Part II: NASDAQ’s Proposed Changes May Impact SPACs
So what does this mean for SPACs….
Below is the follow-up to the article that was published last week detailing Nasdaq’s proposed changes to its listing requirements. This time around, we focus on how the proposed changes could potentially impact SPAC combinations going forward should these listing standards become the new norm. As you’ll see, there are a few challenges. However, that’s why having an experienced SPAC lawyer is critical.
Read on to see what might be in store…
Part II: Nasdaq’s Proposed Changes May Impact Business Combinations… Although, Perhaps Some More Than Others
By: Carol Anne Huff, Kirkland & Ellis LLP*
As discussed in Part I of this article, Nasdaq’s proposal to exclude shares that are not currently freely tradeable for purposes of its initial quantitative listing standards will make it more difficult for some SPACs to meet Nasdaq’s standards upon closing a business combination. The extent to which the proposed rule changes impact a particular SPAC’s ability to remain listed at closing will depend on a variety of factors.
Which deals are likely to be impacted?
The good news is that SPACs with low levels of redemptions will likely not be impacted by Nasdaq’s proposed rule changes. The bad news is that redemptions happen and the extent of redemptions can be difficult to predict, making this an issue that all SPACs will need to understand.
Some recent SPACs have closed business combinations with redemptions in excess of 95% of their trust account. However, a high level of redemptions is not the death knell to closing a business combination that one would assume. Some SPACs have successfully sold equity through PIPE transactions enabling them to replace some, or in some cases virtually all, of the funds used to pay redeeming stockholders. It is this “recycling” of capital—replacing the SPAC’s IPO investors with a limited group of PIPE investors—that has resulted in illiquidity and contributed in some cases to volatility in trading and price distortion.
SPACs that have found themselves in this situation have generally nevertheless managed to meet the round lot holder requirement by working with their investment bankers to increase the number of retail account holders. Whether adding a $2,500 minimum value to the round lot requirement will make a significant difference in SPACs’ ability to generate a sufficient number of round lot holders remains to be seen. The bigger issue for some SPACs will likely be the exclusion of “restricted shares” from the shares that count towards meeting the publicly-held share and public float requirements. SPACs with high levels of redemptions end up with a relatively small number of stockholders so maximizing the number of non-affiliated stockholders that receive shares at closing that are freely tradeable will be very important.
As we discussed in Part I, to be freely tradeable, the shares must be either registered in the business combination transaction itself or registered for resale pursuant to a resale shelf registration statement. Nasdaq has informally indicated that shares registered for resale on a shelf registration statement would count as “unrestricted”. A resale registration statement can be filed relatively quickly post-closing, with most SPACs already committing to do so within 30 days post-closing. This raises the question of whether a short grace period might solve this problem for some SPACs.
When do the Initial Listing Standards Need to be Met—At Closing or 30 Days Later?
Currently, the timing for meeting Nasdaq’s initial listing standards varies as a matter of practice depending on the structure of the business combination transaction—specifically whether the SPAC remains the public company or if a new holding company is formed.
If the SPAC Remains the Public Company
When the SPAC remains the public company, the stock held by its pre-business combination stockholders remains outstanding and the SPAC merely changes its name. Nasdaq has not required SPACs that are continuing a listing in this manner to demonstrate compliance at closing with the round lot holder requirement. Instead, Nasdaq has used its discretion to allow companies to demonstrate compliance within 30 days after closing. If the company cannot demonstrate compliance within this period, a delisting letter is issued at that time and delisting would occur following Nasdaq’s normal appeal process, providing a further grace period, appeals process and time to regain compliance.
If a New Holding Company is Formed
In contrast, if a business combination is structured so that a new holding company is formed, Nasdaq treats the new holding company as making an initial listing of its shares. For tax or other reasons, a new holding company is sometimes formed and the SPAC and target each merge into subsidiaries of the new holding company and their respective stockholders receive stock of the new holding company. In this scenario, there appears to be less discretion for the stock exchange to allow a grace period after closing. This is likely due to the fact that the stock exchange must make a filing with the SEC regarding the new company having been approved for listing.
This 30-day timing difference for meeting the initial listing standards has been important to some SPACs in maintaining their listing and may become more important if Nasdaq’s new rules are approved.
Should SPACs Expect a 30-Day Grace Period to Comply with the Proposed New Standards?
Nasdaq has not indicated whether it expects to permit a similar grace period with respect to the “publicly held” requirement. Thirty days would be sufficient time for an issuer to file a shelf registration statement to register the resale of the shares issued to PIPE investors or issued to the target in the business combination. The registration of these shares would increase the number of shares available for trading.
In fact, in 2017, Nasdaq had proposed rule changes to allow SPACs 30 days following closing to demonstrate compliance with its listing standards. This proposal, which also included a proposal to reduce the number of required round lot holders, was withdrawn in 2018 and not resubmitted. Nasdaq has nevertheless as a matter of practice allowed SPACs that are continuing their listing a 30-day grace period to demonstrate compliance with the round lot requirement. Hopefully, Nasdaq will extend this position to the publicly held shares requirement as well, although there is no guarantee it will do so.
Can a Shelf Registration Statement for the Private Placement Shares be Effective at Closing?
It has become market practice for companies to agree contractually with PIPE issuers to file a registration statement within 30 days following closing and to have the registration statement declared effective within a specified number of days, e.g. 90 days. If Nasdaq does not permit issuers a 30-day grace period, SPACs may need to explore whether it will be possible to file a registration statement prior to closing with respect to the resale of shares issued to PIPE investors at closing.
This method has not typically been used in the SPAC context and the SEC has generally limited the circumstances in which it will permit issuers to register privately placed securities for resale prior to their issuance. Although the SEC has not tended to take an expansive approach when it comes to SPACs, the SEC does currently allow issuers to file resale registration statements prior to the issuance of securities in a PIPE in cases where the investor is irrevocably bound to purchase a set number of securities for a set purchase price.
In addition, the SEC requires that there can be no conditions to closing that are within an investor’s control or that an investor can cause not to be satisfied. Generally, PIPE investors in SPACs are irrevocably bound to purchase securities and there are no closing conditions within their control, suggesting filing a registration statement prior to closing may be an option SPACs could explore with the SEC, should it become necessary.
What About Transactions Using a New Holding Company Structure?
For transactions structured with a new holding company, there is good news and bad news. First, the bad news—as mentioned above, Nasdaq has required issuers to demonstrate compliance with all listing requirements at closing in order to commence trading. The goods new, though, is that issuers file a registration statement on Form S-4 and the new shares issued to both the SPAC stockholders (including holders of private placement and founder shares) and the target stockholders are registered and freely tradeable, other than by persons that are affiliates of the SPAC or target.
In some cases, in connection with this holding company structure, SPACs have also registered the shares issued to the PIPE investors. In these cases, PIPE investors received shares in the SPAC immediately prior to closing and the shares of the SPAC the investors received were then converted into shares of the new holding company. The issuance of shares to the PIPE investors by the new holding company was registered on the Form S-4. Utilizing this structure therefore increases the number of potentially freely tradeable shares.
Contractual Lock-Up Restrictions
To be “publicly held” for listing purposes, stock must be held by non-affiliates and:
- not subject to SEC resale restrictions; and
- not subject to lock-up restrictions.
Assuming a SPAC has solved the first issue by registering the transaction on Form S-4 or putting up a resale shelf at closing or shortly thereafter (if a grace period is permitted by Nasdaq), SPACs will still need to comply with the Capital Market requirement that at least 1 million shares be publicly held (with a value of either $15 million or $5 million, depending on which listing standard is used) by non-affiliates that are not subject to contractual lock-up restrictions. If the PIPE is placed with a sufficient number of holders that are not affiliates of the company, these requirements may be easy to meet.
If shares held by the PIPE investors are insufficient to meet the public float requirement, other options might include removing lock-up restrictions from shares held by non-affiliates of the surviving company such as:
- target stockholders who are not officers and directors of the surviving company (the number of which can sometimes be increased by distributing shares out of an entity that is the selling stockholder to its members or limited partners); and
- investors in the sponsor vehicle to whom private placement or founder shares are distributed.
Although it has become market practice for target stockholders to agree to a lockup of some duration, this is a matter of contract between the parties. If necessary to close a transaction, removing lock-ups from some of the shares held by non-affiliated target stockholders is an option.
With respect to pre-IPO private placement or founder shares, releasing lockup restrictions may be more difficult given the restrictions are pursuant to a letter agreement with the underwriters from the IPO. Depending on the number of investors in a sponsor vehicle, a distribution of shares to non-affiliated investors, with a release of lockup restrictions on those shares, could also add needed public float.
Thinly-Traded SPACs Should Expect Greater Scrutiny
Thinly-traded SPACs should assume that both exchanges are looking closely at whether sufficient public float exists to support a stock exchange listing. Regardless of whether the technical listing standards are met, both exchanges have discretion to deny or discontinue listing, which may make it difficult for SPACs that use a PIPE to “recycle” a large portion of the capital from their IPO investors to remain listed.
*Carol Anne Huff is a partner at Kirkland & Ellis LLP and regularly advises clients on transactions involving special purpose acquisition companies.