Board governance of SPACs

    Effective governance requires independent directors to understand the value creation process, the risks involved, and how these risks can be managed through diligent board oversight.


    The Business Times, 9 August 2021

    SPECIAL purpose acquisition companies (SPACs) have been in the limelight. SPACs - basically, listed "blank-cheque" companies that merge with target firms seeking access to equity markets without going through an initial public offering (IPO) - are gaining traction in Asian markets. Examples of potential targets include Grab Holdings, Carousell, and PropertyGuru. The Singapore Exchange also launched a consultation exercise on SPAC listings earlier this year and is expected to release the results of this public consultation soon.

    A SPAC is different from other forms of listed entities and deserves special attention by its independent directors. To appreciate how this impacts board governance, it is important to understand the value creation process for two key stakeholders: the founders and investors of a SPAC.

    Value creation

    The SPAC founders, also known as sponsors, benefit through a promote, comprising additional shares and a substantial equity stake in the SPAC at a nominal purchase price. These founder shares are converted into shares of the new entity after the SPAC merges with the acquired firm or target, in a business combination transaction.

    SPAC investors, like founders, benefit through an appreciation in the stock price with a successful acquisition, as well as warrants that convert into SPAC shares at lower than market price.

    Overall, SPAC founders reap a windfall with a successful acquisition, given the nominal price paid for their shares and warrants. While investors also benefit, the upside is lower when compared with those of founders.
    Independent directors must pay close attention to three phases in the acquisition process.

    Selection of acquisition target

    A SPAC uses its IPO proceeds to acquire an operating company within a time frame of two to three years. Failing to meet the deadline leads to a winding up of the SPAC with the balance of funds returned to investors.

    SPAC investors rely on the expertise of founders to identify and pursue an acquisition target that creates value for shareholders. Independent directors must monitor the progress of searching for an acquisition target.

    Timely monitoring is crucial. A study published in the Journal of Accounting and Economics by Lora Dimitrova found that SPAC performance tends to be worse for acquisitions announced nearer the pre-determined deadline. Founders under time pressure may have an incentive to reap a windfall from their promote and warrants, even if the acquisition creates less value for investors.

    Acquisition approval

    Once an acquisition target is identified, listing rules may require independent directors to approve the acquisition. Independent directors must possess sufficient knowledge to assess a proposed acquisition. For instance, how knowledgeable and informed are they about the industry and operating environment of a target firm, especially if the firm operates in a foreign market? Are they familiar with valuation methods that assess whether the acquisition price fairly reflects the fundamentals of a target firm?

    Target firms identified near SPAC deadlines require directors to adapt to fast-moving transaction timelines, schedule meetings at short notice, and review complex and critical information quickly but carefully. Independent directors with limited knowledge are at risk of rubber-stamping what founders have proposed.

    Good governance avoids a power imbalance in the boardroom, especially when reputable founders have management expertise and a track record of investing in certain industries. While the reputation of founders is important, it is not a panacea for poor board oversight.

    Similarly, while an independent financial adviser may advise on the acquisition target, substantive monitoring requires independent directors to ask the right questions and to make an informed judgment.

    Independent directors must also be alert to conflicts of interests when SPAC founders have financial interests in target firms or when appointing financial advisers to advise on the business combinations.

    Potential candidates considering an independent director appointment in a SPAC should evaluate the reputation of the founders and clarify whether they intend to focus on certain industries or geographic focus for the business combination.

    Post-acquisition combination

    After a target acquisition has been identified and a deal negotiated, the "de-SPAC" process begins. This transaction occurs when the SPAC and acquired firm merge into one publicly listed entity. The corporate leaders of the SPAC and acquired firm must ensure an orderly transition for the board and executive team of the new entity.

    Since a SPAC has no business operations, the directors of the new entity must be able to effectively govern the acquired firm, while meeting all listing requirements. Hence, some turnover of independent directors presiding over the SPAC is not unexpected.

    Thomson Reuters recently reported that demand for directors' and officers' liability insurance in the US is increasing, given the higher litigation risks of breaching fiduciary duties related to SPAC acquisitions. Regulatory scrutiny over SPACs is also increasing.

    Recent class action lawsuits include those against Churchill Capital Corp III on grounds of making false or misleading statements and failing to disclose material adverse facts on a business combination.

    In general, independent directors must be familiar with the regulations governing SPACs for monitoring compliance. Effective governance also requires them to understand the value creation process, the risks involved, and how these risks can be managed through diligent board oversight.

    The writer is a member of the Advocacy and Research Committee of the Singapore Institute of Directors.