The Rise of SPACs
As the investment objectives of private equity sponsors and LPs evolve, the industry has shown itself willing and able to adopt increasingly creative partnership structures to disrupt the typical private equity model and offer more flexibility to all parties involved. This certainly holds true for Special Purpose Acquisition Companies (“SPACs”), a relatively niche partnership structure which is emerging as an added point of sourcing differentiation for certain types of GPs and companies. Of course, the SPAC itself is not a new structure – investors have formed SPACs and “blank check” companies since the 1980s. The renewed excitement around SPACs is due to innovation around governance rights geared towards making SPACs a more attractive investment for LPs and hence a more viable structure for GPs to pursue.
As a refresher – a SPAC is a publicly traded entity through which a GP raises funds, typically to acquire a single asset that fits certain investment criteria. Investors can buy shares of a SPAC and the committed capital is held in escrow for an investment period of 2-3 years. If a GP is unable to deploy the capital in that time period, the SPAC is dissolved and the capital is returned to investors.
SPACs have long held a negative connotation in the market for several reasons. They have historically been associated with “troubled managers” that have had difficulty raising capital in private markets and were often seen as a structure of last resort. These days, however, the market is proactively restructuring partnership terms in order to alleviate concerns for LPs and thus realize the potential benefits of the structure for both parties.
Given these innovations in the structure of SPACs, GPs that we have been tracking are now turning to SPACs as a way to enhance their sourcing capabilities and pursue deals that would have been outside their purview in a simple fund structure. Essentially, a GP that has identified an attractive outsized investment opportunity can create a SPAC and invest the maximum amount of capital allowable through the fund, and then engage an investment bank to raise public capital through the SPAC to fund the remainder of the equity needed. Raising an SPAC, especially if the GP already has an asset identified, is administratively easier than forming a private SPV for the same purpose.
Although this structure is rapidly being welcomed by LPs, a critical step in this process is for GPs to gain approval form their LPAC. GPs pursuing this strategy should be prepared to respond to concerns from the LPAC around such a structure, including whether an outsized investment through a SPAC will receive outsized attention from the manager. This is problematic for the LPAC because their upside in the SPAC transaction is limited compared to their potential upside in assets held strictly through the fund. Additionally, LPs may voice concerns about whether the GP’s value creation playbook will yield the same results for a company that is much larger than what they typically manage. As you navigate these conversations, a good way to allay these concerns is to offer your LPAC a Right of First Refusal (“ROFR”) on commitments into the SPAC, which would optimally align incentives.
Today, we are seeing a growing number of GPs utilize or explore SPACs as a way to leverage their sourcing network and compete for outsized investment opportunities. To do so successfully, these GPs solicit feedback from their existing LPs and often offer them co-investment opportunities into the SPAC. Of course, given the esoteric nature of SPACs, they are not a fit for every manager or situation. That said, even if a SPAC doesn’t fit your needs, their reemergence is an encouraging indication that the market is always evolving. It is critical that GPs think outside the box and actively explore creative capital solutions that can be used to solve whatever sourcing or funding dilemma they may be facing.
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