Inside M&A Fall 2015 | View Full Issue


Creative Business Combination Structures Allow SPACs to Successfully Compete with Non-SPAC Bidders

Heidi J. Steele

Certain structural features of special-purpose acquisition companies (SPACs) that offer benefits to their public investors often put SPACs at a competitive dis-advantage when they are among multiple bidders for a target company. Recent SPAC business combination transactions demonstrate, however, that careful structuring of a transaction to meet the needs of the target’s owners can overcome these structural challenges and level the playing field for SPACs in a competitive bidding process.

SPAC Structure

The hallmark feature of the SPAC structure is that the gross proceeds of the SPAC’s initial public offering (IPO) are placed into a trust account for the benefit of the SPAC’s public stockholders. The public stockholders have a right to receive their pro rata share of the trust account if they choose to redeem their common stock in connection with the SPAC’s initial business combination transaction, or if the SPAC is unable to complete an initial business combination within a specified period of time, generally 24 months from the closing of the IPO. The cash in the trust account cannot be accessed until the SPAC’s initial business combination is closed. Only a limited amount of additional cash is invested in the SPAC by its sponsors and held outside the trust account to pay the SPAC’s expenses in connection with identifying, investigating, negotiating and closing its initial business combination transaction.

The Appeal of SPACs

For the SPAC’s public investors, the trust account structure is intended to eliminate the downside risk of their investment. If the SPAC fails to complete a business combination transaction within the specified time period, or if an investor redeems its shares in connection with the SPAC’s initial business combination transaction, the investor receives substantially all of its initial investment back. For target companies, a SPAC’s public company status allows them to go public more quickly than the timing of a traditional public offering. It also provides a path to go public for companies whose stories may not be appreciated by public market investors. Perhaps more significantly, a business combination transaction with a SPAC provides a significant amount of flexibility for the target’s owners to receive a portion of their business combination consideration in cash and a portion in public company stock, which will allow them to participate in the future growth of the business.

The SPAC Challenges

While the SPAC structure provides public investors with safeguards to protect their investment, it also creates obstacles to closing a business combination. The redemption rights of SPAC stockholders and the short SPAC lifespan can create deal un-certainty and timing obstacles, making targets reluctant to sell to a SPAC. Targets often want at least some cash consideration or for a specified amount of cash to remain in the company for future growth—and always desire certainty of closing—but the ability of the SPAC stockholders to redeem their shares can impact both. Even if SPAC business combination agreements include a minimum cash condition to protect a target from a closing if more redemptions than expected occur, a SPAC generally cannot offer the deal protection of a breakup fee due to its lack of access to the trust account funds prior to closing a business combination. Further, a large number of redemptions can put the post business combination’s public company status at risk due to a reduced market float that does not meet public company listing requirements. The time it takes to close a SPAC business combination adds to these impediments, putting a SPAC at a dis-advantage against private equity funds and strategic buyers in a competitive bidding process. In a SPAC business combination transaction, the parties must file disclosure documents with the U.S. Securities and Exchange Commission (SEC), which include extensive information about the transaction and the target, including audited financial statements, pro forma financial information and other information that is typically disclosed in an IPO prospectus. The process of preparing and resolving SEC comments on these documents is time-consuming and expensive. Unless these obstacles are addressed, some sellers may discount the bid of a SPAC and not enter into a sale process with a SPAC.

SPAC Solutions

Recently completed SPAC business combinations demonstrate how SPACs can be successfully utilized in the private equity dominated mergers-and-acquisitions (M&A) market. To compete with private equity bidders’ access to cash, SPACs can enter into arrangements with third-party investors or the SPAC’s sponsors to “backstop” a specified amount of potential redemptions by public stockholders at the same price per share as the redemption price per share. These arrangements can guarantee cash certainty at closing and provide validation of the SPAC’s valuation of the business combination transaction, which in turn supports the trading price of the SPAC’s shares. These arrangements encourage targets to be more accepting of the timing and public disclosure requirements and the redemption process of SPAC bidders.

In addition, the attenuated timing to closing inherent in SPAC transactions for sellers who are seeking cash can be addressed through these arrangements. For example, the recent $500 million acquisition of Del Taco Holdings, Inc. by Levy Acquisition Corp. included a novel two-step structure. In the first step, the SPAC’s sponsor and third-party investors made an upfront cash investment of $120 million in the equity of Del Taco by purchasing stock from Del Taco stockholders and the company itself. The upfront investment provided stockholders with immediate liquidity for a portion of their holdings and allowed Del Taco to re-finance its indebtedness—making its debt/equity ratio a more suitable investment for public investors. In addition, at the time of entering into the agreement for the business combination transaction, the SPAC arranged for a $35 million private placement to take place at the closing of the business combination to provide additional cash and additional deal certainty. Moreover, because the price paid in both the step-one cash investment and the closing private placement was based on the proposed $500 million enterprise value for Del Taco in the business combination transaction, it demonstrated to the market and SPAC stockholders that third-party investors and the SPAC’s sponsor supported the proposed valuation of the transaction. The additional cash investments also helped support a SPAC common stock price at or in excess of the redemption price that SPAC stockholders would receive if they redeemed their shares. The transaction was well-received by the public markets, with the SPAC’s common stock trading up to more than $5 above the per-share trust amount prior to the closing of the business combination transaction, resulting in nominal redemptions by public stockholders.

In Boulevard Acquisition Corp.’s recent acquisition of AgroFresh, a business of The Dow Chemical Company, more than two-thirds of the purchase price was paid with cash infused in the business combination in the form of a private placement completed concurrently with the closing, increased debt on the target and standby agreement under which the seller and an affiliate of sponsor agreement to provide up to $50 million in the event that the SPAC had insufficient cash to pay the full cash consideration. Similar to the Del Taco transaction, a significant portion of the cash infusion came from parties to the business combination, an affiliate of the sponsor and The Dow Chemical Company, which served as an endorsement of the business combination valuation to the market. The AgroFresh transaction demonstrates how a business combination with a SPAC can be an alternative to the traditional spin-off transaction.

These recent SPAC transactions demonstrate that SPACs can significantly increase deal certainty and their competitive position in bidding processes by utilizing one or more of the following:

  • An upfront cash investment to provide owners of the target immediate cash liquidity and validation that the equity value of the SPAC post-business combination is greater than the redemption price (thus discouraging redemptions)
  • Re-financing the post-business combination company to make it in line with debt/equity leverage ratios of public companies of similarly situated businesses
  • Obtaining additional support by means of a capital infusion or continued investment in the company by the sellers and/or sponsor to show confidence in the valuation of the business combination

SPAC Directors Cannot Take the Protection of the Business Judgment Rule for Granted

The strategic decisions made by directors of Delaware corporations are typically accorded the protection of the business judgment rule, which “is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” (Aronson v. Lewis, 473 A.2d 805 (Del. 1984)). This presumption may be rebutted if, among other things, it is shown that the directors had a conflict of interest in making the decision or breached their fiduciary duties, in which case the burden shifts to the directors to defend the decision under the entire fairness standard. A recent decision by the New York State Supreme Court’s Commercial Division—in AP Services, LLP v. Lobell, et al., No. 651613/12—suggests that certain structural terms of special-purpose acquisition companies (SPACs) may make it more challenging for the business judgment rule to apply to decisions by SPAC directors to enter into agreements for business combination transactions.


In June 2005, principals of a bioscience venture capital firm founded Paramount Acquisition Corp. (Paramount) as a SPAC, purchasing 2,125,000 shares of Paramount’s common stock (founder shares) for $0.01176 per share, or $25,000 in the aggregate. These principals also served as members of the board of directors of Paramount. In October 2005, Paramount conducted its initial public offering (IPO), selling 9,775,000 units, each consisting of one share of common stock and two warrants, for a purchase price of $6 per unit, raising approximately $53 million in net proceeds after offering expenses. Approximately $52 million of the proceeds was placed into a trust account for the benefit of Paramount’s public stockholders. Following the IPO, pursuant to an agreement with the underwriters of the IPO, Paramount’s directors purchased approximately two million warrants in the open market for an aggregate purchase price of approximately $1.3 million.

According to the IPO prospectus, Paramount’s purpose was to effect a business combination transaction with an operating business in the health care industry. However, under Paramount’s certificate of incorporation, if a shareholder-approved acquisition of a health care entity failed to close by a “drop-dead” date [either April 27, 2007 (18 months after Paramount’s IPO) or October 27, 2007 (24 months after Paramount’s IPO) if Paramount had entered into a letter of intent by April 27, 2007 but the transaction had not closed by such date], Paramount would dissolve. In such an event, the IPO proceeds held in the trust account would be distributed in liquidation to Paramount’s public stockholders, and all of Paramount’s warrants (including those purchased by the directors) would expire worthless. In connection with the IPO, the directors waived their right to any liquidating distributions from the trust account with respect to their founder shares. In addition, under the terms of Paramount’s certificate of incorporation, public stockholders would have the right to convert their public shares into a pro rata portion of the proceeds held in the trust account in connection with a business combination transaction if they voted against the transaction.

On April 24, 2007, after having considering a number of business combination candidates, and after a different potential transaction fell through, Paramount entered into a letter of intent for a business combination with Chem Rx, a long-term-care pharmacy, as well as letters of intent for two other potential business combinations, thereby extending the drop-dead date to October. On October 22, 2007, five days before the drop-dead date, Paramount acquired Chem Rx in a leveraged acquisition in which it used the cash remaining in its trust account after conversions plus approximately $160 million in debt financing and 2.5 million shares as the purchase price (the Business Combination Transaction). In connection with the closing of the transaction, Paramount changed its name to Chem Rx Corporation.

In April 2009, 18 months after the transaction closed, Chem Rx publicly announced that it was un-able to file its annual report for 2008, because it was in violation of certain financial covenants under its two principal credit facilities and, because of the un-certainty as to a resolution of the covenant violations, the proper accounting for the credit facility indebtedness was in doubt. In May 2009, Chem Rx announced that it had entered into forbearance agreements with its lenders and, according to the complaint in Lobell, the company admitted that the historical audited financial statements on which the Business Combination Transaction was based were false. In violation of its loan covenants, and un-able to work out its debt, Chem Rx filed for bankruptcy in May 2010. The bankruptcy led to a distressed sale of Chem Rx and a Chapter 11 liquidation. Following liquidation, the bankruptcy court established a litigation trust to prosecute claims for Chem Rx’s unsecured creditors.

Lobell is the litigation trust’s (i.e., the Plaintiff’s) suit against Paramount’s directors (the Directors), in which the Plaintiff alleged, inter alia, that the Directors breached their fiduciary duties of loyalty and care to Paramount by allowing Paramount to enter into the Business Combination Transaction, because, in approving the transaction, the Directors were self-interested or controlled by an interested director and, in their rush to approve the Business Combination Transaction, the Directors ignored key red flags that should have alerted them to the fact that Chem Rx’s audited financial statements were un-trustworthy. The Directors moved to dismiss Plaintiff’s complaint, arguing, among other things, that their decision to approve the Business Combination Transaction should be protected by Delaware’s business judgment rule.

Justice Marcy Friedman ruled on the motion in a June 19, 2015, decision/order (the Lobell Order), dismissing certain causes of action but denying the Directors’ motion with regard to the fiduciary breach claim. Specifically, the court rejected the Directors’ reliance on the business judgment rule in their argument for dismissal, holding that the Plaintiff alleged sufficient facts to plead a claim for breach of the duty of loyalty or a claim for breach of the duty of due care. An appeal of the Lobell Order filed by both parties remains pending in the First Department.


The court’s conclusion that the Plaintiff adequately pled a breach of the duty of loyalty was based on the alleged self-interest of the majority of the Directors arising from their ownership of founder shares and warrants, which would have no value if Paramount did not close the Business Combination Transaction by the drop-dead date. This has implications for many SPACs, because it is common for SPAC directors to own similar founder shares or warrants.

One of the arguments the Directors made in their defense was that the Directors did not have the power to cause the acquisition to be made, because it was expressly subject to the affirmative vote of a supermajority of disinterested stockholders. In its decision, the court acknowledged this argument in a footnote, but stated that the Defendants did not submit “legal authority addressing the impact on directors’ good faith decision-making of investor protections which may be adopted in connection with SPACS, including a requirement that a majority of IPO stockholders approve a business combination” and that the court expected this omission to be “addressed at a future stage of the litigation.” Notably, there are numerous Delaware court decisions holding that the legal effect of a fully informed stockholder vote of a transaction is that the business judgment rule applies and insulates the transaction from all attacks other than on the grounds of waste, even if a majority of the board approving the transaction was not disinterested or independent. See In re KKR Financial Holdings LLC Shareholder Litigation, C.A. No. 9210-CB (Del. Ch. October 14, 2014).

Thus, this defense should ultimately prevail if the Defendants can show that the disclosure included by Paramount in its proxy statement for the stockholder vote was sufficient to fully inform Paramount’s stockholders about the Business Combination Transaction, as well as that it did not constitute waste, which is a low bar to meet. In a related argument, the Defendants asserted that the ability of each public stockholder to choose to convert their shares into a pro rata portion of the trust account also supported the notion that the board decision had no operative effect and, therefore, that it could not constitute a breach of fiduciary duty. Here too the Defendants did not cite legal authority, which they may seek to do in a future stage of the litigation. However, neither of these arguments was dispositive of the motion before the court, as the court’s focus was solely on the sufficiency of the pleading.

Thus, the court’s conclusion that the Plaintiff adequately pled a breach of the duty of care puts a focus on the adequacy of the due diligence that SPACs undertake in connection with their business combination transactions. The Plaintiff claimed that the Directors “willfully ignored” and “closed their eyes” to red flags, and that their failure to investigate in response to the red flags amounts to “gross negligence” and “intentional dereliction of their fiduciary duties.” The court acknowledged these allegations, and found that even where the SPAC’s certificate of incorporation exculpates the directors from ordinary negligence, a duty-of-care claim may be premised on gross negligence in failing to heed red flags.

Key Takeaways

The Lobell Order highlights the need for SPAC directors to make sure that management of the SPAC engages in thorough due diligence of a business combination target, and investigates any red flags before entering into a binding agreement to fulfill their duty of care. Directors also should ensure that the disclosure document that the SPAC prepares and circulates to its shareholders is comprehensive and highlights not only the positive aspects of the target, but also any negatives. Thus, the shareholders can make an informed decision, and approve the transaction by a majority of disinterested shareholders (as a supermajority vote of public stockholders no longer is required under SPAC charters in order to approve a business combination). By taking these two steps—even if the directors own founder shares or warrants—their decisions may qualify for the protection of the business judgment rule. SPACs may also consider appointing one or more directors who do not own any founder shares or warrants—and are not otherwise affiliated with the principal sponsor—to act as a special independent committee to approve the transaction, thereby obviating the need to rely on an informed decision by shareholders in order to qualify for the protection of the business judgment rule.