is run by people already experienced in running a public company and in SEC-required disclosure. The same underwriter will also feel more comfortable with the idea of having access to publicly filed information, analyst reports, and the like going back several years. So access to extensive publicly filed information and the public-company experience of the target’s directors and officers would be a plus in any underwriter’s risk calculations.

On the other hand, operating as a public company comes with its own set of risks. Public company operations and having large numbers of public shareholders could give rise to securities class action lawsuits, activist investors, or some other lawsuits that are potentially hidden in the previous operations of the public company.

From an insurance perspective, structuring the directors' and officers' coverage for a traditional SPAC is complicated. It will be no less complicated for a public-to-public SPAC. You will have multiple policies in play and tails to consider on both ends. A knowledgeable insurance broker can help you structure and place all these policies and ensure against gaps in coverage.

What About Foreign Capital Markets and the SEC Perspective?

Yelena Dunaevsky: Another reason why public companies might consider merging with a US SPAC is to obtain access to a US listing.

James Hu: We have seen a growing number of foreign-listed companies seeking to combine with a US-listed SPAC as a way to achieve dual listing in the US. There might be a different multiple assigned to a foreign company’s stock in the US than in its local market. Or the company may see more opportunities for its products in the US market. Using a SPAC as the vehicle to go public in the US—while it may not save you any time versus a typical IPO—provides a readier path to go public because you're not relying on a traditional costly underwriting process. The SPAC gives you that listing status.

However, the SEC is taking a closer look at target companies from outside the US because from the SEC's perspective, you're now offering securities to US investors.

But for a foreign public company, the process of a US listing is easier. Being an already public company, you are light years ahead from the financial statements, auditing, accounting, and public company readiness perspective.

Mark Deters: A foreign company’s financial statements will need to transition to meet US requirements and standards. There are two elements to consider here:

• The auditing must be under PCAOB standards, no matter what. The foreign company may not be working with a PCAOB-registered auditor, so in that case, it’ll have to go back and get a new auditor and get those financial statements audited to comply with PCAOB standards. This will, of course, add time and cost to the process.
• Accounting basis, whether it is GAAP or IFRS. Depending on the goals of the company, it will likely need to be recast in US GAAP. The basis of presentation will need to depend on the ultimate transaction structure and what the company is post-merger.

Yelena Dunaevsky: We brainstormed the motivators for a public-to-public deal and came up with the following:

• Gaining a US listing or a dual US and foreign listing status, thereby expanding brand recognition and customer base into the US market
• Attaining a more favorable valuation and larger market footprint
• Achieving cash inflow through the absorption of the SPAC’s trust funds
• Attracting strategic high-level management and/or advisors not otherwise available

Other Trends in the SPAC World

Yelena Dunaevsky: Other trends to watch in the SPAC marketplace include the Bill Ackman SPARC (special purpose acquisition rights company), an alternative structure where the funds from investors don't get deposited into the trust but the investors are essentially on stand-by to invest them once the right company is found. This option has not been very popular so far.

James Hu: This structure offers investors the right to choose to invest when and if a merger target is identified. It remains an area of innovation. We will have to see how the SEC views it. The general rules of disclosure still apply to this structure, just in a different context. One benefit, reading strictly from the SPARC’s public filing, is that since a bank is not being asked to raise the funds, there do not seem to be any significant underwriting expenses or commissions.

Mark Deters: On the audit side for SPARCs, the structure could run into derivative accounting issues and will create a lot of work for the accounting group within the entity due to a lot of estimates involved in valuing these things—all of which will result in extra money and time.

We've seen the SPAC evolve over the last 15 years quite a bit, and I would expect the product to evolve long-term based on these new rules.

Final Thoughts

Changes in the macroeconomic environment are prompting people to explore innovation. Once the final SEC rules come out in April, things will become clearer and SPAC market participants will feel free to push forward new ideas.

James Hu: For a public-to-public type of SPAC transaction, it's important to ask both the SPAC and the public company target what the transaction's ultimate purpose is. Their responses will answer a lot of questions about both the structure and deal terms, including time and pricing. For each of our clients, we start by asking that question, which then informs the rest of our advice.

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