Usually between 80 % and 90 % of the funds are placed in a trust that earns a rate of return while the company seeks to invest the monies in acquisitions. The remainder of the monies is used to pay expenses. Shareholders usually have the right to reject proposed deals. In addition, if the founders do not recommend a deal within a defined time period, such as 18 months, or complete a deal within 24 months, the monies are returned to investors less expenses plus a return earned in the capital. This contrasts with private equity investments, where shareholders do not have to approve specific deals.
Such investments can be risky for investors as it is possible that the company may not complete an acquisition. If that is the case, investors could get back less money than they originally invested. Even when the company does complete deals, they do not know in advance what targets will be acquired. During the period of time between the IPO and the completion of an acquisition, the funds raised are held in a trust fund and typically are invested in government securities.
The IPO offerings of SPACs are unique and differ in many ways from traditional IPOs. In addition to the differences in the nature of the company that we have discussed, they usually sell in units that include a share and one or two warrants, which usually detach from the shares and trade separately a couple of weeks after the IPO. Because the market for these shares can be illiquid, they often trade at a discount – similar to many closed-end funds. The post-IPO securities can be interesting investments as they represent shares in an entity that holds a known amount of cash but that trades at a value that may be less than this amount.
Founders of SPACs benefit by receiving a share, usually 20 %, of the value of the acquisition. Normally, other than this ownership position, the founders of the SPAC do not receive any other remuneration. Their shares usually are locked up for a period, such as three years, after the IPO date.
In Chapter 4 we discuss the various factors that lead to a value-destroying M&A strategy. With SPACs, however, there is no strategy as investors are seeking to convert their liquid cash into an equity investment in an unknown company. Not surprisingly, in a study of 169 SPACs over the period 2003–2010, Jenkinson and Sousa found that over half of the deals immediately destroyed value.14 They compared the per share value of the SPAC at the time of the deal with the per share trust value. They reasoned that if the market value is equal to or less than the trust value, the SPAC should be liquidated and the acquisition should not go forward.
In spite of the disappointing results of Jenkinson and Sousa, there is an explanation for SPAC's continued popularity. The investments are liquid and the shares have been sold to the market in the initial IPO. This compares favorably to private equity investments, which are not very liquid.
In spite of the fact that the market prices as of the acquisition approval date indicated ex ante that the deals would be value-destroying, more than half of the deals were nonetheless approved by investors. Jenkinson and Sousa found that investors who went along with the recommendations of the SPAC founders in spite of a negative signal from the market suffered –39 % cumulative returns within six months and –79 % after one year. The fact that the founders recommended the deal is not surprising given that they derived their compensation by receiving 20 % of the capital value of any acquisition. Therefore, they want the investors to approve an acquisition as that is how they get their money. The deal may cause investors to lose money, but it can still make the founders a significant return. In light of the poor performance of SPACs it is surprising that roughly three quarters of deals are approved by the SPAC investors.
Holding Companies
Rather than a merger or an acquisition, the acquiring company may choose to purchase only a portion of the target's stock and act as a holding company, which is a company that owns sufficient stock to have a controlling interest in the target. Holding companies trace their origins back to 1889, when the State of New Jersey became the first U.S. state to pass a law that allowed corporations to be formed for the express purpose of owning stock in other corporations. If an acquirer buys 100 % of the target, the company is known as a wholly owned subsidiary. However, it is not necessary to own all of a company's stock to exert control over it. In fact, even a 51 % interest may not be necessary to allow a buyer to control a target. For companies with a widely distributed equity base, effective working control can be established with as little as 10 % to 20 % of the outstanding common stock.
Holding companies have certain advantages that may make this form of control transaction preferable to an outright acquisition:
● Lower cost. With a holding company structure, an acquirer may be able to attain control of a target for a much smaller investment than would be necessary in a 100 % stock acquisition. Obviously, a smaller number of shares to be purchased permits a lower total purchase price to be set. In addition, because fewer shares are demanded in the market, there is less upward price pressure on the firm's stock and the cost per share may be lower. The acquirer may attempt to minimize the upward price pressure by gradually buying shares over an extended period of time.
● No control premium. Because 51 % of the shares are not purchased, the full control premium that is normally associated with 51 % to 100 % stock acquisitions may not have to be paid.
● Control with fractional ownership. As noted, working control may be established with less than 51 % of the target company's shares. This may allow the controlling company to exert certain influence over the target in a manner that will further the controlling company's objectives.
● Approval not required. To the extent that it is allowable under federal and state laws, a holding company may simply purchase shares in a target without having to solicit the approval of the target company's shareholders. As discussed in Chapter 3, this has become more difficult to accomplish because various laws make it difficult for the holding company to achieve such control if serious shareholder opposition exists.
Holding companies also have disadvantages that make this type of transaction attractive only under certain circumstances:
● Multiple taxation. The holding company structure adds another layer to the corporate structure. Normally, stockholder income is subject to double taxation. Income is taxed at the corporate level, and some of the remaining income may then be distributed to stockholders in the form of dividends. Stockholders are then taxed individually on this dividend income. Holding companies receive dividend income from a company that has already been taxed at the corporate level. This income may then be taxed at the holding company level before it is distributed to stockholders. This amounts to triple taxation of corporate income. However, if the holding company owns 80 % or more of a subsidiary's voting equity, the Internal Revenue Service allows filing of consolidated returns in which the dividends received from the parent company are not taxed. When the ownership interest is less than 80 %, returns cannot be consolidated, but between 70 % and 80 % of the dividends are not subject to taxation.
● Antitrust issues. A holding company combination may face some of the same antitrust concerns with which an outright acquisition is faced. If the regulatory authorities do find the holding company structure anticompetitive, however, it is comparatively easy to require the holding company to divest itself of its holdings in the target. Given the ease with which this can be accomplished, the regulatory authorities may be quicker to require this compared with a more integrated corporate structure.
● Lack of 100 % ownership. Although the fact that a holding company can be formed without a 100 % share purchase may be a source of cost savings, it leaves the holding company with other outside shareholders who will have some controlling influence in the company. This may lead to disagreements over the direction of the company.
Chapter 2
History of Mergers
IN MUCH OF FINANCE there is very little attention paid to the history of the field. Rather, the focus is usually on the latest developments