SPACs: International Practices, Governance Aspects and Their Implementation in Brazil

Introduction

Special purpose acquisition companies (SPACs) are publicly held shell companies whose sole purpose is to acquire participation in one or more operating companies. The strategy consists of raising funds in the market through an initial public offering (IPO) and reserving them in a separate bank account, while the sponsor[1] seeks out a company intending to go public within a pre-established period.

This funding structure first emerged in the United States in the 1990s and more recently has drawn the attention of several market participants worldwide. In 2021, 613 SPACs were launched in the U.S., reaching a funding total of USD 162.5 billion[2].

Although the Brazilian legal system does not prohibit the structuring of SPACs or the public offering of securities issued by them, there is a premise by the Brazilian Securities and Exchange Commission (CVM) that this kind of structure must be accessed solely by qualified investors.

Given the growing interest in Brazil, B3 S.A. – Brasil, Bolsa, Balcão (B3, the Brazilian stock exchange), conducted studies on the structuring of SPACs in various jurisdictions, in order to prepare a report with guidelines for SPACs aiming to list on B3. Some of the findings are summarised below. The full report can be found here.

Five Elementary Aspects

B3 identified five aspects in international standards that could contribute to overcoming existing issues while offering adequate protection to investors and legal certainty to sponsors.

Specific Allocation of the Funds Raised

In international practice[3], at least 90% of the funds raised in the SPAC's IPO must remain deposited in an escrow account allocated to: (i) enable investment in the target company; (ii) pay the shareholders' proportional interest in a SPAC, in case they decide to leave before the business combination; and (iii) refund investors in the event of a SPAC liquidation. It is important that the documents and contracts ring-fence the use of these funds.

Approval of a Business Combination at a General Meeting

Following the IPO, the target company search process is conducted and once chosen, the business combination must be formally approved. Some jurisdictions – notably the U.S.[4] – allow deliberation on this subject to be made by the board of directors, without approval in a shareholders’ general meeting.

According to Brazilian Corporate Law, the resolution on the target company acquisition may or may not be submitted to shareholders, depending on the chosen format. In any case, it is recommended to always be deliberated on by the shareholders, regardless of the chosen format and observing the due disclosure about, for instance, the operation’s conditions, evaluation criteria and capital structure following the transaction.

Minimum Clause

One of the SPAC’s main qualities is the reimbursement option during the business combination process. Therefore, it is recommended that the SPAC’s bylaws establish the scenarios in which the shareholders receive the proportional amount of their contribution back. Ideally, such a right would be given at least in: (i) a business combination approval; (ii) a bylaw amendment that results in a restriction of rights or the imposition of burdens on its shareholders; and (iii) a sponsor change.

Investor Compensation

If a SPAC’s term expires without the business combination being carried out, its managers must: (i) return the funds from the escrow account to the shareholders proportionally to their respective ownership; and (ii) delist the SPAC[5].

Informational Obligations

Seeking adequate disclosure for shareholders, it is recommended that SPAC and IPO documents show, besides their other disclosure duties: (i) risk factors specifically arising from the SPAC structure; (ii) remuneration and any benefits granted to sponsors and their stakeholders; (iii) funds’ source that will support the SPAC maintenance before the business combination; (iv) the main characteristics of the escrow account; and (v) the data and conditions for exercising the warrants issued by the SPAC.

Ten Additional Characteristics

Besides the points listed above, there are other areas where B3 would like to encourage further discussion.

• Term: there are rules that establish a timeframe for SPACs to acquire a target company – from 24 to 36 months after the IPO. In some jurisdictions, there is the possibility of extending the initial term[6].
• Sponsor: being a key stakeholder of a SPAC, it is recommended that the sponsor has a professional background and/or adequate business experience. They could be required to hold participation in a SPAC, subject to a lock-up, to align their interests with other shareholders[7].
• IPO: while deposited in the escrow account, the funds application may be previously defined[8] or exclusively chosen by the sponsor. Moreover, the underwriters’ fees can be divided into two tranches[9].
• Corporate governance: some rules establish that the SPAC’s board of directors must have independent members, and the business combination must be previously approved by most of them[10]. Furthermore, there could also be set a minimum number of independent members on mandatory advisory committees, such as remuneration and audit[11].
• Target company: stipulate a minimum percentage of the amount reserved in the escrow account for the business combination transaction[12].
• Business combination: some jurisdictions establish specific requirements, such as the need to hire an independent financial adviser to (i) assist the sponsor in finding a target company and conduct the business combination, or (ii) draft an appraisal report for the target company[13].
• Conflict of interests: if a business combination involves a target company that is a sponsor's related party[14], additional safeguards may be observed, such as obtaining a fairness opinion issued by an independent financial institution. Additionally, if the sponsor could act through vehicles other than the SPAC, it is recommended that measures to be taken to manage potential conflicts of interest should be disclosed.
• Refund: NYSE and Nasdaq rules allow all shareholders to have the right to recover the proceeds proportional to the shares owned by them regardless of whether they voted for or against the business combination[15].
• Political rights: NYSE and SGX rules require the business combination to be carried out, while being deliberated on by the board of directors – previously to the general meeting – and to be approved by most of its independent members[16]. Furthermore, the SPAC should consider limiting the sponsor and its affiliates’ stakeholders’ votes regarding the business combination, even though the use of dual class shares is allowed by local law and may be useful to protect the sponsor.
• Post-business combination: in the IPO documents, there could be a specific section exploring the possible scenarios for the shareholding base dilution resulting from the sponsor's participation or the exercise of available warrants and indicating what would be the necessary return on each share to offset them[17]. Also, a limit could be set for the SPAC's shareholding dilution from the exercise of warrants[18].

Conclusion

Considering the above-mentioned points, the adoption of certain practices can contribute to increasing the efficiency of SPACs, while mitigating the risks intrinsic to their structure and maintaining the integrity of the Brazilian securities market.

In this sense, after the conclusion of B3’s report, the SEC launched a public hearing proposing broad reforms for SPAC regulation, aiming to increase disclosure requirements for sponsors and repeal regulatory language that protects SPACs from lawsuits.

Likewise, when the vehicle reaches a certain level of maturity in Brazil, B3 will evaluate the convenience of issuing a specific rule along with the market. Meanwhile, the goal is to promote discussion in the domestic market and to see what the future holds.

---

[1] Responsible for undertaking a SPAC and conducting the business combination process.

[2] Data available at https://www.spacresearch.com.

[3] Nasdaq Rule IM-5101-2 and NYSE Listed Company Manual Section 102.06.

[4] See nº 3.

[5] See nº 3.

[6] Nasdaq Rule IM-5101-2, FCA Listing Rule 5.6.18AG(3), and SGX Mainboard Listings Rule 210(11)(m).

[7] SGX Mainboard Listings Rule 210(11)(e).

[8] SGX Mainboard Listings Rule 210(11)(i)(iv).

[9] NYSE Listed Company Manual Section 102.06 “f”.

[10] See nº 3.

[11] SGX Mainboard Listings Rule 210(11)(g).

[12] See nº 3.

[13] SGX Mainboard Listings Rules 210(11)(m)(v) and (vi).

[14] Concept according to Brazilian Technical Pronouncement CPC nº 05.

[15] See nº 3.

[16] NYSE Listed Company Manual Section 102.06 and SGX Mainboard Listings Rule 210(11)(m)(viii).

[17] FSMA Public Consultation about SPACs on Euronext Brussels (May/2021).

[18] HKEx Consultation Paper on SPACs, paragraphs 299 to 314.