A Special Purpose Acquisition Company, or SPAC, is a publicly traded shell company formed for the sole purpose of identifying and merging with a private operating company, thereby taking that company public without going through a traditional initial public offering. SPACs experienced a dramatic surge in popularity in 2020 and 2021 before falling off sharply due to regulatory scrutiny, poor post-merger performance, and declining investor enthusiasm. Nevertheless, SPACs remain a viable path to public company status for certain target companies, and business owners should understand how these transactions work, what their advantages and disadvantages are, and how the regulatory environment has shaped the current landscape.
How SPACs Are Structured
A SPAC begins as a blank-check company formed by a sponsor — typically an experienced investor or industry operator — who takes the SPAC through an IPO. In the IPO, investors purchase units (consisting of shares and warrants) at a standard price, typically $10 per unit, and the proceeds are placed in a trust account that earns interest but cannot be accessed for any purpose other than completing a business combination or returning money to investors. The SPAC typically has 18 to 24 months to identify and complete a merger with a target company. If it fails to do so, the trust is liquidated and investors receive their pro rata share of the trust.
The SPAC sponsor typically receives a “promote” — shares representing 20 percent of the post-IPO equity — for a nominal cash contribution, in exchange for managing the SPAC and sourcing the target transaction. This promote represents a significant economic stake in the SPAC and is a source of the inherent conflicts of interest between the sponsor and the public shareholders, since the sponsor is highly motivated to complete any transaction that preserves the promote, even if that transaction is not in the best interest of the public investors.
The De-SPAC Merger: How It Works for the Target
When a SPAC identifies a target, the parties negotiate a business combination agreement under which the target merges with or into the SPAC or a subsidiary thereof, resulting in the combined entity becoming a publicly traded company. From the target’s perspective, this transaction is economically and legally complex. The target’s shareholders receive consideration in the form of shares of the combined public company, and the SPAC’s trust cash (less any redemptions) provides the primary source of cash consideration to the target.
The de-SPAC merger is governed by a detailed business combination agreement that addresses the merger consideration (the enterprise value placed on the target and the resulting per-share price), the treatment of target equity (common stock, preferred stock, warrants, and options), the conditions to closing (including shareholder approvals from both the SPAC and the target), the pipe financing (discussed below), and representations, warranties, and indemnification obligations that are structured differently from a traditional M&A agreement because the combined entity will be a public company after closing.
Unlike a traditional IPO, in which a company registers its shares and sells them to the public through a rigorous SEC review process, the de-SPAC merger allows the target to become public through a merger that may involve less initial SEC scrutiny of the target’s financial and business disclosures. This perceived regulatory arbitrage was a significant part of the SPAC appeal during the boom period, but the SEC has moved aggressively to close this gap through new rules adopted in 2024 that impose registration statement requirements and heightened disclosure obligations on de-SPAC transactions.
PIPE Financing
Because SPAC investors have the right to redeem their shares for trust value before the de-SPAC merger closes, there is no certainty about how much of the trust cash will actually be available to the combined company at closing. To address this uncertainty, SPAC transactions are almost always accompanied by a private investment in public equity, commonly called a PIPE. The PIPE is a private placement of shares in the to-be-public combined entity to institutional investors who commit to purchase at a fixed price (typically the $10 per share trust value or close to it) and hold their shares through and after the closing.
PIPE financing serves several functions. It provides a floor of committed capital that is not subject to redemption, giving the target and the SPAC more certainty about the cash available at closing. It signals to the market that sophisticated institutional investors believe in the transaction and the target’s value. And it can increase the total capital raised beyond what the SPAC’s trust alone would provide. However, PIPE financing also dilutes the existing shareholders of the combined company, and the terms on which PIPE investors receive their shares (including registration rights and, in some cases, below-market pricing or warrant coverage) can be economically unfavorable to the target’s founders and other equity holders.
Redemption Risk
The right of SPAC public shareholders to redeem their shares before the de-SPAC merger closes is perhaps the most significant source of deal certainty risk in SPAC transactions. If the market reacts negatively to the announcement of the target transaction — because investors are skeptical of the target’s valuation, the sector, or the transaction terms — a large proportion of public shareholders may elect to redeem. In extreme cases, redemption rates of 80 to 95 percent have been observed, leaving the combined company with very little trust cash.
High redemption rates have two consequences for the target. First, the total cash available to the combined company is reduced, potentially to a level insufficient to execute the target’s growth strategy. Second, the post-closing ownership structure is distorted: a company that anticipated a well-diversified public shareholder base may emerge from the de-SPAC merger with most of its shares held by the PIPE investors and the sponsor, with very little true public float. This thin float creates trading volatility and limits the liquidity benefits that were supposed to come from the public listing.
Targets evaluating a SPAC transaction should model redemption scenarios carefully and ensure that the business combination agreement includes mechanisms to address high redemption — such as a minimum cash condition that allows the target to walk away if redemptions are too high, or a larger PIPE commitment designed to fill the gap if redemptions exceed expected levels.
Lockups and Earnouts in De-SPAC Transactions
Target company shareholders who receive shares in a de-SPAC merger are typically subject to lockup restrictions that prevent them from selling their shares in the open market for a specified period after closing, typically six months to one year. Lockup provisions protect the market for the combined company’s shares by preventing large shareholders from immediately liquidating their positions and depressing the stock price. Target founders and executives should understand the terms of their lockup restrictions before agreeing to the transaction, as they can significantly limit the ability to convert post-merger stock into liquidity.
Earnout provisions are also common in de-SPAC mergers as a mechanism for bridging valuation gaps between the SPAC and the target. Under a typical earnout structure, the target’s shareholders receive additional shares of the combined company if the stock price achieves defined milestones within a specified period after closing, or if the combined company achieves specified financial targets. Earnouts in the SPAC context have unique characteristics because they are linked to a public company stock price rather than private company financial results, but they introduce the same fundamental risk as any earnout: the target’s shareholders are being asked to accept uncertain future value in lieu of certain present value.
The SEC Regulatory Environment
The Securities and Exchange Commission has substantially increased its regulatory scrutiny of SPAC transactions in recent years. The SEC’s 2024 rules governing SPACs and de-SPAC transactions require enhanced disclosures about the sponsor’s compensation and conflicts of interest, impose registration statement requirements on de-SPAC mergers comparable to those applicable in a traditional IPO, address the accounting treatment of SPAC warrants (which under certain interpretations must be classified as liabilities rather than equity), and clarify the liability framework applicable to projections and forward-looking statements made in connection with a de-SPAC transaction.
The liability framework change is particularly significant. One of the principal attractions of SPACs during the boom years was the view — widely held but not definitively established — that forward-looking projections shared in connection with a de-SPAC merger were protected from securities law liability under the Private Securities Litigation Reform Act’s safe harbor for forward-looking statements. The SEC’s new rules effectively deny that safe harbor in the de-SPAC context, meaning that optimistic financial projections made by the target to justify the transaction valuation can give rise to securities fraud liability if they prove incorrect. Targets and their advisors must now treat the financial projections and disclosure documents in a de-SPAC transaction with the same rigor and liability awareness as they would in a traditional IPO.
SPAC transactions remain a complex and evolving area of securities and M&A law. Business owners considering a SPAC as a path to liquidity or public company status should engage experienced securities and M&A counsel early, understand the economic implications of the sponsor promote and PIPE dilution, model redemption risk carefully, and approach the regulatory disclosure process with the same rigor as a traditional IPO.