SPACs Reshape
Financing Markets

SPACs made a spectacular comeback in the first quarter of 2021 (see Europe Prepares for SPAC Surge – March 2021) as new listings beat all previous records. Despite closer scrutiny from regulators and a cooling of activity, blank cheque vehicles appear here to stay as a potentially attractive opportunity for public equity investors and an efficient exit alternative for sellers.

As the formation of SPACs fuels momentum in M&A deal activity, they are becoming an increasingly important driver of leveraged loans and high-yield bond volumes, for both acquisition and refinancing purposes. Furthermore, the very existence of SPACs as a potential exit route for private equity investments is starting to impact LBO debt documentation.

Releveragings and Deleveragings

A SPAC’s primary source funding for deals is the equity raised in its IPO. But with many potential target companies stretching to multi-billion dollar valuations, SPACs may need to obtain debt financing to bridge the difference between equity funds and the purchase price. Debt financing may also be necessary to backstop or refinance any existing target company debt that may become due as a result of the transaction.

The debt commitment process and package for a SPAC taking part in an auction process resembles that of a sponsor competing for a buyout – a SPAC is effectively an SPV in search of limited recourse financing. There are some quirks, however. Under U.S. listing rules, shareholders in SPACs enjoy redemption rights (effectively, a put against the SPAC) in connection with the proposed acquisition. Although European rules may not mandate such redemption rights, it is not unusual for European SPAC documentation to include them voluntarily for marketing purposes.

A redemption right, if exercised, creates a contingency in the capital structure that the arrangers of the debt financing will require to be addressed. This is achieved either with a condition in the funding agreement or, in the current seller-friendly market, by the SPAC founders or other investors providing a backstop in the form of a committed PIPE (private investment in public equity) in order to ensure deal certainty. The requirement to offer redemption rights to shareholders or obtain their consent for the initial acquisition also impacts the timing and structure of syndication, as shareholder disclosure may need to contain information on the proposed financing (including potentially sensitive terms such as underwriting fees or flex items).

Contrary to typical sponsor LBOs, however, SPACs often use a portion of IPO proceeds to pay down target company debt. In recent SPAC transactions, target company leverage indeed reduced from 5.4 times EBITDA to 3.8 times, according to DoubleLine¹. In some cases, the SPAC may seek to retain the company’s existing financing for the time being, with a view to refinancing it on better terms post acquisition.

The typical terms and documentation of a SPAC debt package resemble those of a newly IPO-ed companies in many ways. That can mean cross-over credit terms, such as lack of collateral/intercreditor agreements, unsecured subsidiary guarantees, perhaps one financial covenant and relatively conservative incurrence covenants. Moreover, their loans tend to be syndicated in the commercial bank market rather than to institutional term loan investors.

Preparing for SPACSIT

As SPACs become an increasingly common exit route for private equity sponsors, more attention is being given to the terms of the initial LBO financing to ensure that it can be maintained in a later exit to one of the vehicles. The benefit is that the SPAC can potentially refinance on better terms and at the most favourable time, instead of refinancing at the same time as the acquisition closes.

The key focus in the debt terms is the definition of ‘change of control’. Issues to address include:

The existence of both a pre- and a post-IPO limb.

This ensures that post-IPO, the sponsor is no longer required to control the target and a change of control is only triggered if another ‘person’ acquires control.

The SPAC transaction qualifies as an initial public offering for the purposes of having the post-IPO limb apply.

The SPAC is not considered a ‘person’ acquiring control and the language instead looks through to the public shareholders behind the vehicle.

Market participants are also beginning to pay more attention to ‘qualified listing’ or similar triggers in the documentation to ensure that they apply in a potential SPAC deal. The provisions cause financing terms to flip to looser investment grade terms upon a successful IPO of the borrower – sometimes coupled with the achievement of deleveraging or another milestone. They can also include releasing subsidiary guarantees and collateral, relaxing negative covenants, and easing the burden of information covenants.

In the current borrower-friendly market, we expect that SPAC momentum will contribute to further innovation in these and other financing terms in order to provide additional flexibility to accommodate SPAC structures.