Alternative Initial Public Offering Models: The Law and Economics of Shell Company Listings in German Capital Markets (Studien Zum Auslandischen Und Internationalen Privatrecht) 9783161538940, 3161538943

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Studien zum ausländischen und internationalen Privatrecht 368 Herausgegeben vom

Max-Planck-Institut für ausländisches und internationales Privatrecht Direktoren: Jürgen Basedow, Holger Fleischer und Reinhard Zimmermann

Axel Moeller

Alternative Initial Public Offering Models The Law and Economics Pertaining to Shell Company Listings on German Capital Markets

Mohr Siebeck

Axel Moeller, born in Windhoek (Namibia); studies in law and economics at the University of Cape Town, Bucerius Law School and WHU Otto Beisheim School of Management; research and teaching associate at the Institute of Law and Economics, University of Hamburg; 2013– 2015 research associate at the Max-Planck-Institute for Comparative and International Private Law; currently Max Planck Fellow, Faculty of Law, University of Oxford.

ISBN 978-3-16-153894-0 ISSN 0720-1141 (Studien zum ausländischen und internationalen Privatrecht) Die Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliographie; detailed bibliographic data are available on the Internet at http://dnb.dnb.de. © 2016 by Mohr Siebeck Tübingen, Germany. www.mohr.de This book may not be reproduced, in whole or in part, in any form (beyond that permitted by copyright law) without the publisher’s written permission. This applies particularly to reproductions, translations, microfilms and storage and processing in electronic systems. The book was printed by Gulde-Druck in Tübingen on non-aging paper and bound by Buchbinderei Nädele in Nehren. Printed in Germany.

Acknowledgements This thesis was admitted for the degree of Doctor of Law (doctor iuris) at the Bucerius Law School during the second trimester in 2015. The research described herein was conducted during my research associateship with the Institute of Law and Economics at the University of Hamburg and subsequently as a research associate with the Max Planck Institute for Comparative and International Private Law. Three professors have played a pivotal role in my academic development as a postgraduate and doctoral student in Hamburg. First, I am very grateful to my first advisor, Prof. Dr. Hans-Bernd Schäfer, for his trust and encouragement towards my endeavors of an interdisciplinary thesis topic and for his highly valuable input toward the economic part of my thesis. Equally important, my second advisor, Prof. Dr. Dr. h.c. mult. Karsten Schmidt, has substantially contributed to my insights and understanding of the German business and capital markets law, all of which was highly beneficial to the legal deliberations in this book. Finally, I am particularly grateful to Prof. Dr. Dr. h.c. mult. Reinhard Zimmermann for the valuable support and counsel in all of my endeavors and for the unparalleled opportunities offered during my research associateship with the Max Planck Institute for Comparative and International Private Law. Good friendship has been equally invaluable to me over the past years. Dr. Henric Hungerhoff, Dr. Karoline von Loeper, Donata von Enzberg, Dr. Clemens von Doderer, Konrad von Lyncker, Dr. Arletta Guenther-Lübbers, Yong Nguyen, Klaus-Peter Thießen and Lennart Kähling have been and continue to be very dear friends since earlier and more recent times. Also my current and former office colleagues at both the Institute for Law and Economics and the Max Planck Institute for Comparative and International Private Law, Dr. Sönke Häseler, Sina Imhof, Eike Hosemann, Samuel Fulli-Lemaire and Jakob Gleim were valued companions! The third pillar of support has undoubtedly been my family in Namibia and Germany. Their unconditional faith and guidance has been contributing to my well-being in ways immeasurable. I dedicate this book to them. Clearly, I cannot claim that this piece of work is the result of a purely solitary endeavor brought about under pain-staking personal privations. And

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Acknowledgements

though I claim this dissertation to be an individual work, I must acknowledge that I could never have reached the heights or explored the depths without the friendship, support, guidance and efforts of the above mentioned persons and institutions. Oxford 2016

Axel Moeller

Summary of Contents Acknowledgements : : : : : : : : : : : : : : : : : : : : : : : : : : List of Tables

V

: : : : : : : : : : : : : : : : : : : : : : : : : : : : : XIII

List of Figures : : : : : : : : : : : : : : : : : : : : : : : : : : : : : XIV List of Abbreviations : : : : : : : : : : : : : : : : : : : : : : : : : XV Introduction : : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

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Chapter 1: Background Information on SPAC Shells : : : : : : : : :

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Chapter 2: SPAC Anatomy and Transactional Practice : : : : : : : :

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Chapter 3: SPACs and the Applicable German Law : : : : : : : : : :

33

Chapter 4: Statistical Analysis of SPACs : : : : : : : : : : : : : : : :

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Conclusion and Outlook : : : : : : : : : : : : : : : : : : : : : : : :

101

Bibliography : : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

107

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111

Index

Contents Acknowledgements : : : : : : : : : : : : : : : : : : : : : : : : : : List of Tables

V

: : : : : : : : : : : : : : : : : : : : : : : : : : : : : XIII

List of Figures : : : : : : : : : : : : : : : : : : : : : : : : : : : : : XIV List of Abbreviations : : : : : : : : : : : : : : : : : : : : : : : : : XV Introduction : : : : : : : : : : Outline . . . . . . . . . . . Research Topic and Aim . Course of Study . . . . . .

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1 1 1 2

Chapter 1: Background Information on SPAC Shells : : : : : : : : :

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Historical Development of SPACs in US and European Capital Markets . . . . . II. Fraudulent Blank Cheque Company Listings on the Penny Stock Market . . . . . . . . . . . III. The Passing of Corrective Legislation . . . . . IV. The Emergence of SEC Rule 419 . . . . . . . V. The Emergence of 1st Generation SPACs . . . VI. 2nd and 3rd Generation SPACs and the Leap into European Capital Markets . . . . . . . .

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Chapter 2: SPAC Anatomy and Transactional Practice : : : : : : : :

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Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . 1. SPAC Founders and Management Team . . . . . . . 2. SPAC Shareholders . . . . . . . . . . . . . . . . . . . 3. Owners and Management of the Target Corporation Corporate Governance Structures . . . . . . . . . . . . . 1. Stipulated Time Frame . . . . . . . . . . . . . . . . . 2. IPO Proceeds Held in Trust . . . . . . . . . . . . . . 3. Shareholder Vote and Right to Opt Out . . . . . . . 4. Conversion Threshold Through Share Redemption .

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Contents

5.

Managerial Compensation and Incentive Scheme vs. “At Risk Capital” . . . . . . . . . . . . . . . . . . . . . . . . 6. Minimum Fair Market Value Multiple . . . . . . . . . . . . 7. Interim Result . . . . . . . . . . . . . . . . . . . . . . . . . . III. SPAC Transaction: A Twofold Double Trust Dilemma . . . . . 1. Moral Hazard between SPAC Shareholders and Managers . 2. Moral Hazard between Target Firm and SPAC Managers . a) Economic Benefits . . . . . . . . . . . . . . . . . . . . . b) Economic Risk Factors . . . . . . . . . . . . . . . . . . 3. Interim Result . . . . . . . . . . . . . . . . . . . . . . . . . . IV. Case Study: Hicks Acquisition vs. Graham Packaging . . . . . . 1. Target Description: Graham Packaging I, Inc. . . . . . . . . 2. Deal Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Investment Rationale . . . . . . . . . . . . . . . . . . . . . . a) Premium Asset in the Packing Industry . . . . . . . . . b) New World-Class Senior Management Installed in 2006 c) Significant Upside Potential to New Investors . . . . . . 4. Company Overview and Transaction Structure . . . . . . . 5. Interim Result . . . . . . . . . . . . . . . . . . . . . . . . . . V. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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15 17 18 20 21 23 23 25 27 27 28 28 29 29 29 29 29 30 30

Chapter 3: SPACs and the Applicable German Law : : : : : : : : : :

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I.

34 34 35 36 37 37 37 38 40 40 40 41 42 43

Going Public with a SPAC – Capital Markets Law . . . 1. Prospectus Requirement . . . . . . . . . . . . . . . a) SPAC Units Consisting of Shares and Warrants b) Public Offer . . . . . . . . . . . . . . . . . . . . c) Regulated Domestic Market . . . . . . . . . . d) Interim Result . . . . . . . . . . . . . . . . . . 2. Prospectus Content . . . . . . . . . . . . . . . . . . a) SPAC-specific Challenges . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . 3. Accessing Alternative Capital Market Segments . a) Admission Through the OTC Market . . . . . b) Admission Through the Regulated Market . . c) Interim Result . . . . . . . . . . . . . . . . . . 4. Interim Conclusion: Capital Markets Law . . . . .

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Contents

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Corporate Law Aspects Pertaining to SPACs . . . . . . . . . . . . 1. Aspect 1: SPAC Share Subscriptions and Trust Account . . . a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 2. Aspect 2: Differing Share Classes for Sponsors and Investors a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 3. Aspect 3: SPAC Merger Transaction and Shareholder Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 4. Aspect 4: Opt Out and Share Redemptions . . . . . . . . . . a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 5. Aspect 5: Acquisition or Liquidation . . . . . . . . . . . . . . a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 6. Aspect 6: Naked Warrants . . . . . . . . . . . . . . . . . . . . a) SPAC-specific Challenges . . . . . . . . . . . . . . . . . . b) Interim Result . . . . . . . . . . . . . . . . . . . . . . . . 7. Interim Conclusion: Corporate Law . . . . . . . . . . . . . . III. SPACs in View of the BGH Judgments on Shell Utilisations . . . 1. Shell Utilisations in Germany . . . . . . . . . . . . . . . . . . a) Off-the-shelf Shell versus “Recycled” Shell . . . . . . . . b) Shell Utilisation versus Business Restructuring . . . . . . 2. BGH Judgments on Shell Utilisations . . . . . . . . . . . . . a) 2002/2003: Doctrine of “Economic Re-incorporation” . . b) 2010: Narrower Applicability of an “Economic Re-incorporation” . . . . . . . . . . . . . . . . . . . . . . c) 2012: Dismissing Perpetual Liability? . . . . . . . . . . . d) Attempting to Classify SPACs: Empty or not? . . . . . . 3. Legal Consequences for SPAC Transactions . . . . . . . . . . a) Disclosure and Register Court Controls . . . . . . . . . . b) Adverse Balance Liability . . . . . . . . . . . . . . . . . . c) Action Liability . . . . . . . . . . . . . . . . . . . . . . . . 4. Interim Result and Critique on the BGH Judgments . . . . . IV. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

XI 43 43 44 45 45 46 48 49 49 53 53 53 55 55 55 57 57 57 58 59 60 60 60 61 62 63 63 65 66 69 69 71 72 72 74

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Contents

Chapter 4: Statistical Analysis of SPACs : : : : : : : : : : : : : : : :

77

I. II.

SPAC IPO and Execution Statistics . . . . . . . . . . . . . . SPAC Excess Return Patterns: Shares and Warrants . . . . . 1. The CAPM Approach . . . . . . . . . . . . . . . . . . . a) A Cursory Note on the Mathematical Framework . b) A Cursory Note on Market Efficiency . . . . . . . . c) A Cursory Note on the Estimation of Rf and Rm . 2. Results: Excess Returns on SPAC Shares and Warrants a) The SPAC Dilution Hurdle . . . . . . . . . . . . . . b) Sensitivity Analysis: Addressing the SPAC Dilution Hurdle . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Interim Results . . . . . . . . . . . . . . . . . . . . . . . III. Comparative Single Factor Portfolio Regression . . . . . . . 1. Determining the Beta Equation . . . . . . . . . . . . . . a) Automatic Rebalancing of Portfolios . . . . . . . . . b) Additional Considerations . . . . . . . . . . . . . . 2. Comparative Regressional Outputs and Interpretation thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . a) Significance of Beta and Risk-adjusted Performance b) Significance of Alpha . . . . . . . . . . . . . . . . . c) Coefficient of Determination (R2 ) . . . . . . . . . . d) Comment on the Standard Error of Estimate . . . . 3. Interim Results . . . . . . . . . . . . . . . . . . . . . . . IV. Analysing the Trading Behaviour of SPACs . . . . . . . . . . 1. Fama–French Four Factor Regressional Approach . . . a) Market Weighted vs. Equal Weighted Portfolio Regressions . . . . . . . . . . . . . . . . . . . . . . . b) Interim Results . . . . . . . . . . . . . . . . . . . . . 2. Trust Account Statistics . . . . . . . . . . . . . . . . . . V. Pre-IPO SPAC Statistics . . . . . . . . . . . . . . . . . . . . 1. Comparative IPO Time and Cost Structure . . . . . . . 2. Pre-IPO Target Focus of SPACs . . . . . . . . . . . . . . VI. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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93 95 95 97 97 98 99

Conclusion and Outlook : : : : : : : : : : : : : : : : : : : : : : : :

101

Bibliography : : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

107

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111

Index

List of Tables 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Life Span of SPACs (Months) . . . . . . . . . . . . . . . . . . . SPAC IPO Proceeds (%) Held in Trust . . . . . . . . . . . . . . Conversion Threshold (%) of SPACs . . . . . . . . . . . . . . . Sponsors’ “At Risk Capital” . . . . . . . . . . . . . . . . . . . . No. of SPACs per Managerial Compensation Scheme . . . . . . Fair Market Value Multiple . . . . . . . . . . . . . . . . . . . . . SPAC IPO Statistics (2003–2011) . . . . . . . . . . . . . . . . . . SPAC Execution Statistics (2003–2011) . . . . . . . . . . . . . . Monthly Excess Return (ER) Statistics on SPAC Shares and Warrants (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Value Weighted Fama–French Excess Returns (2003–2011) . . . Equal Weighted Fama–French Regression Results (2003–2011) Comparative Share Price and Trust Value Statistics (2005–2011) Average IPO Statistics . . . . . . . . . . . . . . . . . . . . . . . . Illustrative SPAC Execution Time Line . . . . . . . . . . . . . .

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13 14 15 16 16 18 78 78

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83 94 95 96 97 98

List of Figures 1 2 3 4 5 6 7 8 9 10 11

Sponsor Economics (Assume: $100 Million IPO) . . . . . . . . . Life Cycle of a SPAC Investment Process . . . . . . . . . . . . . Illustrative Transaction Structure . . . . . . . . . . . . . . . . . . SPAC Acquisition Focus since 2003 (Based on the Vol. of IPOs as at 31/12/2011) . . . . . . . . . . . . . . . . . . . . . . . . . . . Average No. of Days Utilised until Takeover Execution (as at 31/12/2011) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The SPAC Dilution Hurdle – A Calculated Example . . . . . . SPAC Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . Beta Equation for a SPAC Portfolio . . . . . . . . . . . . . . . . Beta Equation for a Non-SPAC Portfolio . . . . . . . . . . . . . SPAC Target Sectors since 2003 (as at 31/12/2011, Based on 94 Successful Acquisitions) . . . . . . . . . . . . . . . . . . . . . . . SPAC Target Type since 2003 (as at 31/12/2011, Based on 94 Successful Acquisitions) . . . . . . . . . . . . . . . . . . . . . . .

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17 19 30

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79 84 86 88 88

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99

List of Abbreviations

AA acquis. ADF Adj. AG AGB AGM AktG Alt. AMEX Announc. Apr. ARDL BaFin BB BGB BGH BGHZ

BörsG BörsO BörsZulV BR-Drs. BT-Drs.

CA

Announced Acquisition phase (of a SPAC transaction) acquisition Augmented Dickey–Fuller (regressional test) Adjusted German stock corporation (Aktiengesellschaft), Die Aktiengesellschaft (journal) terms and conditions (Allgemeine Geschäftsbedingungen) Annual General Meeting German Stock Corporation Act (Aktiengesetz) Alternative American Stock Exchange Announcement April Autoregressive Distributed Lag Model German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) Betriebs-Berater (journal) German Civil Code (Bürgerliches Gesetzbuch) German Federal Court of Justice (Bundesgerichtshof ) Judgments of the German Federal Court of Justice on civil matters (Entscheidungen des Bundesgerichtshofes in Zivilsachen) German Stock Exchange Act (Börsengesetz) German Stock Exchange Rules (Börsenordnung) German Stock Exchange Admission Regulation (Börsenzulassungs-Verordnung) Negotiations of the German Federal Council/Printed Materials (Verhandlungen des Bundesrates/Drucksachen) Negotiations of the German Bundestag/Printed Materials (Verhandlungen des Bundestags/Drucksachen) Completed Acquisition phase (of a SPAC transaction)

XVI

List of Abbreviations

CAPM CapEx CESR C.F.R. Cov.

Capital Asset Pricing Model Capital Expenditure Committee of European Securities Regulators Code of Federal Regulations Covariance

DB de. Dec. Dev. DStr

Der Betrieb (journal) German December Deviation Deutsches Steuerrecht (journal)

E[x] EBIT EBITDA

Expected Value of x Earnings Before Interest and Tax Earnings Before Interest, Tax, Depreciation and Amortisation European Commission, European Community Error Correction Model edition Electronic Data Gathering, Analysis, and Retrieval for example (lat. exempli gratia) Efficient Market Hypothesis and the following singular (lat. et sequens) and the following plural (lat. et sequentia) European Union excluding

EC ECM ed. EDGAR e.g. EMH et seq. et seqq. EU excl. FB Feb. Fed. Reg. FIG FMV fn. Frankf. Komm. FS GmbH GmbHG

Finanz-Betrieb (journal) February Federal Register of the United States Government Financial Industry Group Fair Market Value footnote Frankfurt Commentary on the German Securities Prospectus Act (Frankfurter Kommentar zum WpPG) Commemorative Publication (Festschrift) Limited Liablity Company (Gemeinschaft mit beschränkter Haftung) German Limited Liability Company Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung)

List of Abbreviations

XVII

GP GroßkommAktG

Going Public phase (of a SPAC transaction) Commentary on the German Securities Act (Großkommentar zum Aktiengesetz)

HAC Hdb. HML

Hicks Acquisition Company Handbook (Handbuch) High Minus Low (return spread variable)

ibid. i.e. IPO

the same place (lat. ibidem) in other words (lat. id est) Initial Public Offering

Jan. Jul. Jun. JuS

January July June Juristische Schulung (journal)

KG KGaA

Court of Appeal in Berlin (Kammergericht) German partnership limited by shares (Kommanditgesellschaft auf Aktien) Commentary on Capital Markets Law (KapitalmarktrechtsKommentar) Cologne Commentary on the German Securities Act (Kölner Kommentar zum Aktiengesetz) German Control and Transparency Act (Gesetz zur Kontrolle und Transparenz im Unternehmensbereich)

KMRK KölnKommAktG KonTraG

lat. LOI LTM

Latin Letter of Intent Last Twelve Months

m M&A Mar. Mkt. Münch.Hdb.GesR.

million Mergers and Acquisitions March Market Munich Handbook on German Business Law (Münchener Handbuch zum Gesellschaftsrecht) Munich Comment on the German Securities Act (Münchener Kommentar zum Aktiengesetz)

MünchKommAktG

NASAA NASD

North American Securities Administrators Association National Association of Securities Dealers

XVIII

List of Abbreviations

NJW No. NPV NYSE

Neue Juristische Wochenschrift (journal) Number Net Present Value New York Stock Exchange

OLG OLS Oct. OTC OTC

German Higher Regional Court (Oberlandgericht) Ordinary Least Squares October Over-the-Counter Over-the-Counter Buletin Board

P p. para. PEHAC P/E PIPE Portf. Prem. ProspektVO PSRA PSS ARDL publ. Pub. L. No. PV

Price page paragraph Pan-European Hotel Acquisition Company Price Earnings ratio Private Investment in Public Equity Portfolio Premium EC Prospectus Regulation (Prospektverordnung) Penny Stock Reform Act of 1990 Pesaran, Shin and Smith Autoregressive Distributed Lag Model publication Public Law Number Present Value

RA ROI

Rejected Acquisition phase (of a SPAC transaction) Return on Investment

SE SEC sec. Sec. Act Sec. Exch. Act Sep. S/H SMB S&P 500 SPAC Stand.

Societas Europaea Securities and Exchange Commission section Securities Act Securities Exchange Act September shareholder Small Minus Big (return spread variable) Standard and Poors 500 Index Special Purpose Acquisition Company Standard

List of Abbreviations

XIX

Stat. Std. Dev. sub. Subcomm.

statute Standard Deviation subparagraph Unites States Congressional Subcommittee

T, t Telecomm. TEV

time Telecommunication (industry) Total Enterprise Value

UMD UmwG US U.S.C. U.S.C.C.A.N.

Up Minus Down (momentum variable) German Transformation Act (Umwandlungsgesetz) United States United States Code United States Code Congressional and Administrative News

Vol. vs.

Volume versus

WpHG WpPG

German Securities Trading Act (Wertpapierhandelsgesetz) German Securities Prospectus Act (Wertpapierprospektgesetz)

ZGR

Zeitschrift für Unternehmens- und Gesellschaftsrecht (journal) Zeitschrift für das gesamte Handelsrecht (journal) Zeitschrift für Wirtschaftsrecht (journal) German Code of Civil Procedure (Zivilprozessordnung)

ZHR ZIP ZPO

Introduction Outline Today’s international capital markets present a seemingly inexhaustible multitude of financial instruments. Their primary aim is the saturation of contemporary investment requirements in the securities market. The continuous search for even better and yet more flexible models of public equity financing has resulted in a fierce competition for potential capital market investors, specifically in the realm of mergers and acquisitions. These developments have also targeted the classical Initial Public Offering (IPO) model of companies on stock exchanges, the result of which has been the derivation of an alternative way of listing a company through a so called Special Purpose Acquisition Company or SPAC. The latter seeks to subsequently place an unlisted company on the stock exchange by means of a shell company. In light of the fact that a SPAC does not have any operations, the sole purpose of the shell is to find an operating company which is ultimately merged with or acquired from the proceeds of the initial SPAC listing. Ultimately SPACs provide the means for a “swift and smooth” listing of companies seeking access to the capital markets. Having evolved from the fraudulent blank cheque company listings in the United States of America in the 1980s, SPACs have undergone multiple transformations from the first generation model in the 1990s to the current third generation model. Recently SPACs have also reached Europe and have since steadily penetrated into multiple European countries, including Germany. Research Topic and Aim The underlying thesis seeks to answer the dogmatic questions pertaining to SPACs in Germany from a law and economics perspective. In light of the fact that a legal framework with regard to SPAC-IPOs does not exist, the underlying legal analysis is based on the accumulation of general principles derived from German business and corporate law as well as capital markets law. From an economic and financial perspective, the ensuing analysis seeks

2

Introduction

to illustrate the potential efficiency gains of a SPAC-IPO for German small and medium-sized enterprises (so called “Deutscher Mittelstand”). Subsequently this thesis seeks to provide a practical guideline against the background of the underlying legal and economic considerations deployed therein. Thus the primary success of this thesis should be judged in terms of its ability to provide an initial overview of the methods of practically implementing a SPAC in the German corporate landscape. Course of Study The course of study is as follows: chapter one provides background information on SPACs, especially with regard to their historical evolvement from the fraudulent blank cheque listings during the 1980s as well as the subsequently passed SEC Rule 419 of 1991. The anatomy of SPACs will be discussed in chapter two by focussing specifically on the stakeholders involved as well highlighting the rigorous corporate governance structures applicable to SPACs. The same chapter will also contain a principal-agent analysis of SPACs and will draw conclusions on the transactional practice of the SPAC model from the viewpoint of the three major stakeholders involved: SPAC management board, SPAC shareholders and target firm. Finally chapter two contains a case study with an overview of the underlying transaction, the investment rationale as well as the deal terms pertaining to a SPAC IPO transaction. The ensuing chapter three has been devoted to the German law as it applies to SPAC shells, with an analysis of both the capital markets law as well as business law pertaining to SPACs. Moreover, chapter three contains a scrutiny of SPACs in light of the judgments of the German Federal Supreme Court (BGH) on shell utilisations. Subsequently the data sets will be subjected to a rigorous econometric analysis with a view on both pre- and post-IPO statistics as well as deal execution considerations (chapter four). Moreover, various regressional models will be applied to both SPAC and non-SPAC data, the aim of which will be to demonstrate the relative performance and efficiency discrepancies inherent in the two alternative IPO models. Also, the trading behaviour of SPAC shares will be analysed against three economic assumptions defined at the outset of that subsection. The thesis will be concluded in chapter five, with recommendations about the feasibility of the SPAC shell as an alternative IPO model.

Chapter 1

Background Information on SPAC Shells I. Historical Development of SPACs in US and European Capital Markets SPAC shell companies have evolved from a history of corrupt and fraudulent transaction schemes which plagued the US stock market during the 1980s.1 In fact first generation SPACs have directly descended from the historically misused and fraudulent blank cheque companies2 and have thus existed as an asset class since the early 1990s.3 Ever since, SPACs have undergone multiple transformations beginning with the first generation model of the 1990s, via second generation SPACs from 2003–2008, to the current third generation model which was first observed in late 2010. The underlying sections provide an overview of the historical developments and regulatory framework pertaining to SPACs both in the United States of America as well as in Europe. Notably, the advance of European SPACs first occurred in July 2007 with the listing of the Pan-European Hotel Acquisition Company (PEHAC) on the NYSE Euronext in Amsterdam.4

1 Compare Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 238; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 932; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 532. 2 The term “blank cheque company” describes the idea of entrusting the underlying management team with a broad freedom of transaction on behalf of its investors. 3 Compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 932; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 319. 4 Compare press release of NYSE Euronext Amsterdam of 19 Jul. 2007, available at hwww.euronext.com/fic/000/023/346/233467.pdfi (accessed 28 Apr. 2012).

4

Chapter 1. Background Information on SPAC Shells

II. Fraudulent Blank Cheque Company Listings on the Penny Stock Market During the 1980s, US capital markets were marked by enormous growth5 as stated in a United States Senate report: “Between 1980 and 1989, the number of securities firms increased approximately 90 per cent, the number of investment companies grew more than 145 per cent, the number of investment advisers more than tripled, the number of registration statements filed annually with the SEC doubled, and the number of tender offer filings increased over 670 per cent.”6

During this surging wave of stock listings, the founding of so called blank cheque companies was triggered. These companies were incorporated on the penny stock market7 as shell companies whose sole purpose was to seek investment opportunities via mergers and acquisitions through so called pump and dump trading practices.8 These manipulative practices9 involved allotting the majority of shares issued through a blank cheque company to insiders and their close affiliates, who would then – in collusion – spread wrong information about a forthcoming and highly lucrative acquisition of an allegedly profitable target.10 Such rumours would force (pump) share prices up, whereupon insiders would sell (dump) the majority of shares on the market. As a result, the artificially inflated share prices would drop, leaving the uninformed

5

Compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 934, quoting from Senate Report No. 101-337, at 2 (1990): “[I]n recent years, the markets under the SEC’s jurisdiction have grown dramatically in size and complexity”. 6 See Senate Report No. 101-337, at 2 (1990); Also compare Morris, The Administrative Law Journal, Vol. 7 (1993), p. 151 et seqq., 155; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 934. 7 Penny stocks are often also referred to as cent shares of listed corporations with very low market capitalisation. Historically such shares traded at or below values of $ 1. 8 See House of Representatives Report No. 101-617, at 10–12; Also see Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 246; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 535. 9 According to the House of Representatives Report No. 101-617, at 9–10, “the increased manipulation of the penny stock market in the 1980s has been linked to two developments: (1) Brokerage firms shifted from dealing solely with the initial offerings of penny stocks to also trading the penny stocks on the secondary market, and (2) marketing securities to potential customers became less onerous as communication technology, such as long distance telephone calling, the computer, and the telefax, became less expensive and more accessible to brokerage firms”; also see Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531, 535. 10 Also see Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 535; Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 246.

III. The Passing of Corrective Legislation

5

investor with essentially worthless shares.11 These trading practices lead to approximately $2 billion losses of shareholder value per annum towards the end of the 1980s.12 In 1988 blank cheque listings were officially declared as highly manipulative and corrupt investment tools in need of aggressive regulation and disclosure requirements as well as strict investor protection mechanisms.13

III. The Passing of Corrective Legislation In light of the above scenario, the so called Penny Stock Hearings were instituted by members of the US Congress, the National Association of Securities Dealers (NASD), the SEC, the North American Securities Administrators Association (NASAA), and other regulatory bodies.14 These hearings ultimately culminated in a regulatory framework which was promulgated under the so called Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (PSRA).15 The latter induced significant amendments of Section 7 of the Securities Act of 193316 to the extent that blank cheque companies were – inter alia – defined as “any development stage company that (i) has no specific business plan or purpose; or (ii) has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies.”17 Moreover, § 77 g(b)(1) Sec. Act now stipulates special rules as to the registration statements filed by the issuer of a blank cheque company. Specifically, and to the extent deemed appropriate with regard to protecting investors, the 11 Also see Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 535; Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 247. 12 Compare Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 244; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 934; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 535. 13 See House of Representatives Report No. 101-617, at 7–10, 20–23. Also compare Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 239; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 936. 14 Penny Stock Market Fraud (Part 2): Hearings before the Subcomm. on Telecommunications and Finance of the H. Comm. on Energy and Commerce, 101st Cong. 93 (1990). Also see Niesar/Niebauer, Securities Regulation Law Journal 20 (1992), p. 227 et seqq., 268; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 937, 940, Murray, James S.: The Regulation and Pricing of Special Purpose Acquisition Corporation IPOs, Christchurch Polytechnic Institute of Technology, Christchurch 2014, p. 4. 15 Securities Enforcement Remedies and Penny Stock Reform Act of 1990, Pub. L. No. 101429, 104 Stat. 931 (1990), often simply referred to as the Penny Stock Reform Act or PSRA. 16 Securities Act of 1933, 15 U.S.C. § 77g(b) (2000). Also compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 936. 17 15 U.S.C. § 77 g(b)(3) (2006).

6

Chapter 1. Background Information on SPAC Shells

SEC is authorised to require timely disclosure of (i) information regarding the company to be acquired and the specific application of the proceeds of the offering, or (ii) additional information necessary to prevent such statement from being misleading according to § 7 g(b)(1)(A) Sec. Act. Also, in accordance with § 77 g(b)(1)(B) Sec. Act, limitations are imposed on the use of such proceeds and the distribution of securities by such issuer until the disclosures required under subparagraph (A) have been made. Ultimately, shareholders shall have a right of rescission of such shares as stipulated in § 77 g(b)(1)(C) Sec. Act. The PSRA also lead to the amendment of § 15 (b)(6) Sec. Exch. Act, in terms of widening the SEC’s competencies to exclude certain participants from the stock exchange, who were former or current perpetrators of the applicable law.18 Hence, due to such expansion of the SEC’s competencies, the latter forbade the distribution of penny shares without the SEC’s prior consent, if on the basis of reasonableness the underlying broker was or should have been aware of the participation of an excluded participant.19

IV. The Emergence of SEC Rule 419 Significant parts of the PSRA pertaining to blank cheque offerings were further substantiated through the subsequently issued SEC Rule 419 of 199120 , the purpose of which was (i) to impose rigorous controls on blank cheque listing proceeds and (ii) to enhance the quality and disclosure of information to investors with regard to shell companies as well as potential acquisition targets.21 The following quintessential and path-breaking provisions22 were passed through the SEC Rule 419: 1. The requirement to promptly deposit the gross proceeds from the blank cheque offering in a trust account maintained by an insured depository institution according to § 230.419 (b)(A) C.F.R., or to deposit such proceeds 18 See § 504 PSRA; also see House of Representatives Report No. 101-617, at 28; also compare Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 249. 19 Compare Castelli, Boston College Law Review, Vol. 50 (2009), p. 237 et seqq., 249. 20 C.F.R. § 230.419 (2007); Blank Check Offerings, Securities Act Release No. 6,891, Exchange Act Release No. 29,096, 48 SEC Docket 962, 1962 (17 Apr. 1991). 21 Also see Cohn, Securities Counseling for Small and Emerging Companies, Thomson Reuters Westlaw, 2006, § 19:19; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 538. 22 Also compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 937, 942; Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 538 et seq.

V. The Emergence of 1st Generation SPACs

7

into a separate bank account established by a broker or dealer registered under the Exchange Act, maintaining net capital equal to or exceeding $25.000 and acting as trustee in accordance with § 230.419 (b)(B) C.F.R. 2. The filing of a prompt post-effective amendment requirement upon the identification of a probable acquisition target, disclosing all pro forma financial information in accordance with the applicable law as well as ensuring a continuous offering of the underlying security as defined under § 230.419 (d) C.F.R. 3. Similarly, a post effective amendment requirement to be filed according to § 230.419 (e)(2)(ii) C.F.R., which holds that the company’s registration statement must be amended upon signing the executing document of an acquisition, also disclosing all details of such acquisition. 4. In the event that any shareholder decided to opt out of a proposed acquisition, such investor shall be entitled to redeem the pro rata investment including accrued interest thereon.23 5. § 230.419 (e)(1) C.F.R. imposed an 80% threshold rule, according to which no less than 80% of the shareholders must agree not to redeem their shares for the pro-rata trust value, else the acquisition fails. 6. Finally, § 230.419 (e)(2)(iv) C.F.R. placed a time limit of 18 months on the shell company’s management team to find a suitable target for a merger or an acquisition, else the funds held in trust would have to be refunded to investors. The above provisions put an abrupt end to the fraudulent practices in the US penny stock market and paved the way toward the implementation of a new investment vehicle which became known as a Special Purpose Acquisition Company or SPAC.

V. The Emergence of 1st Generation SPACs Despite the immediate end of corrupt penny stock dealings through blank cheque offerings, the decree of SEC Rule 419 broadly constrained such issuers from using blank cheque offerings for legitimate investment purposes.24 In 23 Certain expenses may be deducted, ranging between 8–15% of the amount refunded; See Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 538 et. seq. 24 As quoted in Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seq., 944, 957, the “SEC Chairman Richard Breeden and NASD Enforcement Director John Pinto agreed that blank check offerings were a source of fraud”; however, they “were of the view that blank check offerings could be and were used in legitimate business transactions outside of the penny stock area. Accordingly, they opposed an outright ban of all blank check

8

Chapter 1. Background Information on SPAC Shells

fact, the anticipation of the passing of some highly strict regulation initiated a wave of urgent applications for blank cheque companies to be created before the new rule would come into effect.25 Another group of capital market participants decided to design a shell company model which would not be tainted by the fraudulent history of blank cheque companies, whilst broadly complying with the new Rule 419 requirements.26 Thus the first generation of SPACs was born: a listed public shell company incorporated for the purpose of acquiring an unlisted target company with the IPO proceeds, whereupon the target would subsequently replace the shell on the stock exchange. Essentially the SPAC model adopted all Rule 419 restrictions although it was potentially exempt from those requirements: the shares of an issuer who would have assets in excess of five million dollars, would not fall within the statutory definition of the penny stock.27 Nevertheless, upholding Rule 419 was in the interest of any issuer in order to regain confidence on the part of investors and – above all – to remain unobtrusive in the eyes of the SEC. The first generation of SPACs provided for substantial investor protection such as the depositing of the IPO proceeds into a trust account as well as the right to opt out of a proposed acquisition. However, the stipulated time frame of 18 months to find a suitable target according to Rule 419 was extended to 24 months. Also, prior to the announcement and execution of a takeover, shareholders were allowed to trade SPAC shares and thus enjoyed substantial freedom in terms of deciding when to opt out of an undesired takeover. Hence, in 1993 a total of thirteen SPACs had been listed, twelve of which had executed an acquisition as early as 1994.28 Moreover, first generation offerings.” Also see House of Representatives Report No. 101-617, at 22 (1990), as reprinted in 1990 U.S.C.C.A.N. 1408, 1424; according to the Penny Stock Hearings (fn. 14), note 13 at 31, Breeden noted in his remarks regarding penny stock market fraud that blind pools were a “proven mechanism for raising capital for productive uses” in the fields of “venture capital, real estate, oil and gas exploration, and equipment leasing programs.” Also, in accordance with Fed. Reg. 21,650, 21,651 No. 18 (21 Apr. 2004), the SEC reaffirmed this view, stating that “[n]either blind pool offerings nor blank check offerings are inherently fraudulent. Many responsible business persons sponsor legitimate blind pool and blank check offerings.” 25 See Feldman, Reverse Mergers: Taking a Company Public without an IPO, 2006, p. 46; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 944. 26 Compare Heyman, Entrepreneurial Business Law Journal, Vol. 2, No. 1 (2007), p. 531 et seqq., 540. 27 See fn. 7; also compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 945. 28 David Nussbaum, Chairman of GKN Securities was the issuer of the first wave SPACs that emerged in the early 1990s. He is often referred to as the founder of SPAC model. Also compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper No. 11–12 (Oct. 2011), p. 1 et seqq., 15; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 946.

VI. 2nd and 3rd Generation SPACs and the Leap into European Capital Markets

9

SPACs were incorporated with an industry-specific focus in terms of finding a (suitable) target and were increasingly managed by reputable managers from the venture capital industry. This in turn raised the level of confidence and transparency towards investors, who were able to make better informed investment decisions than in the 1980s. The favourable economic developments during the 1990s tech boom further enhanced the need for smaller companies to gain access to the capital markets through alternative ways and a SPAC was able to provide such access via its innovative, potentially profitable and reasonably safe investment model.29 However, with the bursting of the dot.com bubble in March 2000, IPOs of first generation SPACs were abruptly put on hold, with investors fleeing from capital markets and avoiding unorthodox investment models.

VI. 2nd and 3rd Generation SPACs and the Leap into European Capital Markets In May 2003, the second generation of SPACs emerged when the investment boutique EarlyBirdCapital filed a registration statement for a SPAC named Millstream Acquisition Corp., which was subsequently listed in August 2003.30 During the following years SPAC IPOs almost doubled on an annual basis with twelve announced IPOs in 2004, 28 IPOs implemented in 2005, 37 conducted IPOs in 2006, and 65 IPOs in 2007. By the end of 2007, SPACs had accounted for almost one quarter of the total IPOs in the USA, in comparison to only about 5% in 2004.31 The primary marketplace of early second generation SPACs had been the NASD regulated over-the-counter bulletin board (OTC-BB). However, subsequent SPACs traded on the national American Stock Exchange (AMEX), thereby advancing to the status of so called “covered securities” which, unlike OTC-BB shares, are exempt from state securities regulation.32

29

See Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 946 et. seq. 30 This first IPO of second generation SPACs was again initiated by David Nussbaum (see fn. 28). Millstream ultimately acquired NationsHealth LLC in March 2004. Also Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper No. 11–12 (Oct. 2011), p. 1 et seqq., 15. 31 See Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 947; Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper No. 11–12 (Oct. 2011), p. 1 et seqq., 15. 32 Compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 949.

10

Chapter 1. Background Information on SPAC Shells

Parallel to these surging IPOs on US capital markets since 2005, SPACs also penetrated into Europe, with the first SPAC listing on the NYSE Euronext Amsterdam in July 2007.33 In 2008, two additional SPACs were listed on the NYSE Euronext Amsterdam.34 As a result of the credit crunch crisis, no SPAC IPOs occurred in the US in 2008 and 2009, whilst in Europe no such IPOs were conducted in 2009. Again this downturn was attributable to the collapse of global equity markets, with investors fleeing into safer and less volatile investment harbours such as gold and real estate. However, despite the critical situation in global equity markets, the first overall IPO on the Frankfurt Stock Exchange in 2010 was the listing of Helikos SE, which also marked the introduction of SPACs into German capital markets.35 The post-crisis emergence of SPACs in US capital markets in 2010 initiated the third generation of SPACs. The current advancement of such third generation SPACs has not yet taken its full dimension and it remains to be seen how this alternative investment model will reassert its previous position in the IPO market. Despite the very young age of this third wave of SPACs, they have already undergone further developments with regard to the fundamental design of SPAC shells which will be addressed in the ensuing chapter. Moreover, to this date both second and current early third generation SPACs have presented with highly diverse and adaptable investment strategies. Underlying acquisitions have been executed in all major business sectors such as technology, shipping, natural resources, advertising and health care. In light of the direct descent from the highly corrupt blank cheque companies, SPACs have ultimately developed into a respectable asset class. Moreover SPACs have established themselves as a seemingly versatile and promising IPO model, the details of which will be analysed in the following chapters.

33

See fn. 4. See press release of NYSE Euronext Amsterdam of 6 Feb. 2008, available at hwww.nyse. com/press/1202296397730.htmli (accessed on 28 Apr. 2012), announcing the IPO of Liberty International Acquisition Company; see press release of NYSE Amsterdam of 21 Jul. 2008, available at hwww.euronext.com/news/press_release/press_release-1731-EN.html?docid=5599 57i (accessed on 28 Apr. 2012), announcing the IPO of Germany1 Acquisition Limited. 35 Compare reporting, amongst others, in Fokus-Money of 03/02/2010, no. 6, p. 65; BörsenZeitung of 03/02/2010, no. 22, p. 9; Handelsblatt of 03/02/2010, no. 23, p. 37. 34

Chapter 2

SPAC Anatomy and Transactional Practice After successfully listing a SPAC, the underlying management team focuses primarily on the planning, implementation and execution of the merger transaction between the SPAC shell and at least one operating company. Thus SPACs are players, negotiators and competitors on the global M&A market. The following chapter discusses the anatomy of SPACs as well as the peculiarities of SPAC transactions with a view on principal-agent theory. The chapter also contains a case study of an IPO through a SPAC. Ultimately, this chapter seeks to draw general conclusions for the transactional practice of SPAC models.

I. Stakeholders The circle of stakeholders in a SPAC investment vehicle is comprised of three groups, all of whom represent differing interests that need to be aligned in order to achieve a successful implementation and ultimate execution of a SPAC merger: (1) the SPAC founders and managers, (2) the SPAC shareholders and (3) the owners and management of the target corporation.

1. SPAC Founders and Management Team At the outset, the so called founders incorporate a SPAC and thus own the initial shares thereof until it is listed on the stock exchange.1 Typically these so called founding shareholders also comprise the underlying management team once the SPAC has been listed.2 These managers are thus responsible for the incorporation and listing of the SPAC shell as well as the screening and identification of potential merger targets.3 Subsequently the implementation

1 Selzner, ZHR 174 (2010), p. 318 et seqq., 322; Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 950. 2 Compare Riemer, Washington University Law Review, Vol. 85 (2007), p. 931 et seqq., 950. 3 Compare Selzner, ZHR 174 (2010), p. 318 et seq., 322.

12

Chapter 2. SPAC Anatomy and Transactional Practice

and execution of a proposed merger deal is an equally important task faced by the underlying management team.

2. SPAC Shareholders Commonly the participation in a SPAC shell is effected through unit offers, i.e. a hybrid of equity shares and equity warrants with the option of purchasing shares.4 The SPAC shareholder base is comprised of both sponsor shares held by the founding shareholders as well as common shareholders. The latter are well protected through a number of shareholder protection mechanisms which will be described in further detail below.

3. Owners and Management of the Target Corporation During the SPAC execution phase the target firm is merged with the SPAC shell as a result of which the latter is filled with the target’s operative business. Against this background, the target firm’s management perspective is particularly relevant, since the design and control of the transactional process is often specifically marked by the transferor’s (i.e. owners of the target firm) interests. This in turn is particularly relevant in terms of the positioning of SPACs as an alternative IPO model. Hence the target firm’s owners and managers are important economic agents and stakeholders, whose decisions are crucial within the framework of a SPAC transaction.

II. Corporate Governance Structures At its core, a SPAC shell company is comprised of a rigid corporate governance structure primarily aimed at regulating the inter-relationship among the above mentioned stakeholders. The underlying section will first focus on the investor protection mechanisms which are of crucial importance due to the initially unforeseeable blank cheque investment in a SPAC shell. Secondly, the incentive scheme for sponsors and the underlying management compensation will also be discussed. The chronological changes that can be observed since the introduction of first generation SPACs until the current third generation model will be highlighted, whilst also contrasting the developments in European and US SPACs where possible and applicable. At this point it shall be pointed out that the empirical data sets employed for the statistical analysis consist of a sample of some 241 US blank cheque 4 Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 11.

13

II. Corporate Governance Structures

companies all of which submitted provisional prospectuses with the SEC from early 2003 to the end of 2008.5 In Europe a total of four SPAC shell listings occurred during 2007 and 2008. Post financial crisis SPAC transactions until early 2012 amount to twenty filings in the USA and two filings in Europe. For the purposes of applying a minimum critical sample size with statistically significant results, most conclusions presented throughout this dissertation will be based on the significantly larger database of second generation US SPACs (2003–2008).6

1. Stipulated Time Frame The stipulated time frame refers to the limited life span of a SPAC shell.7 In the event that a merger transaction does not occur within the specified time frame, the SPAC shell has to be liquidated whilst the funds held in trust are to be re-distributed pro rata to the public (common) shareholders.8 Such transfers shall be initiated timely upon the liquidation of the trust fund.9 Table 1: Life Span of SPACs (Months)

European SPACs (2007–2008) US SPACs (2003–2008)

Mean

Median

Maximum

Minimum

24 24.8

24 24

24 36

24 18

According to table 1 above, both US and European SPACs have an investment horizon of approximately 24 months. This implies that SPAC managers have an average of no more than two years to announce and execute a proposed business merger. The shortest lived US SPAC had a mere 18 months to announce and execute a deal whilst the longest recorded time horizon had been 36 months.10 5 Following the data filtering process of Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 19, the initial number of 297 provisional blank cheque listings were screened by means of applying filtering criteria, resulting in a sample of 241 suitable firms. Rodrigues/Stegemoller obtained a number of 243. 6 European SPAC data was obtained from the NYSE Euronext Amsterdam database as well as the Merger Market database. The US data was obtained from EDGAR filings as well as the SDC M&A database. 7 Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 20. 8 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 345. 9 Ibid., p. 345. 10 Also compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 20.

14

Chapter 2. SPAC Anatomy and Transactional Practice

2. IPO Proceeds Held in Trust An important investor protection measure is the duty on the part of the SPAC management team to transfer an average of 98% of the underlying SPAC IPO proceeds into a trust account. The notion is to strictly preserve the funds until a successful target acquisition has been announced, in which case the proceeds are transferred to the newly acquired firm, else it is to be liquidated and redistributed pro rata to the shareholders. Table 2: SPAC IPO Proceeds (%) Held in Trust

European SPACs (2007–2008) US SPACs (2003–2008)

Mean

Median

Maximum

Minimum

97.9 95.7

98.0 98.0

98.0 110.1

97.0 82.8

The observed percentage values range from mid 80% to 110% among US SPACs.11 Both European and US SPACs have a median of 98% held in trust, which proves that the funds are well protected until the merger between a SPAC shell and a target is executed.

3. Shareholder Vote and Right to Opt Out The execution of a proposed SPAC transaction, i.e. the material acquisition of the target firm and not merely the signing of a so called letter of intent, is subject to a shareholder vote.12 Founding and/or sponsor shareholders are explicitly excluded from such vote, thus implying that the common shareholders are the sole incumbents in terms of voting in favour of the merger or not.13 Again, in order to protect shareholders, the SPAC model provides for the possibility of an opt-out, whereby such shareholders who do not vote in favour of the proposed acquisition will be refunded pro rata of the total amount held in trust, including accrued interest for the period during which the funds were held in trust.14 11

All values were calculated as the fraction of net IPO proceeds (A) versus gross IPO proceeds (B), of which the former includes the net value of private placements (C) and listing expenses (D). If .C /  .D/ then .A/=.B/  1 resulting in a percentage value above 100%., Similar results were obtained by Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 21. 12 Compare Riemer, Washington University Law Review Vol. 85 (2007), p. 931 et seqq., 954; Selzner, ZHR 174 (2010), p. 318 et seqq., 326. 13 Compare p. 7 and p. 10 of the respective issue prospectuses of Germany1 Acquisition Limited and Helikos SE. 14 Compare Riemer, Washington University Law Review Vol. 85 (2007), p. 931 et seqq., 952; Selzner, ZHR 174 (2010), p. 318 et seqq., 327.

15

II. Corporate Governance Structures

4. Conversion Threshold Through Share Redemption The so called conversion threshold rule stipulates that a minimum of 80% of the common shareholders must agree not to redeem their shares for the pro-rata trust value on the date of the shareholder vote, else the proposed merger transaction fails. Should this threshold not be met for a specific target, the management can of course seek alternative targets. This ultimately raises the level of complexity with regard to preparing and concluding a potential transaction. Table 3: Conversion Threshold (%) of SPACs

European SPACs (2007–2008) US SPACs (2003–2008)

Mean

Median

Maximum

Minimum

80.0 73.1

80.0 70.0

80.0 60.0

80.0 80.0

Statistically, European SPACs present with a higher conversion threshold than US SPACs, which is indicative of better corporate governance measures in favour a European SPAC shareholders. It should be noted, that the conversion threshold rule ultimately acts as a double qualified majority vote in terms of any proposed SPAC transaction: Provided that the common shareholders initially vote against the proposed transaction (as described in section II.3. above), the acquisition will not take effect.15 Moreover, once shareholders redeem their shares beyond the stipulated conversion threshold, the merger would also not occur, thus giving rise to a qualified double majority (or super majority) vote on the part of SPAC investors.16 Such investor protection has been nearly unparalleled in most common capital market transactions, which constitutes a particular strength of the SPAC model.

5. Managerial Compensation and Incentive Scheme vs. “At Risk Capital” A managerial incentive scheme is important in terms of aligning the investor protection mechanisms with the managerial duties resulting thereof. The primary incentive pertaining to a SPAC management team is vested in a compensatory structure. Commonly SPAC managers are compensated through a permission to buy 20% of the SPAC shares at a pre-determined nominal amount.17 These so called sponsor shares are compulsorily held in trust and 15 Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 3. 16 Ibid., p. 3. 17 Compare ibid., p. 23.

16

Chapter 2. SPAC Anatomy and Transactional Practice

are only released upon the execution of a proposed merger transaction.18 Ultimately, the liquidation of the trust funds in the event that no such merger is executed, would imply that the management board effectively receives no compensation. Moreover, sponsors are also sometimes offered the opportunity to purchase SPAC shares and warrants through a private placement19 (see table 420 ). Such private placements would commonly occur on a secondary market and would supplement the sponsors’ “at risk capital” should the SPAC shell be liquidated.21 These warrants would ultimately only be convertible into common shares upon the successful execution of the proposed merger. Table 4: Sponsors’ “At Risk Capital” Mean Sponsors’ Investment ($m) Sponsors’ Investment (% of IPO)

Median

3.1 2.1%

Maximum

4.1 3.1%

15.6 16%

Minimum 0 0%

Table 5: No. of SPACs per Managerial Compensation Scheme % Compensation Initial shares only Initial shares plus private placement

1–15%

16–19%

20%

> 20%

9 11

12 11

225 220

8 30

Table 5 demonstrates that the majority of US SPACs award an equity promote of 20% of the post deal common stock ownership.22 Moreover, a SPAC sponsor faces the prospects of a significant compensation as potential senior management consultant or board member of the post-acquisition company. Hence the SPAC structure ideally provides highly attractive economics for sponsors who are able to execute on their acquisition strategies. Figure 1 below provides a calculated example of a $200 million IPO with two different scenarios. 18

Compare ibid. A private placement is a non-public offering of shares usually to a small number of private investors. 20 Compare results obtained by Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 33. 21 Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 25. Also see Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 33. 22 Also compare the results obtained by Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 23. 19

17

II. Corporate Governance Structures

• • • •

Initial Investment $100m SPAC offering 10m units offered to public @ $10.00 per unit 2,5m shares issued to sponsor Sponsor makes $3m “at risk” investment by purchasing 3m warrants @ $1.00 per warrant

• • • • •

Base case scenario Share price = $10.00 Sponsor promote shares valued at $25m Sponsor warrants worth approx. $11m Total value of sponsor’s stock = $36m Initial investment multiple: 12x

• • • • •

Upside case scenario Share price = $13.00 Sponsor promote shares valued at $32.5m Sponsor warrants worth approx. $19m Total value of sponsor’s stock = $51.5m Initial investment multiple: 17.2x

$30m

$20m

$32.5m $25m $19m

$10m $11m $3m

Figure 1: Sponsor Economics (Assume: $100 Million IPO)

In each of the above scenarios, a unit is comprised of one share and one warrant with a strike price of $7.50. A $6 million investment of “at risk warrants” held by SPAC sponsors, will achieve multiples of 11.8x and 17.3x in the respective scenarios. Hence the initial investment will inflate to $21 million and $39 million respectively in the post merger phase, which are highly attractive compensation prospects. However, a key challenge to securing shareholder approval for a proposed acquisition is the valuation dilution23 created by the promote and warrant overhang upon execution of a merger transaction. This issue will be addressed in further detail in chapter 4.

6. Minimum Fair Market Value Multiple Commonly, a SPAC merger transaction must be equal to no less than 80% of the fair market value of the total funds held in trust at the time of the trans23 Shareholder value dilution is created as a result of the large number of warrants which are convertible into common shares upon execution of the merger, implying that shares are created without creating shareholder value. Also see Friedmann/Larson, The Hedge Fund Journal, May 2008, available at hwww.thehedgefundjournal.com/magazine/200805/technical/aspac-evolution.phpi.

18

Chapter 2. SPAC Anatomy and Transactional Practice

action proposal, whereby the fair market value excludes the working capital deployed for the day-to-day business transactions during the SPAC’s predetermined time horizon.24 This shareholder protection mechanism provides for a restriction on the part of the SPAC management team to access the trust funds only in the event of a substantial business combination.25 Table 6: Fair Market Value Multiple

IPO Proceeds (mil. $) Deal Value (mil. $) Multiple

Mean

Maximum

Minimum

120 254 2.1x

900 3403.4 3.8x

15.8 13 0.8x

The statistics above demonstrate that the mean market value multiple of 2,1x with regard to successfully executed mergers lies well beyond the required 80% (i.e. 0.8x) of the trust fund’s fair market value26 .

7. Interim Result Principally the corporate governance and shareholder protection mechanisms described above are centered around (a) providing adequate protection through a prudent preservation of the invested funds in a trust account coupled with an opt-out option; (b) the ability to exercise control over the execution of a proposed merger transaction and (c) a clearly defined time horizon in terms of proposing and executing a transaction, else the trust account is to be liquidated compulsorily.27 Figure 2 (following page) illustrates and summarises the investment life cycle of a SPAC from the outset of its IPO. Essentially, this cycle contains four mutually exclusive investment phases, the categorisation of which will be particularly relevant with regard to the ensuing regressional analysis in chapter 4:28 1. Going Public phase (GP): The SPAC shell company sets out with the intention of acquiring a suitable target within a specified time frame. 24

Compare Riemer, Washington University Law Review Vol. 85 (2007), p. 931 et seqq.,

954. 25 Compare Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 29. 26 Similar results were obtained by Rodrigues/Stegemoller, University of Georgia School of Law Research Paper Series, Paper no. 11–12 (Oct. 2011), p. 1 et seqq., 29. 27 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 327; Davidoff, Columbia Business Law Review, Vol. 2008, p. 223. 28 For a similar categorisation see Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 5 et. seq.

>99% of gross proceeds held in trust until completion of acquisition Working capital available to identify and research targets (includes partial draw on accrued interest in the trust account) Cash-in-trust invested in €-denominated interest bearing cash accounts

Public Offering

Figure 2: Life Cycle of a SPAC Investment Process Shareholders’ vote: simple majority of votes cast by public shareholders determines outcome Deal is marketed to current shareholders, new investors and sector specialists

Roadshow

Up to 24 months

New target search is instituted by SPAC management

Minimum deal size equal to 80% of SPAC’s net assets No effective maximum deal size (i.e. new shares can be issued concurrently) Company prepares materials for shareholders and regulatory approval

Acquisition announced

Proposed transaction rejected if negative votes constitute a simple majority of those cast by public shareholders OR shareholders elect to redeem shares equal to predetermined % or more of the issued shares

Acquisition not approved

Simple majority of votes cast by public shareholders approve the acquisition AND dissenting shareholders holding less than predetermined % of the issued shares elect to redeem shares

Acquisition approved

Pro rata refund of trust funds to public shareholders Preference of public shareholders over sponsor shareholders Also occurs upon lapsing of 24 month timeframe

Trust liquidation

Company "deSPACs" and becomes an operating company Minority dissenting shareholders have the right to redeem shares for pro rata funds in trust

Acquisition completed

II. Corporate Governance Structures

19

Shareholders’ Approval

20

Chapter 2. SPAC Anatomy and Transactional Practice

2. Announced Acquisition phase (AA): The SPAC shell company announces a deal and seeks approval on the part of its shareholders. 3. Completed Acquisition phase (CA): The SPAC shell company successfully executes a merger transaction with at least one target. 4. Rejected Acquisition phase (RA): The SPAC shell company withdraws the announced acquisition following a rejection on the part of its shareholders or a share redemption of the latter beyond the stipulated threshold. This categorisation will be relevant with regard to the ensuing regressional analysis in chapter 4.

III. SPAC Transaction: A Twofold Double Trust Dilemma Against the background of the corporate governance framework pertaining to the stakeholders of SPACs, the underlying section will analyse SPAC transactions on the basis of economic principal-agent theory. In terms of a principal-agent scenario, the SPAC founders and managers collectively pursue a strategy of finding a suitable target as agents for the SPAC shareholders, who collectively act as principal (from now on termed Stakeholder Group I). However, a SPAC transaction also invokes a second principal-agent relationship between the SPAC managers and the target firm (from now on termed Stakeholder Group II). Within Group II, the SPAC management team must again be viewed as the agent, who institutes the merger between the SPAC shell and the target firm on behalf of the target firm’s owners and managers, who collectively act as the principal. A SPAC transaction bears economic risks and costs on the part of both mentioned stakeholder groups, which need to be carefully considered and closely monitored during the transactional progress: (1) the net present value of the merger transaction between the SPAC shell and the target firm, (2) the contractual liability provisions of the underlying merger transaction, (3) the signalling costs incurred for securing the transaction (4) the time value of money in terms of transactional speed.29 Alongside the above mentioned economic costs, the parties of both Group I and Group II are faced with asymmetric information at the outset of a SPAC IPO. Within Group I, SPAC shareholders can merely guess how their money will be re-invested since the potential target firm is unknown. The SPAC management team must in turn hope that the shareholders will vote in favour of 29 A similar set of parameters was defined by Selzner, ZHR 174 (2010), p. 318 et seqq., 348. However, the parameters and approach adopted by Selzner are not linked to principal-agent theory.

III. SPAC Transaction: A Twofold Double Trust Dilemma

21

a proposed merger transaction. Similarly within Group II, the SPAC management is faced with uncertainty as to the final willingness of the target firm to go public through a SPAC shell, whilst the target firm’s owners and managers face uncertainty with regard to the shareholder vote instituted by the SPAC managers. In short: In order to successfully execute a SPAC transaction, the shareholders must trust the SPAC management team to find a profitmaximising target firm, and the management team must trust the shareholders not to vote against the proposed merger. Simultaneously the target firm’s management team must trust that the SPAC managers will achieve a majority vote from the SPAC shareholders, whilst the SPAC managers must trust that the target firm will ultimately agree to the SPAC merger. By implication, the above mentioned economic costs and asymmetric information bear the potential for moral hazard30 among the stakeholders. This scenario can be described as a twofold double trust dilemma.31 In contrast to the classical principal-agent scenario, the “double trust dilemma” is defined as a principal-agent game with double sided moral hazard.32 The strategies to avoid or mitigate such moral hazard will be discussed below, bearing in mind the set of corporate governance structures described in chapter 2, section II.

1. Moral Hazard between SPAC Shareholders and Managers In order to protect SPAC shareholders, the initiation and execution of a SPAC transaction is commonly limited to a time frame of around 24 months post the SPAC IPO.33 This corporate governance feature potentially gives rise to moral hazard within the first principal-agent group (Stakeholder Group I) and has a direct impact on the speed and security of the underlying transaction. In particular, the SPAC managers (agents) need to monitor the extent to which any competing strategic or financial investors are also bound by such time limitations.34 Moreover, despite the fact that a time frame of 24 months would seemingly suffice to prepare, conclude and execute a SPAC merger 30 Moral hazard is a situation in which two parties are faced with differing risk patterns due to cross-diagonal cost/reward effects. Thus moral hazard is induced as soon as one party tends to engage in a risky transaction of which the costs are borne by the opposing party and vice versa. 31 The concept of a “double trust dilemma” was first defined in the context of development economics and innovation by Robert Cooter and Hans-Bernd Schäfer in their recently published textbook; see Chapter 3 of Cooter/Schäfer, Solomon’s Knot: How Law Can End the Poverty of Nations, 1st edition 2012, p. 27 et seqq. 32 Compare Cooter/Schäfer, Solomon’s Knot: How Law Can End the Poverty of Nations, 1st edition 2012, p. 234. 33 See chapter 2, section II. 34 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 349.

22

Chapter 2. SPAC Anatomy and Transactional Practice

transaction, transactional success would also crucially depend on whether or not any preceding mergers between a target and the SPAC have failed.35 This gives rise to the second corporate governance feature, namely the right to reserve approval on the part of the shareholders36 , which also affects the two economic factors of transactional speed and security. The transferors bear the risk that the proposed merger fails either due to a lack of approval from the SPAC shareholders or due to so called greenmailing37 as a result of which the transactional progress is strategically delayed beyond the 24 months time frame by a group of (minority) shareholders. Within a competitive environment, this can be decisive for a successful deal execution, which in turn raises the question as to how this disadvantage can be circumvented.38 Selzner suggests the implementation of a contractual voting agreement between SPAC shareholders and sponsors upon the acquisition of SPAC shares, which could be stipulated in the certificate of incorporation39 in order to ensure that the sponsors can effectively influence the vote in favour of the proposed merger.40 This would enable the SPAC management team to significantly facilitate the transactional security of a potential merger transaction.41 However such contractual voting agreement would fundamentally undermine pillars of the investors’ level of control with regard to any proposed merger, which makes it unsuitable in practice.42 Ultimately it is also thinkable that the sponsors could concede options of acquisition from shareholders who vote against the merger, provided that such shareholders seek to make use of their opt-out instrument.43 However, this practice would significantly depend on the sponsors’ financial leeway so as to invest significant amounts if necessary.44 In terms of transactional security, the SPAC managers have to take into account the so called 80% threshold rule, according to which a minimum 35

Ibid. See chapter 2, section II.3. 37 Greenmailing is a process whereby an investor or group of investors signals to vote against a proposed transaction, thereby threatening the potential execution of the underlying transaction. Shareholders usually practice greenmailing with the aim of forcing the opposing party to pay them a premium in order to incentivise a positive vote. 38 Also see Selzner, ZHR 174 (2010), p. 318 et seqq., 349 et seq. 39 Compare Hüffer, AktG, 10th edition 2012, § 133 AktG para. 26. 40 In this scenario one would have to take into consideration that in terms of a so called “acting in concert”, the sponsors would have to apply a mandatory tender offer to all involved shareholders, which is certainly not in the interest of the SPAC model; Selzner, ZHR 174 (2010), p. 318 et seqq., 350. 41 See cost parameter 3 of section III. above. 42 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 350. 43 See page 5 of the Helikos SE Founder’s Purchase Option. as described by Selzner, ZHR 174 (2010), p. 318 et seqq., 351. 44 Selzner, ZHR 174 (2010), p. 318 et seqq., 351. 36

III. SPAC Transaction: A Twofold Double Trust Dilemma

23

of 80% of the shareholders must agree not to redeem their shares for the pro-rata trust value on the date of the shareholder vote.45 This is particularly imminent during the screening and selection process of potential target firms. Should 80% threshold not be met for a specific target, the management can of course parallely seek other targets, which ultimately raises the level of complexity with regard to preparing and concluding a potential transaction. Moreover, parallel target seeking has to be bound by execution conditions in order not to undermine the shareholders’ right to reserve approval.46

2. Moral Hazard between Target Firm and SPAC Managers The following section will present the peculiarities of a SPAC transaction from the view point of the above mentioned Stakeholder Group II (SPAC managers and target firm). This perspective is particularly relevant, since the design and control of the transaction process is often specifically marked by the target firm’s interests, which in turn are particularly relevant to the SPAC managers, whose aim it is to position SPACs as a feasible alternative IPO model.47 Firstly, the economic chances which can be derived from transaction specifics will be highlighted, followed by an analysis of the potential economic risks associated with a SPAC transaction.48 a) Economic Benefits The investor protection mechanisms instilled within a SPAC model inherently define the management board’s realm of competencies as to the negotiation and execution of the merger. Such limitations of competencies are particularly relevant in terms of the 80% threshold rule as well as the fixed time frame of usually 24 months within which a merger has to be executed.49 Growing time pressure on the part of the management team during merger negotiations could potentially induce a noticeable disadvantage for the SPAC, e.g. during an imminent dissolution of the SPAC, provided the board is unable to find a suitable target.50 Due to the 80% threshold rule, the SPAC

45

See chapter 2, section II.4. Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 349. 47 Ibid., p. 353. 48 Also compare the transaction specific risks and chances described by Selzner, ZHR 174 (2010), p. 318 et seqq., 353 et seq. 49 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 353. 50 Ibid. 46

24

Chapter 2. SPAC Anatomy and Transactional Practice

management team might have to simultaneously search for other targets51 , which would simultaneously raise the level of complexity and efforts required to execute a deal. As time lapses, this persistently rising structural disadvantage in terms of the board’s negotiation position turns into an advantage that can be utilised by the transferor (target firm) during negotiations.52 Hence it is thinkable that the outcome of such negotiations e.g. with regard to the purchase price or the design of the liability regime could be optimised by the transferor in the advent of a compulsory SPAC liquidation scenario.53 These structural SPAC elements can thus induce an asymmetry in negotiation powers in favour of the transferor.54 With a view on this asymmetry in negotiation powers, one also has to consider the other structural characteristics of a SPAC model, e.g. the right to reserve of approval on the part of SPAC shareholders.55 Essentially one can assume that as the above mentioned asymmetry rises in favour of the transferor, this development will inversely correlate with the probability of a shareholder vote in favour of the merger and hence the transferor has to carefully consider the extent to which such alleged advantage is exercised.56 The limited time frame of 24 months can ultimately also be advantageous to the transferor in terms of enhancing the transactional speed once the underlying time period nears completion.57 Essentially the SPAC as potential acquirer is bound by its own time limits irrespective of the phase of any specific merger negotiations and would thus potentially be prepared to make considerable efforts in order to close the deal.58 To conclude, the transferor’s allegedly advantageous position arising from asymmetric negotiation powers has to be dealt with cautiously when trying to optimise either the purchase price or the liability regime; else the envisaged merger will not meet the shareholders’ approval.

51 The process of simultaneously searching for other potential targets is also known as “parallel target searching”. 52 Selzner, ZHR 174 (2010), p. 318 et seqq., 353. 53 Ibid., p. 354. 54 Ibid. 55 See chapter 2, section II.3. Also compare Selzner, ZHR 174 (2010), p. 318 et seqq., 354. 56 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 354. 57 Ibid. 58 Ibid.

III. SPAC Transaction: A Twofold Double Trust Dilemma

25

b) Economic Risk Factors The transferor would however also have to consider the potential risks arising from merger negotiations with SPAC managers.59 Such risks will primarily occur between the deal closure and its execution.60 Greenmailing activities61 could trigger an execution risk on the part of the transferor, provided the closing conditions of the underlying deal provide for a right to reserve approval on the part of the shareholders. The first mitigative step would have to determine whether or not the SPAC statutes and corporate law stipulate that shareholders would have to vote on the deal prior to compiling the merger transaction documents in which case the actual transaction process would occur ex post the shareholder vote.62 Selzner holds, that in the event that the above mentioned scenario would not be implementable, the possibilities of committing the majority of shareholders to vote in favour of the merger would have to be considered.63 This could be in the form of an irrevocable undertaking whereby shareholders who, in aggregate, hold the majority of public shares have to agree to vote their public shares in favour of the transaction and related resolutions and/or not to request redemption of their public shares.64 In order to mitigate the executional risk by avoiding that the proposed merger transaction fails during the shareholder vote, a so called break fee agreement65 could be implemented, as suggested by Selzner.66 Such break fee agreements originate from the Anglo-American law and either bind one or both contractual parties to pay a fee in the event that the underlying transaction fails.67 Yet, it is doubtful whether a break fee agreement would effectively reduce the executional risk, since the vast majority of the SPAC IPO proceeds are held in trust (including the proceeds from sponsor shares)

59

Compare discussion in Selzner, ZHR 174 (2010), p. 318 et seqq., 355 et seq. Ibid., p. 355. 61 See footnote 37 for a definition. 62 This would imply that negotiations with other potential acquirors would still be kept open up to the point of a deal closure and thus the inherent transactional security risk would be neutralised. Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 355. 63 See Selzner, ZHR 174 (2010), p. 318 et seqq., 355. 64 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 355. 65 For a description of a so called break fee and its positioning within the German corporate landscape see: Guinomet, Break fee-Vereinbarungen, 2003. Also see Fleischer, AG 2009, p. 345 et seqq.; Drygala, WM 2004, p. 1457 et seqq.; Hilgard, BB 2008, p. 285 et seqq. 66 See Selzner, ZHR 174 (2010), p. 318 et seqq., 355. 67 For further references compare Selzner, ZHR 174 (2010), p. 318 et seqq., 355. 60

26

Chapter 2. SPAC Anatomy and Transactional Practice

which may only be utilised either upon execution of a merger or in the event of a SPAC shell liquidation.68 Hence, successfully hedging the execution risk faced by the transferor would certainly presuppose a fair chance as to the enforcement of the (accordingly significant) break fee agreement and thus realising the actual payment thereof in accordance with the stock corporation statutes.69 This would imply an enforceability of the break fee from SPAC trust account funds since the SPAC does not have any significant funds at its disposal.70 However, enforcing payment against the account operating financial institute will be impossible according to applicable law if the trust account is not held by the SPAC but by a third (independent) trustee.71 Thus the transferor can merely enforce payment of such amounts arising from the relationship between the SPAC and its trustee according to German law, e.g. by way of seizure or remittance.72 However, Selzner points out that transfers and payments from the trust account will only arise under two circumstances: first if the shareholders have consented to the merger, in which case a break fee agreement would clearly not arise, and secondly in the event of a trust account liquidation.73 There again, the latter would solely entail the pro rata transfer of funds to the shareholders with no entitlement on the part of the SPAC on any portion of the funds remitted to its shareholders.74 In the event that the trust agreement stipulates that the SPAC shall act as intermediate recipient of the funds before transferring them to the shareholders, this would imply that the SPAC would act as trustee on behalf of its investors.75 Thus it has to be noted that even if a (significant) break fee agreement were implemented in accordance with the applicable law, it would still be impossible for the transferor to effectively reduce the execution risk of the

68 Apart from the funds held in trust, a SPAC does not have any significant amounts at its disposal; Selzner, ZHR 174 (2010), p. 318 et seqq., 357. 69 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 357. 70 Ibid. 71 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 357. 72 Trust accounts incorporated within a SPAC model are referred to as fiduciary trust accounts in which the title to assets are held by the trustee on behalf of the beneficiary. According to German law, creditors of the trustor (SPAC) cannot enforce payment against the funds held in trust which are bound by the enforcement order of the judgement debtor; compare BGHZ 11, 37, 41 et seqq. Also compare Selzner, ZHR 174 (2010), p. 318 et seqq., 357. 73 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 358. 74 Ibid. 75 Ibid.

IV. Case Study: Hicks Acquisition vs. Graham Packaging

27

underlying SPAC transaction.76 Given that a SPAC lacks disposable funds at all times, the payment of a break fee could not be successfully enforced.77 To conclude, transferors are primarily faced with risks pertaining to the execution of a merger. The prime concern in this regard is the right to reserve approval by the shareholders. This risk can potentially be magnified through so called greenmailing activities but it can also be counteracted either by means of an irrevocable undertaking or by implementing the shareholder vote ex ante to the compilation of the merger documents. A break fee agreement on the other hand cannot effectively reduce the risk of a transaction failure due to the lacking of shareholders’ approval.

3. Interim Result The strategies to mitigate the phenomenon of a “twofold double trust dilemma” were described in detail. At the outset of incorporating a SPAC company the underlying management team will have to conduct extensive research as to the current potentials of the M&A market in general as well as the potential of specifically finding target firms. Ultimately a comprehensive and early evaluation of potential merger candidates is crucially important for the success story of a SPAC. Hence the SPAC management board will have to ensure that the common time frame of 24 months is utilised to the best possible extent. Simultaneously the SPAC initiators should aim to find targets which are exposed to minimal competition within the M&A market. Moreover, such targets should ideally fulfill the 80% threshold rule in order to avoid complex parallel transactions which, above all, are also unfavourable to the respective transferors in terms of the underlying risks. Ultimately the successful execution of a SPAC merger transaction will depend on a careful consideration of (a) the fundamental characteristics of the SPAC model and (b) the legal framework pertaining SPACs. The latter will be discussed in further detail in chapter 3.

IV. Case Study: Hicks Acquisition vs. Graham Packaging This section is devoted to an illustration and discussion of a case study involving a SPAC IPO78 . Hicks Acquisition Company I, Inc. (HAC) was a 76

Ibid. Ibid. 78 Also see Berger, Journal of Applied Corporate Finance, Vol. 20 No. 3 (2008), p. 68 et seqq. 77

28

Chapter 2. SPAC Anatomy and Transactional Practice

Special Purpose Acquisition Company which listed on the American Stock Exchange (AMEX) through a $552 million IPO in September 2007. In July 2008 HAC announced that Graham Packaging Holdings Co. (Graham) would go public via a business combination with HAC, in partnership with The Blackstone Group and the Donald Graham Family in a transaction valued at $3,150 million.79

1. Target Description: Graham Packaging I, Inc. Graham Packaging is a leading global manufacturer of custom blow-molded plastic containers with 83 manufacturing facilities located throughout North America, Europe and South America. The company presented with strong positions in food and beverage, household, automotive lubricants and personal care/specialty product categories and had successfully pursued a strategy of locking up large customers in long-term contracts. In July 2008 Graham Packaging had revenues of $2,5 billion and Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) of $441 million.

2. Deal Terms The structure of the deal proposed a purchase of 66% of common shares of Graham Packaging for the following consideration: 1. $350 million of cash held in trust as cash consideration, 2. 35 million shares and 2.76 million warrants as equity consideration (shares with trigger price of $13,75; warrants with a strike price of $10,00 and a trigger price of $15,00), 3. $2.450 million of net debt ($2.294 million outstanding at close, assuming that HAC would repay the difference using remaining cash held in trust)80 Based on the above deal terms, the underlying acquisition multiple for the merger was 7.8 times EBITDA.

79 Excludes $15 million from buyout of monitoring and oversight fee post close (payable by Graham Packaging in 2009) and a transfer of value of approx. 2.8 million warrants to the Graham family at closing. 80 Based on Graham’s projected debt as of September 30, 2008; HAC cash in trust at close estimated to be $561 million.

IV. Case Study: Hicks Acquisition vs. Graham Packaging

29

3. Investment Rationale The investment rationale toward the shareholders with regard to the proposed transaction was founded on three important facts pertaining to Graham Packaging: a) Premium Asset in the Packing Industry Graham Packing had a leading market position with regard to technology and innovation. Moreover it had forged long-standing relationships with blue chip global consumer products companies. Finally the company had achieved leading industry EBITDA margins in plastic containers. b) New World-Class Senior Management Installed in 2006 Overall the new senior management team presented with a new culture of accountability and data-driven decision making. According to its own statements, the management team was committed to profitable growth and had achieved nearly 300 basis points improvement in EBITDA margins from 2006 to 2008. c) Significant Upside Potential to New Investors Graham Packaging had also achieved a large and stable profit base with $450 million of EBITDA, coupled with a continued margin enhancement through efficiency gains and cost take-out. Moreover, it was facing the prospects of a strong free cash flow to support considerable earnings growth through deleveraging in a post merger scenario.

4. Company Overview and Transaction Structure According to figure 3 the execution of the deal entailed a purchase of 51.7– 68.2m shares by HAC from Graham Packaging, using $350 million of the cash held in trust. The actual shares purchased and the associated cash that was to be used to fund the purchase was dependent on the number of HAC shares redeemed by existing shareholders. Subsequently HAC distributed Graham shares to its shareholders on a one-for-one basis and thus merged into Graham Packaging. The pro forma ownership structure was such that Graham was

30

Chapter 2. SPAC Anatomy and Transactional Practice

Graham Family 15.00% Management 1.30%

Blackstone 83.70% Management 0.40% Blackstone 24.40%

Graham Packaging

51.7m Graham shares

Graham Packaging

$350m cash HAC Founders 14.70% Graham Familiy 4.30%

SPAC

Public HAC 56.20% Source: Bloomberg

Figure 3: Illustrative Transaction Structure

owned 56% by public HAC shareholders, 15% by HAC Founders and 29% by current Graham equity holders (including warrant dilution).81

5. Interim Result The underlying case study has demonstrated that a SPAC model provides a highly flexible structure that does not have to fit within the typical IPO construct regarding deal size and/or secondary proceeds. Moreover, this case study also proves the ability to provide seller upside through retained equity and the ability to structure around change of control provisions on inexpensive debt. Also, the SPAC structure can evidently be tailored to meet both the needs and unique issues of all parties involved (in this case Blackstone, Graham family, Graham Packaging and Hicks Acquisition Company).

V. Summary At its core a SPAC shell consists of three important stakeholder groups, namely the SPAC managers, the SPAC shareholders and the owners and 81 Note: Analysis assumes that no SPAC share redemptions occured. Also, Graham management options and HAC Founders earn-out units were excluded from the calculations.

V. Summary

31

managers of the target firm. The interaction of these stakeholders needs to be optimised in such manner that all interests are aligned during the planning, implementation and execution of a merger transaction between the SPAC shell and at least one operating company (target). Hence the economic interplay among the stakeholder groups is governed by a rigorous set of corporate governance features which are primarily aimed at (1) protecting the IPO proceeds through a trust account, (2) implementing a shareholder vote and right to opt out of a proposed merger transaction and (3) stipulating a time frame within which a SPAC deal closure has to occur, else the SPAC is dissolved. Against the background of these protective measures, SPAC managers are incentivised through attractive compensation schemes upon the closure of a merger transaction whilst the target firm faces the prospects of swiftly accessing the capital markets through a SPAC. SPAC transactions bear economic risks and costs. In particular, there are four economic factors pertaining to a SPAC merger that need to be closely monitored during the transactional progress: (1) the net present value of the merger transaction between the SPAC shell and the target firm, (2) the contractual liability provisions of the underlying merger transaction, (3) the signalling costs incurred for securing the transaction and (4) the time value of money in terms of transactional speed. As a result of asymmetric information and on the basis of principalagent theory, a SPAC merger transaction also bears potential for moral hazard among the stakeholders which was described a “twofold double trust dilemma”: Between SPAC mangers and SPAC shareholder (Stakeholder Group I), the latter can only guess how the IPO proceeds will be invested since the potential target firm is unknown. The SPAC management team must in turn hope that the shareholders will vote in favour of a proposed merger transaction. Similarly between SPAC managers and the target (Stakeholder Group II), the former are faced with uncertainty as to the final willingness of the target firm to go public through a SPAC shell, whilst the target firm’s owners and managers face uncertainty with regard to the shareholder vote instituted by the SPAC managers. The strategies to mitigate and avoid moral hazard require that the planning and steering of the SPAC transaction is based on a careful consideration of the fundamental characteristics of the SPAC model as well as the immanent aspects pertaining the business and corporate law thereof. Ultimately this would include an optimisation of potential negotiation disadvantages due to the extensive investor protection mechanisms. In order to achieve a successful deal closure and execution, the board ought to pursue a cautious and foresighted management strategy.

Chapter 3

SPACs and the Applicable German Law Based on the distinctive characteristics of SPACs discussed above, the following chapter seeks to analyse the applicable German law with regard to SPACs as an asset class. The analysis is divided into three parts. The first part of this chapter will focus on the German capital markets law with regard to SPAC IPOs. In particular, the practicability of a SPAC IPO will be assessed against the background of the statutory prospectus requirements as well as the required prospectus content. Subsequently, the alternative market segments through which SPACs can access the German capital market will be discussed. The second part of the underlying chapter is devoted to the German business law applicable to SPACs. This analysis will assess whether the distinctive features of a SPAC model can be practically implemented according to German business law. In particular the limits and challenges of the German stock corporation (AG) as a (suitable) business form will be highlighted and discussed with a view on the German stock corporation act (AktG). Finally, the third part analyses SPAC shell transactions in view of the judgments of the German Federal Supreme Court (BGH) on shell utilisations. The latter have become jurisdictionally anchored in Germany on the basis of the assumption that they equate the act of legally incorporating a company.1 Since during the execution of the merger between the target firm and the SPAC shell, the former fills the latter with its operative business, it is reasonable to ask whether this transactional process initiates the utilisation of an “empty” shell as defined by the BGH. The extent to which this question can be positively answered will be discussed against the background of the statutory framework pertaining to shell utilisations. Whilst parts one and two above have already been thoroughly discussed in literature2 , the added value of these two parts within the context of this 1

BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. See von Ilberg/Neises, GoingPublic Kapitalmarktrecht 2008, p. 54 et seqq.; Röder/ Walkshäusl, FB 2008, p. 641 et seqq.; von Ilberg/Neises, GoingPublic Sonderbeilage “Special Purpose Acquisition Companies (SPACs)” annex to publ. 10/2008, p. 26 et seq.; Harrer/Janssen, FB 2009, p. 46 et seqq.; Just, ZIP 2009, p. 1698 et seqq.; Krug, Zweck, Bedeutung und Würdigung von Special Purpose Acquisition Companies (SPAC), 2010; Selzner, ZHR 174 (2010), 2

34

Chapter 3. SPACs and the Applicable German Law

dissertation is twofold: (1) it provides a succinct and sharp summary of the aspects relevant to the practical implementation of SPACs in a German corporate landscape and (2) it has been written in the English language and thus addresses an international circle of readers in the realm of law and economics. The analysis of SPACs in view of the BGH judgments on shell utilisations has thus far been entirely omitted and hence the underlying discussion thereon shall constitute the foremost scholarly yield of this chapter.

I. Going Public with a SPAC – Capital Markets Law Is it possible for a SPAC to be listed on a German stock exchange? The primary peculiarity concerning such a SPAC IPO is the fact that the empty (SPAC) shell does not have an operating business and therefore does not possess a financial history. Only the subsequent takeover of a target from the proceeds of the initial IPO will lead to the establishment of an operating business. This in turn raises questions as to the prospectus requirements as well as permission to list on the stock exchange.3

1. Prospectus Requirement The primary point of departure should be a view at § 3 WpPG, which along with §§ 17 and 18 WpPG forms the central norm of the German Securities Prospectus Act (WpPG)4 . The first paragraph thereof states that a share may only be domestically offered to the public subsequent to a prospectus issue, whilst according to § 3 para. 3 WpPG, a prospectus has to be published prior to being offered on the regulated market.5 The section below will examine whether a prospectus requirement is invoked through a SPAC IPO and

p. 318 et seqq.; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq.; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq.; Thiergart/Olbertz, BB 2010, p. 1547 et seqq.; Schanz, NZG 2011, p. 1407 et seqq.; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011; Benz/Wulf, GoingPublic Sonderbeilage “Special Purpose Acquisition Companies (SPACs)” annex to publ. 10/2008, p. 14 et seq. 3 Compare Harrer/Janssen, FB 2009, p. 46 et seqq.; Just, ZIP 2009, p. 1698 et seqq.; Krug, Zweck, Bedeutung und Würdigung von Special Purpose Acquisition Companies (SPAC), 2010, p. 9 et seqq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 328; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 19; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 180 et seqq. Also see Schnorbus, AG 2008, p. 389 et seqq. 4 Also compare Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 3 WpPG para. 1. 5 Ibid. Also compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 3 WpPG para. 1.

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35

whether or not the substantive requirements according to §§ 5–12 WpPG can be met, despite the fact that the SPAC shell is not an operating business. a) SPAC Units Consisting of Shares and Warrants Fundamentally, a prospectus must be issued in connection with the offer of shares, i.e. the offeror of such shares is inherently obliged thereto according to § 3 para. 1 WpPG.6 Since SPAC units consist of both shares and (naked) warrants (see chapter 2, section I.2.), Foppe holds that one needs to establish (1) whether warrants are classifiable as shares pursuant to the law and (2) whether SPAC shares and warrants require independent prospectuses.7 The definition of shares is stipulated in § 2 para. 1 WpPG. Naked warrants (which are not linked to a bond) are not explicitly provided for in the German statutes.8 However, within a SPAC framework Foppe points out that warrants shall be classified as “other” shares according to § 2 para. 1c WpPG and as such would then meet the definition of shares pursuant to the statutes.9 Just and Foppe thus conclude that since SPAC shares and warrants are always offered jointly (in the form of units), a meaningful and comprehensive SPAC unit offer would also have to be described in a joint prospectus.10 According to commentaries11 the notion of a joint prospectus is substantiated by § 7 WpPG in connection with § 21 ProspektVO, which contains patterns and tables that are to be compiled in connection with joint share and warrant offers12 . It follows that SPAC IPOs shall be accompanied by joint prospectuses.13

6

Compare Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 3 WpPG para. 5. Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 180. 8 Compare Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21; Selzner, ZHR 174 (2010), p. 318 et seqq., 343. 9 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 180. 10 Compare both Just, ZIP 2009, p. 1698 et seqq., 1698; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 11 Compare Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 7 WpPG para. 6; Meyer in: Berrar/Meyer/Müller/Schnorbus/Singhof/Wolf, Frankf. Komm. zum WpPG, 1st edition, 2011, § 7 WpPG para. 20. 12 Also compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 13 Compare with further references Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 7

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Chapter 3. SPACs and the Applicable German Law

b) Public Offer In accordance with § 3 para. 1 WpPG, one also needs to assess whether a SPAC IPO meets the definition of a public offer as defined in § 2 para. 4 WpPG.14 The latter holds that a public offer is a communication to persons in any form and by any means, presenting sufficient information on the terms of the offer and the investment instruments to be offered, so as to enable an investor to decide to purchase or subscribe to these investment instruments, and which is made by or on behalf of the person who is in a position to issue or transfer these investment instruments. In the context of a SPAC IPO, Foppe holds that this requirement is fulfilled as soon as an undetermined group of investors is offered to subscribe to SPAC units.15 Also, a public offer as defined above invokes a prospectus requirement, provided the offer has a domestic nexus in connection with § 3 para. 1.16 Foppe ultimately concludes that this sufficient condition is commonly fulfilled since SPACs which are listed on German capital markets would inherently be offered to German investors and would thus present with a domestic nexus.17 The WpPG also stipulates exceptions according to which public offers are exempt from the prospectus requirement18 : Such offers which stipulate minimum investment amounts of more than 100.000 Euros per shareholder (§ 3 para. 2 sub 3 WpPG), or a minimum fragmentation of 100.000 Euros (§ 3 para. 2 sub 4 WpPG), or which are merely offered to an exclusive circle of so called qualified investors (§ 3 para. 2 sub 1 WpPG), or which are aimed at less than 150 qualified investors (§ 3 para. 2 sub 2 WpPG) do not apply to the common practice of a SPAC IPO according to Foppe and hence the criteria of a domestic nexus are fulfilled.19

14 Foppe erroneously refers to § 2 para. 4 AktG, see Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 15 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 16 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 3 WpPG para. 4; Schnorbus in: Berrar/Meyer/Müller/Schnorbus/Singhof/Wolf, Frankf. Komm. zum WpPG, 1st edition, 2011, § 3 WpPG para. 4; Ritz/Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 2 WpPG para. 169. 17 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181. 18 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 3 WpPG para. 1; Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 3 WpPG para. 2; Schnorbus in: Berrar/Meyer/Müller/Schnorbus/Singhof/Wolf, Frankf. Komm. zum WpPG, 1st edition, 2011, § 3 WpPG para. 3. 19 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 181.

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37

c) Regulated Domestic Market The possibility of issuing SPAC units through a regulated domestic market, would also require such offer to be accompanied by a prospectus according to § 3 para. 3 WpPG. The latter is complemented by § 32 para. 3 sub 2 BörsG, which requires that the admission to the regulated market is – among others – dependent on the issuance of a prospectus unless the exceptions of § 4 para. 2 WpPG apply.20 Foppe correctly concludes that the exceptions defined in § 4 para. 2 sub 1–6, 8 WpPG would not apply to a SPAC IPO, yet, in terms of § 4 para. 2 sub 7 WpPG shares which are to be issued upon the exercise of conversion or subscription rights are exempt from a prospectus requirement, provided that such shares have already been admitted to trading on the same regulated market and within the same share class.21 In a SPAC scenario, this would apply to shares issued upon exercising SPAC warrants, thus implying that a prospectus would not have to be issued if and only if the same share class had already been previously admitted to trade on the same regulated market.22 d) Interim Result In practice, SPAC IPOs must be accompanied by a prospectus in accordance with the WpPG unless the SPAC unit offer is merely targeted at a limited group of investors. However, the latter is not commonly observed within a unit offer and hence such offer is to be accompanied by a joint prospectus.23

2. Prospectus Content Pursuant to § 5 para. 1 WpPG, the prospectus has to be composed in an easily analysable and comprehensible form. Moreover, it has to contain all information which, according to the particular nature of the issuer and of the securities offered to the public or admitted to trading on a regulated market, is necessary to enable investors to make an informed assessment of the assets and liabilities, financial position, profit and losses, and prospects of

20

Compare Zeising in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 3 WpPG para. 75. Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 182. 22 According to Foppe it must be noted that the issuance of the new shares must occur simultaneously with the offering of the SPAC warrants and the initially offered shares according to §§ 32 para. 3 sub 1 BörsG, 11 para. 1 BörsZulV; see Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 183. 23 Ibid. 21

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Chapter 3. SPACs and the Applicable German Law

the issuer and of any guarantor, and of the rights attaching to such securities (§ 5 para. 1 1st sentence WpPG). Hence a (SPAC) prospectus will have to contain some minimum required information according to § 7 WpPG, which refers to the block building approach for the compilation thereof as stipulated in the EC Prospectus Regulation24 (ProspektVO).25 The latter should in turn be interpreted with a view on the recommendations of the Committee of European Securities Regulators (CESR), which further substantiate the ProspektVO (so called CESR recommendations26 ).27 From these provisions it is clear that the information to be contained in a (SPAC) prospectus can be classified into three groups: (1) the minimum information required pursuant to the ProspektVO, (2) general clause information according to the standards of § 5 para. 1 WpPG and (3) voluntary information.28 With regard to the compilation of a SPAC prospectus, some challenges are bound to arise due to the specific features of a common SPAC’s transactional framework, which will be briefly highlighted below.29 a) SPAC-specific Challenges Pursuant to Annex I clause 20.1 para. 1 ProspektVO audited historical financial information covering the latest three financial years (or such shorter period that the issuer has been in operation), and the audit report in respect of each year shall be included in the prospectus. Within a SPAC model, literature suggests that this requirement cannot be fulfilled, since a SPAC does not possess a financial history.30 However, in the event that SPACs exist for a 24 Commission Regulation (EC) No. 809/2004 of 29 Apr. 2004 implementing Directive 2003/71/EC of the European Parliament and of the Council as regards information contained in prospectuses as well as the format, incorporation by reference and publication of such prospectuses and dissemination of advertisements. 25 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 7 WpPG para. 6; Just in: Just/ Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 7 WpPG para. 1 et seq.; Meyer in: Berrar/Meyer/ Müller/Schnorbus/Singhof/Wolf, Frankf. Komm. zum WpPG, 1st edition, 2011, § 7 WpPG para. 5. 26 CESR/05-054 b available at hwww.cesr-eu.orgi. 27 Compare Just in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 7 WpPG para. 9; Meyer in: Berrar/Meyer/Müller/Schnorbus/Singhof/Wolf, Frankf. Komm. zum WpPG, 1st edition, 2011, § 7 WpPG para. 22. 28 Compare Just in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 7 WpPG para. 11. 29 For a more detailed discussion compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 184–188. Also compare Just, ZIP 2009, p. 1698 et seqq., 1699; Harrer/Janssen, FB 2009, p. 46 et seqq., 46 et. seq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 329 et. seq.; Schanz, NZG 2011, p. 1407 et seqq., 1411. 30 Compare for example Just, ZIP 2009, p. 1698 et seqq., 1699; Selzner, ZHR 174 (2010), p. 318 et seqq., 329; Schanz, NZG 2011, p. 1407 et seqq., 1410.

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39

period not exceeding three years – which is most often the case – it could qualify for the status of a start-up company in terms of Annex XIX ProspektVO.31 According to the CESR recommendations32 so called special purpose vehicles defined in § 2 para. 4 ProspektVO do, however, not qualify as start-ups in fact because they are formed for the purpose of the issuance of securities, not to conduct a business. The question whether SPACs would nonetheless be classified as start-up companies is positively answered in literature, since SPACs are not solely incorporated as holding companies even though they do not posess an operating business.33 Hence, for such start-ups, the Federal Financial Supervisory Authority (BaFin) merely requires an audited interim report for the time since the inception of the start-up until the point of compiling the prospectus.34 Moreover, pursuant to Annex I clause 6.1 ProspektVO a SPAC prospectus would have to contain information about its operating history, e.g. sales figures of products/services, its core business areas as well as key business activities. Naturally this information cannot be provided as it simply does not exist.35 In this regard § 23 ProspektVO, a so called blank clause, would apply, which states that the information about the operating history may be omitted in cases where its application would be absurd to specific scenarios.36 Hence, within a SPAC framework, this requirement may be waived.37 Finally, the CESR recommendations require that a discussion of the issuer’s business plan with a discussion of the issuer’s strategic objectives shall be provided together with the key assumptions upon which such plan is based, in particular with respect to the development of new sales and the introduction of new products and/or services during the next two financial years, and a sensitivity analysis of the business plan to variations in the major assumptions; Issuers are not obliged to include a business plan with figures.38 In the event

31

Compare Just, ZIP 2009, p. 1698 et seqq., 1699; Harrer/Janssen, FB 2009, p. 46 et seqq., 47. Selzner, ZHR 174 (2010), p. 318 et seqq., 329; Schanz, NZG 2011, p. 1407 et seqq., 1411. 32 See CESR/05-054b, para. 136 33 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 184–188. Also compare Just, ZIP 2009, p. 1698 et seqq., 1699; Harrer/Janssen, FB 2009, p. 46 et seqq., 46 et. seq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 329 et. seq.; Schanz, NZG 2011, p. 1407 et seqq., 1411. 34 Compare Just, ZIP 2009, p. 1698 et seqq., 1699; Harrer/Janssen, FB 2009, p. 46 et seqq., 47; Selzner, ZHR 174 (2010), p. 318 et seqq., 329; Krug, Zweck, Bedeutung und Würdigung von Special Purpose Acquisition Companies (SPAC), 2009/2010, p. 9. 35 Compare Just, ZIP 2009, p. 1698 et seqq., 1699. 36 Compare Just in: Just/Voß/Ritz/Zeising, WpPG, 1st edition, 2009, § 7 WpPG para. 14. 37 Compare Just, ZIP 2009, p. 1698 et seqq., 1699; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 188. 38 See CESR/05-054b, para. 137.

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Chapter 3. SPACs and the Applicable German Law

that the business plan does include profit forecasts, such figures have to be independently audited.39 b) Interim Result The requirements in terms of a SPAC’s prospectus content can be fulfilled in practice. Since a common SPAC cannot present with audited financial information, it would instead be classifiable as a start-up company for the reasons described above. Harrer/Jansen and Selzner correctly conclude that a prospectus issued in connection with a SPAC IPO has to contain “details on (i) the composition of securities to be issued, (ii) the legal system applicable to the SPAC, (iii) any specific risk factors inherent to the SPAC model, (iv) any significant relationships to closely linked individuals and (v) any potential conflicts of interest”.40

3. Accessing Alternative Capital Market Segments SPACs can be listed through two alternative market segments: (1) through an over-the-counter (OTC) transaction under private law (§ 48 BörsG)41 or (2) through the regulated market (§§ 32 et seq. BörsG).42 a) Admission Through the OTC Market Pursuant to § 48 BörsG the establishment of an OTC is at the discretion of the respective stock exchanges and requires written permission of a public service institution, i.e. the German Securities and Exchange Commission (BaFin)43 . The underlying rules and regulations of such OTC market are vested in terms and conditions that must be approved by the management board of the stock exchange.44 There are no formal admission procedures laid down by law and 39

See CESR/05-054b, para. 137 in combination with 13.2 of Annex I of ProspektVO. See Harrer/Janssen, FB 2009, p. 46 et seqq., 47; Selzner, ZHR 174 (2010), p. 318 et seqq., 330; translated by the author from two almost identical original texts: “[. . . ]muss der Prospekt Angaben enthalten über (i) die Ausgestaltung der verschiedenen begebenen Wertpapiere, (ii) das für die SPAC geltende Rechtssystem[. . . ], (iii) die auf die spezielle Situation des SPAC Modells bezogene Risikofaktoren, (iv) die wesentlichen Beziehungen zu nahestehenden Personen sowie (v) das Bestehen etwaiger Interessenkonflikte.” 41 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 48 BörsG para. 3. 42 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 190. Also compare Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1548; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229. 43 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 48 BörsG para. 3. 44 Ibid. Foppe states with further references that as an example “the Frankfurt Securities Exchange (Frankfurter Wertpapierbörse) has stipulated its rules under the Terms and Condi40

I. Going Public with a SPAC – Capital Markets Law

41

hence the listing of securities is merely determined by the respective terms and conditions.45 In terms of SPAC units, all initial listing requirements on the Open Market46 of the Frankfurt Securities Exchange that are stipulated in § 13 AGB for SPAC shares and § 11 AGB for SPAC warrants can be fulfilled.47 Pursuant to §§ 9 para. 2, 10 AGB, the application for admission must be addressed to the Deutsche Börse AG in writing, which subsequently decides thereon.48 b) Admission Through the Regulated Market Admission to the regulated market can be effected through either § 32 BörsG or § 33 BörsG.49 The former stipulates the compulsory procedure for primary listings, the application of which has to be submitted to the management board of the stock exchange, with admission being decided on through an administrative act (§ 32 para. 1 et seq. BörsG).50 The formal requirement with regard to the application documents to be appended are stipulated in § 48 BörsZulV whilst the SPAC shell may be listed no earlier than the following trading day pursuant to the submission of the application and which will be announced in the Federal Gazette (§§ 50 et seqq. BörsZulV). Foppe subsequently points out that the underlying SPAC units have to be admitted to trading (§ 38 BörsG and § 52 BörsZulV) which may occur no earlier than three months post the gazette announcement (§ 38 para. 1, 4 BörsG).51 Harrer/Jansen52 and Just53 point out that the regulation under § 3 para. 1 BörsZulV necessitates that the issuer of securities seeking permission to be listed on the regulated market must have existed for at least three years and that such issuer is required – in accordance with the applicable rules – to publish three annual financial statements preceding the envisaged listing tions of Deutsche Börse AG for the Open Market at the Frankfurt Stock Exchange”; compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 190. 45 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 48 BörsG para. 3. 46 “Open Market” is synonymous for “OTC market” and is a term used by the Deutsche Börse AG. 47 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 190 et. seq. 48 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 48 BörsG para. 7. 49 Ibid., p. 190. Also compare Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229. 50 Compare Groß, Kapitalmarktrecht, 4th edition, 2009, § 32 BörsG para. 5; Trapp in: Habersack/Mülbert/Schlitt, Unternehmensfinanzierung am Kapitalmarkt, § 31 para. 10. 51 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 191. 52 See Harrer/Janssen, FB 2009, p. 46 et seqq., 47. 53 See Just, ZIP 2009, p. 1698 et seqq., 1699.

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Chapter 3. SPACs and the Applicable German Law

date.54 This requirement cannot be met within the framework of a SPAC model.55 However, according to § 3 para. 2 BörsZulV the management board of the stock exchange may create an exception, if doing so is in the interest of both, the issuer and the public.56 Against this background the Frankfurt Securities Exchange issued a so called Deutsche Börse Listing Guide which among others stipulates the exceptional conditions specifically for SPACs (no. 1.1.3) to allow their admission to the regulated market: – – – –

transfer of the raised funds to an interest-bearing trust account detailed description of the intended SPAC purpose stipulated time frame within which a takeover transaction is desired reimbursement to shareholders of the funds held in the event of a trust fund liquidation – competence on the part of the shareholders’ meeting to decide on the investment of the trust fund, with a simple majority being required for such resolution Since these requirements are compatible with common SPAC market practice, a listing through the regulated market can be achieved. c) Interim Result SPAC shells can be listed through the German regulated market. Foppe concludes that in comparison to an OTC transaction, the regulated market is more strictly organised especially in terms of post admission obligations: the administrative efforts (e.g. issuance of ad-hoc notifications, interim reporting etc.) as well as liability risks afforded by a listed firm on the regulated market are significantly more elaborate than otherwise.57 This in turn implies that investors can achieve higher levels of confidence especially against the background of the initially unforeseeable blank cheque investment, which makes the regulated market a seemingly more appealing segment than the OTC market.58 54 Also compare Trapp in: Habersack/Mülbert/Schlitt, Unternehmensfinanzierung am Kapitalmarkt, § 31 para. 15; Groß, Kapitalmarktrecht, 4th edition, 2009, §§ 1–12 BörsZulV para. 4. 55 Same opinion: Just, ZIP 2009, p. 1698 et seqq., 1699; Harrer/Janssen, FB 2009, p. 46 et seqq., 47; Selzner, ZHR 174 (2010), p. 318 et seqq., 331; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229. 56 Trapp in: Habersack/Mülbert/Schlitt, Unternehmensfinanzierung am Kapitalmarkt, § 31, para. 15; Groß, Kapitalmarktrecht, 4th edition, 2009, §§ 1–12 BörsZulV para. 4. 57 Compare with further references Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 189 et. seq. 58 Ibid., p. 190.

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4. Interim Conclusion: Capital Markets Law Based on the above considerations, one can conclude that the German capital markets law is sufficiently flexible in terms of enabling both a public offer of SPAC securities as well as the subsequent permission to list such securities on a regulated market. A prospectus has to be issued in connection with a SPAC IPO, the content of which must be computed as defined in the statutes, having recourse to exceptions as described above. SPAC IPOs can be conducted through either the OTC market or the regulated market.

II. Corporate Law Aspects Pertaining to SPACs The immanent aspects pertaining to the business law of SPACs will be analysed below by means of an assessment of the German stock corporation (Aktiengesellschaft) as a (suitable) business form. For this reason, the distinctive characteristics of SPACs discussed in chapter three have to be employed with a view on the status quo of the German stock corporation act (AktG). The assessment of the legal regulations pertaining to the German stock corporation (AG) as a specific business form for a SPAC, applies equally to other potential business forms, e.g. a partnership limited by shares (Kommanditgesellschaft auf Aktien – KGaA), or the Societas Europaea (SE) with headquarters in Germany.59

1. Aspect 1: SPAC Share Subscriptions and Trust Account With a view on preserving the IPO proceeds and thus securing the redemption claim on the part of investors, an average of 98% of the underlying proceeds are transferred to a trust account.60 Only a successful target acquisition will trigger a transfer of the trust funds to the underlying target, with all other scenarios (e.g. rejected acquisition, lapsing of stipulated time frame) involving a liquidation and proportionate redistribution of the funds to the shareholders. The ensuing question is the extent to which this stipulated trust account quota can be aligned with the statutory capital financing regulations.

59

Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 331. See table 3 of chapter 2, section II.2. Also compare Selzner, ZHR 174 (2010), p. 318 et seqq., 331; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 227; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 253. 60

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a) SPAC-specific Challenges Literature suggests that the participation in a SPAC through public (nonfounding) investors could be implemented via a capital increase in exchange for cash pursuant to §§ 182 et seqq. AktG.61 Such a (SPAC) capital increase is subject to numerous legal requirements62 which need due consideration during the practical implementation thereof as they pose potential problems thereto. After all these provisions are anchored on the notion of a creditor protection system to the extent of protecting the capital of (newly) issued shares63 . To start with, § 36 para. 2 AktG requires the orderly payment of the subscription amounts and refers to § 54 para. 3 AktG, according to which any amount called prior to the company having been filed for registration in the commercial register, may be put at free disposal of the management board only in legal tender credit to an account maintained with a credit institution in the name of the company or the management board64 . In analogous application thereto, subscription payments may not be made by credit to an account in the name of the management board according to § 188 para. 2 AktG.65 Moreover, the filing of the SPAC shell with the commercial register may be made only after the amount called on each share has been duly deposited and is at free disposal to the management board (§ 36 para. 2 AktG). Also, the company may only be filed with the register once the management board has called no less than one quarter of the minimum issue price per share as defined in § 9 para. 1 AktG, whilst according to § 9 para. 2 AktG being required to call the premium (agio) in the event of a par value exceeding issue price in its entirety.66 Since depository claims are commonly called in full at 61 See for example Selzner, ZHR 174 (2010), p. 318 et seqq., 331; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 227. 62 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 331 et seq.; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 255 et seq. 63 Compare Pentz in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 36 AktG para. 4; Heider in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 1 AktG para. 95; Hüffer, AktG, 10th edition 2012, § 1 AktG para. 11; Grigoleit in: Grigoleit, AktG, 1st edition 2012, § 1 AktG para. 27. 64 Compare Hüffer, AktG, 10th edition 2012, § 36 AktG para. 7; Vedder in: Grigoleit, AktG, 1st edition 2012, § 36 AktG para. 10; Kleindiek in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 36 AktG para. 18; Döbereiner in: Spindler/Stilz, AktG, 2nd edition 2010, § 36 AktG para. 17; Hommelhoff/Kleindieck, ZIP 1987, p. 477 et seqq. 65 Compare Veil in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 36 AktG para. 18; Servatius in: Spindler/Stilz, AktG, 2nd edition 2010, § 188 AktG para. 15; Hüffer, AktG, 10th edition 2012, § 188 AktG para. 5; Rieder/Holzmann in: Grigoleit, AktG, 1st edition 2012, § 188 AktG para. 7. 66 Compare Hüffer, AktG, 10th edition 2012, § 36a AktG para. 2; Vedder in: Grigoleit, AktG, 1st edition 2012, § 36a AktG para. 2; Kleindiek in: K. Schmidt/Lutter, AktG, 2nd

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the outset, this disclosure requirement can most likely be fulfilled during a SPAC shell utilisation.67 The free disposability of the called funds needs further scrutiny. As defined in §§ 188 para. 2 and 36 para. 2 AktG, the total amount called on all shares must be at free disposal of the management board. With regard to subscription payments deposited into a trust account, free disposability on the part of the management board is only fulfilled if the latter can unilaterally and alone place payment orders against such account.68 However, trust accounts set up during a SPAC IPO do not meet this condition.69 In fact, such trust accounts are maintained as a means of protecting shareholder funds and limiting the management board from freely disposing the funds, except in the event of a successful merger transaction or in the event of proportionately repaying the contributions upon liquidation of such account.70 Hence the stipulations of the AktG are incompatible with the characteristic requirements pertaining to SPAC trust accounts. The discussion on free disposability will be further substantiated in chapter 3, section III.3.a. b) Interim Result Trust accounts set up within the framework of a SPAC model are primarily designed as a shareholder protection measure. The above discussion has schown that, as such, this measure collides with the principle of creditor protection envisaged during a share capital increase, which is detrimental to the practical implementation of a SPAC trust account.71

2. Aspect 2: Differing Share Classes for Sponsors and Investors The rights attached to shares held by founders (sponsor shares) versus publicly held shares (investor shares) are subject to a partially differing control regime up to the point of execution of a SPAC merger transaction.72 These double edition 2010, § 36a AktG para. 2; Döbereiner in: Spindler/Stilz, AktG, 2nd edition 2010, § 36a AktG para. 5 et seq.; Krieger in: Hoffmann-Becking, Münchener Handbuch des Gesellschaftsrechts, vol. 4, 3rd edition 2007, § 56 para. 127. 67 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 331 et seq. 68 Compare Vedder in: Grigoleit, AktG, 1st edition 2012, § 36 AktG para. 11; Hüffer, AktG, 10th edition 2012, § 36 AktG para. 7; Kleindiek in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 36 AktG para. 22; Döbereiner in: Spindler/Stilz, AktG, 2nd edition 2010, § 36 AktG para. 21. 69 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 332; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 228; Schanz, NZG 2011, p. 1407 et seqq., 1411. 70 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 333. Also compare Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 228; Schanz, NZG 2011, p. 1407 et seqq., 1411. 71 Ibid. 72 Compare Schanz, NZG 2011, p. 1407 et seqq., 1411.

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standards are an integral part of the investor protection mechanism and thus require that (1) voting rights with regard to certain resolutions (e.g. voting on a merger transaction) are only attached to investor shares, (2) capital invested by public shareholders is strictly to be held in trust whilst sponsor capital remains unsecured up to the point of acquisition, and (3) that sponsors are prohibited from participating in trust fund distributions in the event of its liquidation i.e. the option of an opt-out instrument is only to be enjoyed by public shareholders.73 Upon the execution of the acquisition these double standards are (automatically) dissolved by converting sponsor shares into publicly held shares.74 a) SPAC-specific Challenges Within a SPAC framework, the primary point of departure is an assessment of the concept of a share class pursuant to § 11 AktG, the second sentence of which stipulates that shares conferring identical rights shall constitue one class. It also holds that shares may confer different rights (§ 11 AktG first sentence), with the principle of equal treatment of shareholders according to § 53a AktG thus not applying unrestrictedly.75 Hence Selzner correctly points out that a difference in membership rights, e.g. with regard to participation in SPAC trust fund liquidation proceeds, comprises differing share classes according to § 271 para. 2 AktG.76 He adds that the implementation of a SPAC opt-out instrument in the articles of association with regard to redeemable vis-à-vis non-redeemable shares would also constitute two share classes.77 A voting right is inextricably linked to a share according to § 12 para. 1 AktG, first sentence,78 as it is the most important administrative right attached to a shareholder79 . Prima facie, this presents the first restriction within a SPAC 73 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 339. Also compare Schanz, NZG 2011, p. 1407 et seqq., 1411 et seq. 74 Ibid. 75 Hüffer, AktG, 10th edition 2012, § 11 AktG para. 2; Vedder in: Grigoleit, AktG, 1st edition 2012, § 11 AktG para. 1; Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 11 AktG para. 1; Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 11 AktG para. 6. 76 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 339 et seq. Also Compare Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 11 AktG para. 5; Hüffer, AktG, 10th edition 2012, § 11 AktG para. 4; Vedder in: Grigoleit, AktG, 1st edition 2012, § 11 AktG para. 7; Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 11 AktG para. 8; Dauner-Lieb in: Zöllner/Noack, KölnKommAktG, 3rd edition 2010, § 11 AktG para. 10. 77 Compare Brändel in: Hopt/Wiedemann, GroßkommAktG, 4th edition, § 11 AktG para. 19. 78 Hüffer, AktG, 10th edition 2012, § 12 AktG para. 2; Vedder in: Grigoleit, AktG, 1st edition 2012, § 12 AktG para. 2; Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 12 AktG para. 4; Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 12 AktG para. 3. 79 Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 12 AktG para. 3.

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scenario. For, SPAC sponsor shareholders are strictly to be excluded e.g. from voting on a takeover transaction, as this constitutes one of the fundamental characteristics of common SPAC market practice. Yet, the AktG does provide for an exception with regard to §§ 12 para. 1, second sentence, 139 et. seq., to the extent that preference shares may be issued without a voting right (so called non-voting preference shares).80 The cumulative preference of such shareholders during profit distributions is ultimately a form of compensation for the loss of the voting right.81 However, there again, such practice would not correspond to a common SPAC framework, i.e. SPAC sponsor shares should not receive preferential treatment over investor shares with regard to profit distributions.82 According to Selzner a differing voting regime between sponsor and investor shares could still be achieved during the vote on a takeover transaction, despite the inextricability of the voting right from sponsor shares83 , since according to § 138 1st sentence AktG special resolutions of certain shareholders could be provided for in the Act or the articles and would have to be be adopted either at a separate meeting of such shareholders or by a separate vote, unless the law provides otherwise84 . Thence Selzner correctly concludes, that a revision of the provision pertaining to the company’s purpose/object stipulated in the SPAC articles to the extent that the acquisition can only be executed upon exclusive approval by public shareholders, would be perfectly sufficient within a SPAC model.85 This special resolution on the part of public shareholders could be implemented through an amendment of the company’s purpose as to the execution of the acquisition, since § 179 para. 1, 1st sentence AktG holds that any amendment of the articles or purpose of the enterprise shall require a resolution of the shareholders’ meeting. Such resolution of the shareholders’ meeting shall require a majority of not less than three quarters of the share capital represented at the passing of the resolution

80 Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 11 AktG para. 13; Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 12 AktG para. 10; Hüffer, AktG, 10th edition 2012, § 12 AktG para. 5; Vedder in: Grigoleit, AktG, 1st edition 2012, § 12 AktG para. 5; Heider in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 11 AktG para. 55; Dauner-Lieb in: Zöllner/Noack, KölnKommAktG, 3rd edition 2010, § 11 AktG para. 13. 81 Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 11 AktG para. 13; Ziemons in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 12 AktG para. 10. 82 Same opinion Selzner, ZHR 174 (2010), p. 318 et seqq., 340; Schanz, NZG 2011, p. 1407 et seqq., 1412. 83 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 341. 84 Compare Spindler in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 138 AktG para. 9; Rieckers in: Spindler/Stilz, AktG, 2nd edition 2010, § 138 AktG para. 11; Hüffer, AktG, 10th edition 2012, § 138 AktG para. 2; Herrler in: Grigoleit, AktG, 1st edition 2012, § 138 AktG para. 2. 85 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 341.

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(§ 179 para. 2, 1st sentence AktG).86 The articles may provide for a different capital majority, however, in the case of an amendment of the purpose of the enterprise, only for a larger capital majority (§ 179 para. 2, 2nd sentence AktG).87 Also, the articles may provide for additional requirements (§ 179 para. 2, 3rd sentence AktG). It thus follows that special resolutions can be implemented for certain share classes only.88 Yet, the distinct share classes described above, shall only be upheld until the target acquisition has been announced and executed, which raises the question whether or not such share classes can ultimately be abolished post the merger transaction?89 The levelling of share classes is subject to the same rules and regulations defined for the amendment of any share class.90 The rights associated with certain share classes can also be levelled after the lapsing of a pre-defined time frame which would not require the passing of any additional resolution of approval.91 This would, however, not be necessary in a SPAC model as the articles could simply state that the levelling of both share classes shall take immediate effect with the amendment of the purpose of the corporation.92 b) Interim Result From the above it follows that the statutory provisions of the AktG are only partially compatible with the classical SPAC transaction model. Although investor shares and sponsor shares can be incorporated into the articles of association as distinctive share classes, both types of shares would have to carry full voting rights, else a limitation thereof would have to be compensated with cumulative preference during profit distributions.93 An opt-out instrument could be attached to publicly held shares. If, however, the company’s object/ purpose is to be amended in the event of a takeover transaction subject to the decision by the shareholders’ meeting, the statute shall also stipulate the passing of a special resolution solely on the part of public shareholders.94 86 Compare Hüffer, AktG, 10th edition 2012, § 179 AktG para. 14; Holzhorn in: Spindler/ Stilz, AktG, 2nd edition 2010, § 179 AktG para. 16; Ehmann in: Grigoleit, AktG, 1st edition 2012, § 179 AktG para. 12. 87 Compare Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 179 AktG para. 11. 88 See Selzner, ZHR 174 (2010), p. 318 et seqq., 342. 89 Ibid. 90 Compare Brändel in: Hopt/Wiedemann, GroßkommAktG, 4th edition, § 11 AktG para. 43; Vatter in: Spindler/Stilz, AktG, 2nd edition 2010, § 11 AktG para. 35. 91 Ibid. 92 Selzner, ZHR 174 (2010), p. 318 et seqq., 342 et seq. 93 Selzner, ZHR 174 (2010), p. 318 et seqq., 341. Also compare Schanz, NZG 2011, p. 1407 et seqq., 1412. 94 Ibid.

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Ultimately, a levelling of both share classes into one class post the merger transaction is achievable without requiring a special resolution.

3. Aspect 3: SPAC Merger Transaction and Shareholder Approval As demonstrated in chapter 2, section II.3. before, the SPAC investor protection mechanism has to provide its shareholders with an ability to vote in favour of or against the investment of the raised share capital during a merger transaction.95 Hence this mechanism necessitates the implementation of a voting right exclusive to the shareholders’ meeting with no such competence being attached to the underlying SPAC management board or supervisory board.96 Do the statutes provide leeway for such distribution of competencies?97 a) SPAC-specific Challenges The above question can either be negated or affirmed, depending on the specific design of the underlying merger transaction.98 Pursuant to §§ 182 et seq. AktG, a merger transaction which institutes a capital increase against contributions, inherently requires a majority of not less than three fourths of the share capital represented at the passing of the resolution.99 Although the articles may provide for a different capital majority, in cases of the issue of non-voting preference shares (e.g. to SPAC founding shareholders), a larger capital majority is strictly required (§ 182 para. 1, second sentence AktG). A capital increase against contributions would thus not be problematic within the transactional framework of SPACs.100 However, a SPAC merger transaction which does not involve measures of a capital increase or restructuring would also be thinkable, e.g. an acquisition or 95 Also compare Schanz, NZG 2011, p. 1407 et seqq., 1412; Selzner, ZHR 174 (2010), p. 318 et seqq., 333; Just, ZIP 2009, p. 1698 et seqq., 1701; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 285. 96 Compare Harrer/Janssen, FB 2009, p. 46 et seqq., 47; Just, ZIP 2009, p. 1698 et seqq., 1701; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1549 et seq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 333; Schanz, NZG 2011, p. 1407 et seqq., 1412. 97 Compare Schanz, NZG 2011, p. 1407 et seqq., 1412; Selzner, ZHR 174 (2010), p. 318 et seqq., 333. For the principle of “separation of powers” within the AG see K. Schmidt, Gesellschaftsrecht, 4th edition 2002, § 26 IV 781. 98 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 333; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 286. 99 Compare Veil in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 182 AktG para. 27; Hüffer, AktG, 10th edition 2012, § 182 AktG para. 7. 100 Same opinion: Selzner, ZHR 174 (2010), p. 318 et seqq., 333; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 286.

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merger against cash, or the acquisition of an equity interest or (partial) assets of the target firm. In such cases the SPAC shell would have to be equipped with an ability to pass a relevant competence on the part of the shareholders’ meeting.101 This necessitates a scrutiny of the rights of the shareholders’ meeting with a view on § 119 AktG, which implies that the catalogue of rights defined therein does not explicitly assign a competence to the shareholders’ meeting during such merger transaction.102 Rather, the management board is directly responsible for the management of the company according to § 76 para. 1 AktG and in complementation with § 77 AktG its competencies would clearly also include the conclusion and signing of a SPAC merger agreement103 . After all, the term “management” is to be understood very broadly as it encompasses all actions and duties of the management board vis-à-vis the company, irrespective of its factual or legal nature104 , which does not only include internal corporate actions (e.g. the running of the trade books, the reporting procedure toward the supervisory board etc.), but also actions on behalf of the company against third parties (e.g. the conclusion of contracts)105 . Hence, one has to assess whether or not the shareholders are indirectly assigned with such competency within the standards of the Holzmüller/Gelatine doctrine106 ruled by the Federal Supreme Court (BGH).107 According to this doctrine, a shareholders’ resolution has to be instituted in cases where any measure on the part of the management board structurally amends the core competencies of the underlying stock coporation, despite the fact that such board still acts within the confines of its statutorily assigned competen101 Compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 286; Schanz, NZG 2011, p. 1407 et seqq., 1412; Selzner, ZHR 174 (2010), p. 318 et seqq., 333. 102 Also compare Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 286 et seq.; Selzner, ZHR 174 (2010), p. 318 et seqq., 334. 103 Selzner, ZHR 174 (2010), p. 318 et seqq., 333; Just, ZIP 2009, p. 1698 et seqq., 1701. 104 Compare Fleischer in: Spindler/Stilz, AktG, 2nd edition 2010, § 77 AktG para. 3; Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 77 AktG para. 4; Hüffer, AktG, 10th edition 2012, § 77 AktG para. 3; Mertens/Cahn in: Zöllner/Noack, KölnKommAktG, 3rd edition 2010, § 77 AktG para. 2; Wiesner in: Hoffmann-Becking, Münch.Hdb.GesR. IV, 3rd edition 2007, § 22 para. 1. 105 Compare Fleischer in: Spindler/Stilz, AktG, 2nd edition 2010, § 77 AktG para. 3; Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 77 AktG para. 4; Vedder in: Grigoleit, AktG, 1st edition 2012, § 77 AktG para. 2; Hüffer, AktG, 10th edition 2012, § 77 AktG para. 3; Wiesner in: Hoffmann-Becking, Münch.Hdb.GesR. IV, 3rd edition 2007, § 22 para. 1. 106 BGH, judgment of 24. Feb. 1982 – II ZR 174/80, BGHZ 83, 122 = NJW 1982, p. 1703 et seqq.; BGH, judgment of 26 Apr. 2004 – II ZR 155/02, BGHZ 159, 30 = NJW 2004, p. 1860 et seqq. 107 Also compare the discussions of Just, ZIP 2009, p. 1698 et seqq., 1702; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Selzner, ZHR 174 (2010), p. 318 et seqq., 335; Schanz, NZG 2011, p. 1407 et seqq., 1412.

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cies.108 Inducing such unwritten competency on the shareholders’ meeting requires that a management measure (1) triggers a mediatisation109 to the detriment of its shareholders, and (2) fundamentally infringes the shareholders’ rights which may either be the result of introducing an additional hierarchy level between shareholders and the underlying corporate assets or due to a restructuring of the corporation’s holdings at the expense of its shareholders’ interests.110 Against this background, Selzner concludes that the Holzmüller/Gelatine doctrine does not apply to SPAC merger transactions, which involve the “acquisition of the target firms’s individual assets, as this case would neither induce any mediatisation effects nor would such a transaction infringe the shareholders participation rights to such an extent that it would fundamentally equate an amendment of the articles of association”111 . With regard to the purchase of equity interests from the underlying target, Just concludes that although the activity of the SPAC shell is fundamentally transformed from a mere shell to a soliciting corporation post the acquisition of an equity interest, a mediatisation effect is not qualitatively induced on the shareholders; hence the shareholders’ meeting is not assigned with unwritten competencies according to the Holzmüller/Gelatine doctrine112 . The application of the standards of the Holzmüller/Gelatine doctrine during the purchase of an equity interest remains highly disputed in the underlying literature, with case law having produced opposing conclusions.113 108 BGH, judgment of 26 Apr. 2004 – II ZR 155/02, BGHZ 159, p. 30 et seqq., 40 = NJW 2004, p. 1860 et seqq., 1862 et seq. 109 “Mediatisation is invoked as soon as responsibilities are shifted within a group building process: whilst the initial control over the capital implemented for the group building rested with the shareholders, this power is now shifted to the management board. The latter is subsequently entitled to the rights attached to the investment, which replaced the capital. Thus shareholders potentially face a reduction in their dominion of control as well as dividend rights, which need to compensated accordingly;” quoted from Selzner, ZHR 174 (2010), p. 318 et seqq., 335. Also compare Habersack in: Emmerich/Habersack, Aktien- und GmbH-Kozernrecht, 6th edition 2010, § 311 AktG, para. 34 with further references. 110 BGH, judgment of 26 Apr. 2004 – II ZR 155/02, BGHZ 159, p. 30 et seqq., 40 = NJW 2004, p. 1860 et seqq., 1863. 111 See Selzner, ZHR 174 (2010), p. 318 et seqq., 335; translated from original text: “Für eine Übernahmetransaktion durch Erwerb einzelner Vermögenswerte kommt eine ungeschriebene Hauptversammlungszuständigkeit nach den Grundsätzen der Holzmüller/Gelatine-Rechtsprechung von vornherein nicht in Betracht, da ein Mediatisierungseffekt gar nicht eintritt und auch sonst – durch den Erwerb selbst – keine Strukturänderung oder Vermögensänderung anzunehmen ist, die einer Satzungsänderung gleich käme.” 112 See Just, ZIP 2009, p. 1698 et seqq., 1702; quoted from the original text: “Die SPAC wandelt sich zwar strukturell in ihrer Betätigung; qualitativ bewirkt dies aber keinen Mediatisierungseffekt der Aktionäre im Sinne der Rechtsprechung und kann daher auch keine ungeschriebene Hauptversammlungszuständigkeit begründen.” 113 See Selzner, ZHR 174 (2010), p. 318 et seqq., 335 with further references.

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However, a convocation of the shareholders’ meeting can also be achieved by other means, particularly in accordance with § 119 para. 2 AktG.114 Thus the management board could convene the shareholders’ meeting through a proposal for a resolution in such cases where no competencies are attached to the shareholders.115 Just raises doubts as to the compatibility of a resolution proposal for a SPAC takeover transaction with § 76 para. 1 AktG.116 After all, a resolution proposal is at the management board’s own discretion117 , yet such discretion is limited by the standards of the Holzmüller/ Gelatine doctrine as well as through the principle that the board cannot sacrafice almost all its management competencies in favour of the shareholder’s meeting.118 The managment board would thus be left with a mere residual competence.119 This concern is rather unfounded since the management board is primarily instilled with the duty to find a suitable target for the SPAC shell, whilst the execution thereof is a distinclty more subordinate duty.120 Selzner and Schanz propose that the initial extent and formulation of the purpose of the SPAC shell corporation shall internally restrict the board’s competencies beyond the point of closure of the envisaged merger transaction.121 Thereupon the SPAC’s purpose is to be amended in the articles of associations, coupled with a resolution of approval on the part of the shareholders with regard to the execution of the SPAC takeover transaction.122 In accordance with § 93 para. 2, first sentence AktG the management board or the supervisory board shall be severally liable to the company for any resulting damages in the event of a violation of their duties in terms of the enterprise’s purpose. Also, the amendment of a coorporation’s purpose after it has been registered, shall require a majority vote of not less than three quarter

114 Just, ZIP 2009, p. 1698 et seqq., 1702; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 287. 115 Spindler in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 119 AktG para. 22; Hüffer, AktG, 10th edition 2012, § 119 AktG para. 14; Vedder in: Grigoleit, AktG, 1st edition 2012, § 119 AktG para. 14; Hoffmann in: Spindler/Stilz, AktG, 2nd edition 2010, § 119 AktG para. 17. 116 See Just, ZIP 2009, p. 1698 et seqq., 1702. 117 Spindler in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 119 AktG para. 17; Herrler in: Grigoleit, AktG, 1st edition 2012, § 119 AktG para. 14; Hoffmann in: Spindler/Stilz, AktG, 2nd edition 2010, § 119 AktG para. 13. 118 Compare Just, ZIP 2009, p. 1698 et seqq., 1702. 119 Ibid. 120 Same opinion: Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 287. 121 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 336 et seq.; Schanz, NZG 2011, p. 1407 et seqq., 1412. 122 Ibid.

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of the share capital represented at the passing of such resolution according to § 179 para. 2, first sentence AktG. b) Interim Result With regard to a SPAC’s transactional framework, the above discussion implies that a convocation of the shareholders’ meeting can be statutorily implemented for the purposes of voting on a proposed SPAC merger123 , although some doubts remain124 . The initially mentioned requirement to enable the shareholders’ meeting to exercise control over the merger transaction can be met irrespective of the highly disputed Holzmüller/Gelatine doctrine, although the risk of potential abuse through legal actions of (minority) shareholders, who deliberately set out to prevent or delay an amendment of the articles of association, still remains.125

4. Aspect 4: Opt Out and Share Redemptions Another important SPAC corporate governance feature outlined in chapter 2, section II.3. is the requirement of providing dissenting shareholders with the possibility to opt out of a proposed merger transaction by being refunded pro rata of the total amount held in trust, including the accrued interest for the period during which the funds were held in trust. The following section seeks to establish whether or not an opt-out can be implemented within the framework of the AktG.126 a) SPAC-specific Challenges Prima facie the opt out instrument seems to infringe the fundamental principle of capital maintenance, according to which contributions may not be repaid to shareholders (§ 57 para. 1, 1st sentence AktG).127 Share buybacks are thus fundamentally prohibited according to German corporate law. However, 123 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 337; Schanz, NZG 2011, p. 1407 et seqq., 1412; Foppe, SPAC AG – Deutsche Aktiengesellschaft als Special Purpose Acquisition Company?, 2011, p. 287. 124 Compare Just, ZIP 2009, p. 1698 et seqq., 1702. 125 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 337; Schanz, NZG 2011, p. 1407 et seqq., 1412. 126 Also see Just, ZIP 2009, p. 1698 et seqq., 1702; Selzner, ZHR 174 (2010), p. 318 et seqq., 337 et seq.; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Schanz, NZG 2011, p. 1407 et seqq., 1412. 127 Compare Just, ZIP 2009, p. 1698 et seqq., 1702; Selzner, ZHR 174 (2010), p. 318 et seqq., 337 et seq.; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Schanz, NZG 2011, p. 1407 et seqq., 1412 et seq.

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exceptions can be derived from §§ 71 AktG et seqq. since the payment of the purchase price in case of a permitted acquisition of own shares shall not be deemed to constitute a repayment of contributions as stipulated by § 57 para. 1, 2nd sentence AktG. A scrutiny of § 71 para. 1, no. 6 AktG reveals that shares may be acquired by the corporation on the basis of a resolution of the shareholders’ meeting to redeem shares pursuant to the provisions governing a reduction of share capital pursuant to §§ 237 AktG et seqq. The articles of incorporation may thus stipulate a mandatory redemption upon its shareholders’ demand.128 Although the restrictions of § 71 para. 2, 1st sentence AktG do not apply to an ordinary share capital reduction, § 225 AktG is invoked in due consideration of § 237 para. 2 1st sentence AktG.129 Hence the corporation will have to provide sufficient creditor protection measures to such an extent, that shareholders may only be paid after a period of six months post the announcement of the redemption.130 Such practice is clearly incompatible with the SPAC transactional framework.131 Moreover, resorting to § 71 para. 1, no. 8 AktG, could provide the necessary exception in terms of implementing a SPAC opt out instrument, by permitting the company to acquire its own shares on the basis of a resolution of approval passed by the shareholders, the validity of which should not exceed a period of five years.132 A five year validity period would indeed suffice for a SPAC model, the typical investment horizon of which ususally does not exceed 24 months.133 However, § 71 para. 1, no. 7 AktG also requires that the corporation may not purchase a total share volume in excess 10% of the share capital held by the corporation. This restriction would again not be compatible with the SPAC model requirements.134 128

Compare Hüffer, AktG, 10th edition 2012, § 237 AktG para. 12; Rieder in: Grigoleit, AktG, 1st edition 2012, § 237 AktG para. 18; Oechsler in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 237 AktG para. 33. 129 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 338 et seq.; Schanz, NZG 2011, p. 1407 et seqq., 1412. 130 Compare T. Bezzenberger in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 71 AktG para. 48. Also see Oechsler in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 237 AktG para. 89; Hüffer, AktG, 10th edition 2012, § 237 AktG para. 27. 131 Compare Just, ZIP 2009, p. 1698 et seqq., 1703; Selzner, ZHR 174 (2010), p. 318 et seqq., 339; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Schanz, NZG 2011, p. 1407 et seqq., 1412 et seq. 132 Compare Just, ZIP 2009, p. 1698 et seqq., 1702; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Selzner, ZHR 174 (2010), p. 318 et seqq., 338; Schanz, NZG 2011, p. 1407 et seqq., 1412. 133 Ibid. 134 Compare Just, ZIP 2009, p. 1698 et seqq., 1703; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Selzner, ZHR 174 (2010), p. 318 et seqq., 338; Schanz, NZG 2011, p. 1407 et seqq., 1412.

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b) Interim Result Implementing an opt out instrument fails as a result of two primary statutory restrictions: (1) the 10% limit in terms of the total share volume is too narrow as the opt out instrument would be relevant to a wider group of shareholders; (2) a time lag of six months resulting from the statutory provisions during a mandatory redemption would not be compatible with the fundamental objectives of a SPAC model.135 Therefore, the envisaged SPAC investor protection resulting from an opt out instrument cannot be fulfilled against the background of the AktG.

5. Aspect 5: Acquisition or Liquidation An important SPAC investor protection measure is the requirement that the SPAC shell has to be dissolved with a pro-rata re-distribution of such funds to the public shareholders, provided that no takeover transaction is executed within the stipulated time frame (see chapter 2, section II.1.). In this event, a timely initiation of the trust fund liquidation is essential. a) SPAC-specific Challenges For the purposes of a SPAC model, the dissolution of a SPAC shell can be achieved on the grounds of two conditions in accordance with § 262 AktG: (1) Upon expiration of the period set in the articles of assocaition (§ 262 para. 1, no. 1 AktG), and (2) upon resolution of the shareholders’ meeting (§ 262 para. 1, no. 2 AktG).136 Both scenarios shall be analysed individually below. Pursuant to § 262 para. 1, no. 1 AktG (scenario 1), the expiration of a stipulated period leads to the SPAC dissolution, provided the time has been determined in the articles.137 The time of expiration must alternatively be determinable from the articles.138 However, Selzner correctly points out that “an ordinary time limitation would be inappropriate within a SPAC model, since a dissolution is of course not desired in the event of a timely takeover transac135 Compare Just, ZIP 2009, p. 1698 et seqq., 1702; Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Selzner, ZHR 174 (2010), p. 318 et seqq., 338; Thiergart/Olbertz, BB 2010, p. 1547 et seqq., 1550; Schanz, NZG 2011, p. 1407 et seqq., 1412. 136 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 345. 137 Bachmann in: Spindler/Stilz, AktG, 2nd edition 2010, § 262 AktG para. 21; Riesenhuber in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 262 AktG para. 4; Servatius in: Grigoleit, AktG, 1st edition 2012, § 262 AktG para. 3; Hüffer, AktG, 10th edition 2012, § 262 AktG para. 8. 138 Bachmann in: Spindler/Stilz, AktG, 2nd edition 2010, § 262 AktG para. 22; Riesenhuber in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 262 AktG para. 4; Grigoleit, AktG, 1st edition 2012, § 262 AktG para. 3; Hüffer, AktG, 10th edition 2012, § 262 AktG para. 8.

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tion, yet a conditional dissolution would be desirable”139 . The latter, however, can neither be derived as a dissolution condition (pursuant to § 158 BGB) from the norm itself, nor teleologically in accordance with the objectives of predictability and security implied by that norm.140 Hence the dissolution of the SPAC shell cannot be linked to an acquisition failure post the lapsing of the specified time frame.141 According to scenario 2 above, a SPAC dissolution can be instituted upon a resolution of the shareholder’s meeting (§ 262 para. 1, no. 2 AktG). In this regard, Selzner questions the extent to which “a legal duty can be imposed upon the shareholders’ meeting to unanimously vote in favour of the dissolution upon an acquisition failure within the specified time frame”142 . By nature such shareholder voting agreements are pure legal obligations that can be incorporated into the articles of association, despite their characteristic lack of an organisational nature.143 Hence a shareholder voting agreement could be implemented as a way of circumventing an obligatory agreement which could pose problems in potentially difficult shareholder circles.144 The above mentioned requirement of a timely initiation of the trust fund dissolution is statutorily obscured by the stipulation of § 272 para. 1 AktG, which requires that the assets may only be distributed if one year has elapsed from the date on which the notice to creditors has been published.145 This one year blocking period is incompatible with the common practice of a SPAC model.146 139

See Selzner, ZHR 174 (2010), p. 318 et seqq., 345; translated by the author from original text: “Eine reine Befristung entspricht aber den Erfordernissen des SPAC Modells nicht, da ja im Falle eines fristgerechten Transaktionsvollzuges eine Liquidation gerade nicht erfolgen soll.” 140 Compare Riesenhuber in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 262 AktG para. 4; Bachmann in: Spindler/Stilz, AktG, 2nd edition 2010, § 262 AktG para. 22. 141 Selzner, ZHR 174 (2010), p. 318 et seqq., 345. 142 See Selzner, ZHR 174 (2010), p. 318 et seqq., 345; translated by the author from original text: “Hier ist zu überlegen, inwieweit den Aktionären für den Fall des nicht fristgerechten Vollzuges der Übernahmetransaktion eine Rechtspflicht zur Fassung des Liquidationsbeschlusses auferlegt werden kann, um das SPAC Modell insofern umzusetzen.” 143 Compare Herrler in: Grigoleit, AktG, 1st edition 2012, § 136 AktG para. 26; Hüffer, AktG, 10th edition 2012, § 133 AktG para. 26; Rieckers in: Spindler/Stilz, AktG, 2nd edition 2010, § 136 AktG para. 46; Spindler in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 136 AktG para. 49. 144 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 345. 145 Compare Just, ZIP 2009, p. 1698 et seqq., 1703; Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Selzner, ZHR 174 (2010), p. 318 et seqq., 346; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21; Schanz, NZG 2011, p. 1407 et seqq., 1412. 146 Compare Just, ZIP 2009, p. 1698 et seqq., 1703; Selzner, ZHR 174 (2010), p. 318 et seqq., 346; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21., Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229.

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b) Interim Result A potential SPAC shell liquidation poses practical difficulties for the SPAC model both in terms of timing and manner of dissolution. The latter can be circumvened by means of a shareholder voting agreement as described above.

6. Aspect 6: Naked Warrants The units issued to founders and investors during a SPAC IPO are to be comprised of both common stock as well as so called naked warrants. Unlike ordinary warrants such naked warrants are not issued in conjunction with a bond. Naked warrants are not explicitly provided for in German statutes.147 Thus the underlying section will analyse the extent to which the allocation of naked warrants is possible within the framework of the German stock corporation act.148 a) SPAC-specific Challenges The primary point of departure shoud be a scrutiny of § 221 AktG, which covers convertible or warrant bonds and dividend bonds in which the rights of the holders are related to dividends paid to shareholders. In light of the exception stipulated in § 192 para. 2, no. 3 AktG, Selzner raises the question whether or not naked warrants could be issued for financing instead of remuneration purposes, whilst – in conjunction with the term naked – not being coupled to a bond.149 . The response thereto is still highly disputed and the question remains unresolved in literature to this date.150 Just and Selzner maintain in this regard that the rule-exception relationship between § 187 AktG on the one hand and §§ 221, 192 para. 2 AktG. on the other hand is abrogated, whilst the protective intentions derived from § 187 AktG, according to which any offer of rights to subscribe to new shares may only be made subject to the subscription rights of the shareholders.151

147 Compare Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21; Selzner, ZHR 174 (2010), p. 318 et seqq., 343. 148 Also compare Just, ZIP 2009, p. 1698 et seqq., 1701; Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Selzner, ZHR 174 (2010), p. 318 et seqq., 343; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21; Schanz, NZG 2011, p. 1407 et seqq., 1411. 149 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 343. 150 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 343 with further references. Also see Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21. 151 Compare Just, ZIP 2009, p. 1698 et seqq., 1701; Selzner, ZHR 174 (2010), p. 318 et seqq., 343 et seq.

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With a specific view on SPACs there are additional difficulties with regard to the issue of naked warrants.152 Selzner points out that since “the protection of the certificated rights are primarily achieved through the conditional capital stipulated in §§ 192 et seqq. AktG, the restriction with regard to the volume of a capital increase poses a problem with both authorised and conditional share capital”153 . Three statutory provisions need to be highlighted in this regard154 : (1) § 192 para. 3 AktG holds that the par value of conditional capital may not exceed 50% of the share capital as at the date of the adoption of the resolution on the conditional capital increase; (2) § 192 para. 2, no. 3 AktG further provides that a conditional capital increase may not exceed 10% of the share capital held as at the date of the adoption of the resolution on the conditional capital increase; (3) § 202 para. 3 AktG requires that the par value of the authorised capital may not exceed 50% of the share capital as the date of such authorisation. The volume restrictions pertaining to both authorised and conditional share capital pose a significant narrowing to the transactional practice of a SPAC model.155 The four year waiting period until warrants may be first exercised is also highly undesired within a SPAC framework.156 Finally, the consideration to issue naked warrants for the purposes of financing rather than as a means of remuneration without being linked to a bond, is still a highly disputed and unresolved issue which would not facilitate the desired implementation of a SPAC model.157 b) Interim Result The statutory restrictions pertaining to the issue of naked warrants are yet again detrimental to the SPAC transactional framework. The notion of issuing one naked warrant per SPAC unit cannot, therefore, be implemented in practice.

152 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 344; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21. 153 See Selzner, ZHR 174 (2010), p. 318 et seqq., 344; translated by the author from original text: “Die wirksame Absicherung der darin verbrieften Optionsrechte erfolgt [. . . ] vorrangig über das bedingte Kapital gem. §§ 192 ff. AktG. Problematisch ist aber sowohl bei dem bedingten wie auch beim genehmigten Kapital die Begrenzung des Volumens der jeweiligen Kapitalerhöhung.” 154 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 344. 155 Compare: Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Selzner, ZHR 174 (2010), p. 318 et seqq., 344. 156 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 344. 157 Ibid. Also compare Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 21.

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7. Interim Conclusion: Corporate Law Against the background of the above discussion, a SPAC model cannot be entirely implemented on the basis of the German stock corporation act.158 On the one hand it has been demonstrated, that there are aspects that can be structured in order to comply with the SPAC features, e.g. the possibility of distinctly classifying and distinguishing sponsor shares from shares held by public investors or the ability to pass relevant competencies on the part of the shareholders at the Annual General Meeting (AGM) in order to exercise control over the execution of a potential merger transaction. Yet there are some fundamental and very distinctive characteristics pertaining to a SPAC model which cannot be implemented in practice. The IPO funds held in trust cannot be deemed to be at free disposal of the management board as required by the statutes. In fact trust accounts set up within the framework of a SPAC model are primarily designed as a shareholder protection measure, yet the implementation thereof collides with the enshrined statutory principle of creditor protection envisaged during a share capital increase. The opt-out instrument fails due to the fact that the corporation will have to provide sufficient creditor protection measures by granting the latter (preferred) securities to such an extent, that shareholders may only be paid after a period of six months post the announcement of a mandatory redemption. Also the restriction that the corporation may purchase a total share volume of no more than 10% of the share capital held by the corporation poses another drawback to the SPAC model. The difficulties with regard to the (potential) issuance of naked warrants in a SPAC framework have been highlighted. Also, the restriction with regard to the volume of a capital increase poses a problem to both authorised and conditional share capital and is thus not compatible with the customary SPAC model. Finally, the consideration to issue naked warrants for the purposes of financing rather than as a means of remuneration without being linked to a bond, is still a highly disputed and unresolved issue which does certainly not facilitate the desired implementation of a SPAC model.

158 The same result applies to alternative German business forms e.g. a partnership limited by shares (Kommanditgesellschaft auf Aktien – KGaA) or the Societas Europaea (SE) with headquarters in Germany. Compare Just, ZIP 2009, p. 1698 et seqq., 1703; Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Selzner, ZHR 174 (2010), p. 318 et seqq., 346; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 229; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 22; Schanz, NZG 2011, p. 1407 et seqq., 1413.

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III. SPACs in View of the BGH Judgments on Shell Utilisations 1. Shell Utilisations in Germany The execution of the merger between the SPAC and the target firm during which the latter fills the former with its operative business, triggers the question whether a SPAC transaction involves a shell utilisation and if so, more specifically, which of the two existing shell types – off-the-shelf shell or “recycled” shell – would apply to a SPAC. The underlying sections seek to answer this question in light of the judgments of the German Federal Supreme Court (BGH) with regard to shell utilisations. As will be shown, this is in turn particularly relevant in view of (subsequent) liability risks and legal consequences upon the implementation of a SPAC. a) Off-the-shelf Shell versus “Recycled” Shell Academic literature has developed a tendency to divide shells into two types, the classification of which is of differing practical nature rather than differing legal quality159 : (1) Off-the-shelf shells are newly incorporated shells awaiting future utilisation for an arbitrary business ex post of their founding; (2) used or “recycled” shells have been stripped off a previously operative company and subsequently await being utilised for an alternative or new operating business.160 Intuitively, this classification is linked to differing risk patterns, implying that in practice “recycled” shells are inherently more risky in terms of former liabilities as well as insolvency risks than off-the-shelf shells.161 However, the utilisation of shell companies as such is subject to the same set of liability principles irrespective of whether the underlying shell is an off-the-shelf shell or a “recycled” shell.162 159 K. Schmidt, NJW 2004, p. 1345 et seqq., 1346; K. Schmidt, ZIP 2010, p. 857 et seqq., 859. Also compare Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 29; Hüffer, AktG, 10th edition 2012, § 23 AktG para. 25. For an American differentiation see Sjostrom, Entrepreneurial Business Law Journal 2008, p. 743et seqq., 744. 160 Compare Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 45; Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 40, 41; Hüffer, AktG, 10th edition 2012, § 23 AktG para. 25; K. Schmidt, NJW 2004, p. 1345 et seqq., 1347; K. Schmidt, ZIP 2010, p. 857 et seqq., 859. 161 See K. Schmidt, ZIP 2010, p. 857 et seqq., 858, who further substantiates that such liabilities may range from former pension obligations to corporate tax evasion or potential claims from environmental contamination. 162 According to the BGH judgment of 7 Jul. 2003 “[t]he real capital raising is to be secured during both the utilisation of a used shell as well as off-the-shelf shell through application of the adverse liability balance model as of the disclosure date of the company’s economic founding to the register court.” (translated by the author); BGH, judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seq.

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Initially a so called “open” off-the-shelf shell solely limits its business purpose to the maintainance and preservance of its raised share capital (assets) until it is utilised for an arbitrary business.163 The permissibility of incorporating open off-the-shelf shell companies was declared by the Federal Supreme Court (BGH) in 1992.164 However, a so called “hidden” off-the-shelf shell company which has not been disclosed to the register court and whose business purpose is fictitious or unachievable, is inadmissable according to the prevailing opinion, resulting in void articles of association.165 b) Shell Utilisation versus Business Restructuring The terms “off-the-shelf shell”, “recycled shell” and “shell utilisation” are not distinctly and precisely definable by law, yet the term “shell utilisation” has emerged as the generic term which encapsulates both types of shells described above.166 In contrast, literature differentiates such shell utilisations from the mere act of “restructuring” a company, the exact differences of which are yet again not distinctly definable: A company restructuring involves a reorganisation and restructuring of an ongoing operating business even if such activity involves a fundamental restructuring of that operative business.167 In this respect the differentiation of a shell utilisation from a mere restructuring activity is indeed rather difficult since the transition is stepless.168 As will be demonstrated further below, this difficulty will be equally prevalent in an attempt to classify a SPAC shell among these alternatives. Moreover, the utilisation of shells manifests itself in a number of different uses, the classical implementation of which involves the initial purchase of 163 Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 21. Also see Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 40; Hüffer, AktG, 10th edition 2012, § 23 AktG para. 25; Pentz in: Goette/Habersack, Münchener Kommentar zum Aktiengesetz, 3rd edition 2008, § 23 AktG para. 88; Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 45. 164 BGH, judgment of 16 Mar. 1992 – II ZB 17/91, BGHZ 117, 323 = NJW 1992, p. 1824 et seqq. Also compare Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 21; Pentz in: Goette/Habersack, Münchener Kommentar zum Aktiengesetz, 3rd edition 2008, § 23 AktG para. 91; Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 40; K. Schmidt, Gesellschaftsrecht, 4th edition 2002, § 4 III 2b) bb). 165 Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 40; Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 21; K. Schmidt, Gesellschaftsrecht, 4th edition 2002, § 4 III 2b) aa). 166 Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 22; Heidinger, ZGR 2005, p. 101 et seqq., 103; K. Schmidt, NJW 2004, p. 1345 et seqq., 1346; K. Schmidt, ZIP 2010, p. 857 et seqq., 859. 167 Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 29; Heidinger, ZGR 2005, p. 101 et seqq., 103. 168 Ibid.

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the underlying shares of an “empty”169 shell by the users and henceforth partners (shareholders) of that shell.170 Subsequently the statutes (articles) of the shell are amended to the extent of stipulating the new purpose, name and domicile of the enterprise whereupon the (newly) nominated management board commences the operating activities of the new enterprise.171 In contrast to the classical utilisation (i.e. purchase) of shells, it is also possible for the founders of a shell to use the latter for the listing of a (new) company, without selling shares to a third party.172 This utilisation seems to principally resemble the practice of a SPAC, based on the fact that a SPAC initially comprises an empty shell which is utilised for the subsequent listing of a target firm through that shell. However, this shall also be examined in more detail further below after a scrutiny of the judicial framework pertaining to shell utilisations.

2. BGH Judgments on Shell Utilisations Shell utilisations have become jurisdictionally anchored in Germany on the basis of the assumption that they equate the act of legally incorporating a company.173 The landmark rulings of the Second Civil Senate of the BGH in this regard will be chronologically highlighted and discussed in the following sections. Notably the judgments apply interchangably to the German limited liablility company (GmbH) and the German stock corporation (AG), since by order of 9 December 2012174 the BGH applied the ruling to both business forms equally and without differentiation.175

169

I.e. containing no business. Compare Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 44; Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 41; Hüffer, AktG, 10th edition 2012, § 23 AktG para. 27; Röhricht in: Hopt/Wiedemann, GroßkommAktG, 4th edition, § 23 AktG para. 129; Pentz in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 93; Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 38. 171 Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 37; K. Schmidt, NJW 2004, p. 1345 et seqq., 1347. 172 Seibt in: K. Schmidt/Lutter, AktG, 2nd edition 2010, § 23 AktG para. 41/§ 23 para. 27; Röhricht in: Hopt/Wiedemann, GroßkommAktG, 4th edition, § 23 AktG para. 129; Pentz in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 93; K. Schmidt, Gesellschaftsrecht, 4th edition 2002, § 26 III 71. 173 BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. 174 BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. 175 Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 46, who also points out that the BGH landmark ruling of 16 Mar. 1992 (II ZB 17/91, BGHZ 117, 323 = NJW 1992, p. 1824 et seqq.) pertained to a stock corporation shell. 170

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a) 2002/2003: Doctrine of “Economic Re-incorporation” By order of 9 December 2002, the mentioned Senate of the BGH ruled that in the event of activating an off-the-shelf shell, the underlying partners (shareholders) shall be bound by the provisions governing the formation of a limited partnership (stock corporation) including controls regarding the stipulated capital contribution.176 This ruling was based on the notion that the utilisation of an off-the-shelf shell would equate the “economic re-incorporation” of a company.177 Subsequently by order of 7 July 2003, the BGH ruled that the concept of an “economic re-incorporation” would equally apply to the activation of “recycled” shells.178 Moreover, it also ruled that the stipulated capital contribution shall be secured during both the utilisation of a used shell as well as off-the-shelf shell through application of the adverse balance liability model from the date of disclosure of the “economic re-incorporation” of the company to the underlying register court.179 The fourth and final guiding principle of the same ruling stated that the management board shall be liable in the event that business operations were assumed prior to the aforementioned disclosure of the “economic re-incorporation” without prior consent on the part of the shareholders.180 The fundamental reasoning vested in the doctrine of an “economic reincorporation” was later explained by Goette to the following extent:181 The judgments were to be interpreted as a creditor protection measure to counter the practice of dumping “empty” shells on the market without prior disclosure of such action, especially in light of the risk that “recycled” shells were potential “debt holes” which could negatively affect the survivability of the succeeding business operations. b) 2010: Narrower Applicability of an “Economic Re-incorporation” The above doctrine of an “economic re-incorporation” corresponded to the prevailing opinion that a disclosure failure triggered the risk of a perpetual 176

BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. Also compare Altmeppen, DB 2003, p. 2050 et seqq., 2050; K. Schmidt, NJW 2004, p. 1345 et seqq., 1346; Habersack, AG 2010, p. 845 et seqq., 845. 178 BGH, judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seqq. 179 See guiding principle 3 of the BGH judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seqq. 180 See guiding principle 4 of the BGH judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seqq. 181 Goette, DStR 2010, p. 764 et seqq., 765. Also see Habersack, AG 2010, p. 845 et seqq., 845; K. Schmidt, ZIP 2010, p. 857 et seqq., 858 et seq. 177

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adverse balance liability, even if at the time of the re-incorporation (i.e. the commencement of business operations) the company’s assets covered the stipulated capital.182 The Higher Regional Court of Berlin (KG) opposed this opinion by order of 7 December 2009, stating that an adverse balance liability would not apply in the event of an undisclosed “economic re-incorporation” provided that the stipulated capital was duly deposited with the company and was unspent at the time of the business commencement.183 Independent thereof the BGH ruled by order of 18 January 2010 that the utilisation of shells shall solely apply to companies with an empty shell, i.e. shells which shall contain no operative business that can be tied to a subsequent continuation of such operations according to any economically identifiable standard or weight.184 Morever, the BGH specified that a shell shall not be considered “empty” in cases where a company engages in preparatory and organisational activites for its future statutorily defined business operations after its founding and registration.185 Hence, the signal sent through this ruling was a clear (re-)confirmation of the doctrine of an “economic re-incorporation”, the scope of which was yet narrowed in order to take into account the crucial criterion of whether or not a shell lacked a business rather than a lack of assets.186 Further disussion thereof with a view on SPACs will follow below. Moreover, by order of 11 March 2010, the Higher Regional Court of Munich (OLG Munich) re-confirmed and upheld the concept of perpetual liability on the part of partners (shareholders).187 It simultaneously considered an exception to this legal consequence in those cases where the partners could prove that at the time of “revitalising” the shell, the share capital was covered by the company’s assets.188

182

OLG Jena, judgment of 1 Sep. 2004 – 4 U 37/04 = NZG 2004, p. 1114 et seqq. See the guiding principle of KG judgment of 7 Dec. 2009 – 23 U 24/09 = NZG 2010, p. 387 et seqq. 184 See guiding principle 1 of the BGH judgment 18 Jan. 2010 – II ZR 61/09 = NJW 2010, p. 1459 et seqq. 185 See guiding principle 2 of the BGH judgment 18 Jan. 2010 – II ZR 61/09 = NJW 2010, p. 1459 et seq. which is a continuation of BGH judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seq. 186 See Goette, DStR 2010, p. 764 et seqq., 765. Also compare Habersack, AG 2010, p. 845 et seqq., 847; Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 29. 187 See guiding principle 1 of OLG Munich judgment of 11 Mar. 2010 – 23 U 2814/09 = NZG 2010, p. 544 et seqq. 188 See OLG Munich, judgment of 11 Mar. 2010 – 23 U 2814/09 = NZG 2010, p. 544 et seqq., 545. Also see Altmeppen, DB 2003, p. 2050 et seqq., 2052. 183

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c) 2012: Dismissing Perpetual Liability? The BGH annulled the above mentioned ruling of the Higher Regional Court of Munich in its most recent order of 6 March 2012, implying a (partial) dismissal of the fundamental premise of the perpetual adverse balance liability model. The central message of this ruling stated that despite a failure to properly disclose the “economic re-incorporation”, the partners’ liability is limited to the amount of any adverse balance that exists at the time when the re-incorporation appears externally.189 In such cases the effective date of an external appearance shall depend on whether the “economic reincorporation” was linked to an amendment of the articles of association or not.190 In the former case, this would depend on the register court application, in the latter case it would depend on the time of commencement of business operations.191 In its reasoning, the Second Civil Senate confirmed the need for an “indispensible preventive protection through the register court against the economic use of a limited liability company to the detriment of creditors”.192 Yet the Senate did not consider the disclosure to be comparable to the initial register entry of a limited liability company pursuant to its legal incorporation for two reasons:193 (1) the (potential) risk patterns are different; (2) the incorporation of a company follows a state awarding deed which subsequently legitimises the use of the entity, whilst this does not apply to the “economic re-incorporation”, provided that it does not involve any amendments or other procedurally relevant steps which require a register court disclosure. Simultaneoulsy the BGH did not principally reject the adverse balance liability model, stating that upon the effective date and in the event of an adverse balance, the partners shall be liable for settling such adverse balance.194 Hence the remaining purpose of the disclosure requirement shall be to prevent – by means of the register court – a circumvention of applying the stipulated share capital, thereby justifying a reversal of the burden of proof: In the event of an undisclosed “economic re-incorporation” the burden of 189

See para. 14 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq.,

1876. 190 See guiding principle 1 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq. 191 See guiding principle 1 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq. 192 See para. 18 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1877. 193 See para. 23 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1878. 194 See para. 28 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1879.

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proof rests with the partners to show that at the point of its external appearance, the diffference between the stipulated share capital and asset value of the company equalled zero.195 d) Attempting to Classify SPACs: Empty or not? Against the background of the above mentioned judicial framework and definitions, the question that subsequently arises, is whether the application of a SPAC can be classified as either a shell utilisation or a mere business restructuring. This will be discussed hereinafter. The primary point of departure in an attempt to distinguish between a shell utilisation and a business restructuring would be to identify whether the underlying stock corporation is an “empty” shell which should contain no operative business that can be tied to a subsequent continuation of such operations – even if it involves a major restructuring of the corporation’s realm of activity – according to any economically identifiable standard or weight.196 This criterion would indeed no longer be fulfilled in cases where a company engages in preparatory and organisational activites – even if such activities are minor and last over a long period of time – for its future statutorily defined business purpose.197 Hence it is important that the underlying shell strictly contains no business, i.e. that it does not unfold any form of (statutory) business operations and is thus a mere legal platform for the listing of an arbitrary business. As described earlier, a common SPAC is specifically incorporated with the purpose of identifying an arbitrary business target which seeks access to the capital market. The extent to which such arbitrary targets and hence business purposes are more closely specified, varies according to business sectors, geographic regions or even target company sizes and values, as illustrated by the following examples: (1) Upon the IPO of Germany1 Acquisition Limited in 2008, its target search was only geographically confined – but otherwise arbitrary – to German speaking countries in Europe, by stating that its purpose was “to acquire one or more operating businesses with principal business operations in Germany, Austria or Switzerland”198 ; (2) similarly, 195

See para. 42 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq.,

1880. 196 See guiding principle 1 of the BGH judgment 18 Jan. 2010 – II ZR 61/09 = NJW 2010, p. 1459 et seqq. Also see Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 29. 197 See guiding principle 2 of the BGH judgment 18 Jan. 2010 – II ZR 61/09 = NJW 2010, p. 1459 et seq. which is a continuation of BGH judgment of 7 Jul. 2003 – II ZB 4/02, BGHZ 155, 318 = NJW 2003, p. 3198 et seq. 198 See proxy statement of Germany1 Acquisition Limited, available at hwww.afm.nl/ registers/emissies_documents/1699.pdfi (accessed 20 Dec. 2012).

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Helikos SE was listed in 2010 with the aim of acquiring one or more operating businesses from German Mittelstand firms199 ; (3) the European Cleantech SE was incorporated with the aim of “acquiring a European business within the cleantech industry, with a company value of between 0.5 and 1.5 billion Euros”200 . These examples suggest that common SPACs portray the characteristics of an open off-the-shelf shell since the business purpose can be lawfully stipulated as merely “the maintanance and preservance of the raised share capital” (see chapter 3, section II.1.a). After all a SPAC’s principal business purpose is to acquire an arbitrary business from the IPO proceeds, irrespective of the (potential) geographic, sectoral or size restrictions. All the more so, a common SPAC’s business purpose cannot be viewed as fictitious, whereupon a hidden off-the-shelf shell is out of the question. Additionally, the register courts apply certain indicators in terms of differentiating the launch of a shell from a business restructuring, all of which hold true for a common SPAC: As such, these indicators include the amendment of the underlying shell’s statutes (articles) to the extent of (simultaneously) stipulating a new business purpose, name and domicile of the enterprise as well as nominating a new management to subsequently commence the operating activities of the new enterprise201 . This aspect affirms the presence of an “empty” SPAC shell, i.e. based on the facts mentioned thus far SPAC shells would be reasonably classifiable as so called open off-the-shelf shells. However, the common transactional practice of a SPAC provides that the underlying management board commences the search for a (suitable) target firm from the moment of the SPAC’s IPO and within a stipulated time frame of usually 24 months (see chapter 2, section II.1.). These activities involve the active search and evaluation of potential business targets and – if applicable – the preparation of the merger transaction between the target and SPAC. As such these activities are clearly of organisational and preparatory nature for the realisation of the statutorily defined business purpose pursuant to the BGH judgment of 18 Jan. 2010. Therefore a common SPAC would ultimately not be considered to be an “empty” shell and thus a SPAC transaction would not involve a shell utilisation. These contradictory conclusions clearly suggest that SPACs are not distinctly and explicitly classifiable as open off-the-shelf shells or not. Hence the 199

See press release of Helikos SE of 12 Jan. 2010, available at hwww.dgap.de/news/ corporate/helikos-helikos-veroeffentlicht-details-zum-boersengang_360454_614799.htmi (accessed 20 Dec. 2012). 200 See press release of European Cleantech SE of 4 Oct. 2010, available at hwww.dgap.de/ dgap/News/?newsType=ADHOC&newsID=647205&print=1i (accessed 20 Dec. 2012). 201 Compare Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 29.

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extent to which the organisational and preparatory activities override the register court indicators as well as the arbitrariness of a target firm is a case specific distinction. It can be assumed that in cases of a reasonable SPAC as illustrated by the above examples, the preparatory and organisational activities conducted by the SPAC management board are sufficiently comprehensive to demonstrably show that such activities were planned and aimed at the realisation of the statutorily defined business purpose. In the end the indicators applied by the register courts merely provide some form of reference in terms of differentiating between a shell utilisation and a business restructuring. Hence these indicators could as such be marginalised and refuted in SPAC-specific cases and should certainly not be viewd as binding reference points. Ultimately, the common market practice pertaining to SPACs suggests that the underlying SPAC transactions do not involve a shell utilisation. It is nonetheless thinkable that the versatile and flexible transactional strucure of SPACs can come up with such SPACs that would indeed be classifiable as “empty” shells. Assume for example that a fictitious SPAC called Solar Technology Acquisition Company is incorporated with the purpose of acquiring one or more businesses with principal operations in the solar industry within Germany, Austria or Switzerland. Towards the end of the stipulated time frame of 24 months no suitable target has been found by the SPAC management board within the solar industry but the board is made aware of a German wind turbine manfuacturer that seeks access to the capital markets. Since this case presents a deviation from the stipulated business purpose, one can reasonably assume that it involves a shell utilisation which is subject to the doctrine of an “economic re-incorporation”. Suppose that in a second case the above mentioned Solar Technology Acquisition Company initially sets out to seek a target but subsequently pauses this search due to an exogenous influence such as financial market turmoil. After a pause of several months the search is resumed. This case involves a substantial discontinuity between the founding of the company shell and the incorporation of its business and hence it is hard to refute that this case would indeed involve a shell utilisation. Last but not least, assume as a third example that an investment bank incorporates several SPACs (named SPAC1, SPAC2, SPAC3 respectively) for the purpose of individually acquiring one or more businesses with principal business operations in Germany, Austria or Switzerland. After the IPO these SPACs are systematically and consecutively called upon for a merger transaction with an arbitrary business that presents itself as a suitable target. Clearly this scenario would involve a shell utilisation. The list of similar thinkable scenarios could be complemented and continued endlessly and bear a number of (potential) legal consequences that will be discussed in the following section.

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3. Legal Consequences for SPAC Transactions From the above it follows that a shell utilisation as defined by the BGH cannot be universally excluded from the versatile transactional framework of SPACs. Consequently the SPAC founders, managers and shareholders should be aware of a number of strict legal consequences for the transactional practice of those SPACs which are ultimately classifiable as “empty” shells. Hence all provisions governing the incorporation of companies as well as the register court control measures pertaining to the German stock corporation act (AktG) need to be applied analogously to the utilisation of a SPAC shell. In addition, a number of strict liability risks need to be taken into consideration, particularly with regard to potential adverse balances as well as action liability. a) Disclosure and Register Court Controls According to the BGH judgments a SPAC shell utilisation would involve the act of an “economic re-incorporation”. Therefore the provisions governing the incorporation of a stock corporation also apply to SPAC shells, by implication of which the SPAC founders as well as members of both management and supervisory board shall file the company in the commercial register with the register court (§ 36 para. 1 AktG)202 . In the event of a shell purchase, literature suggests that “founders” according to § 36 para. 1 AktG are also to be understood as the buyers of the stock corporation shell, who ultimately fill the shell with economic activity.203 Moreover, literature suggests that the utilisation of an open off-the-shelf (SPAC) shell requires (1) the disclosure of such shell utilisation to the register court and (2) assurance that the required capital contribution has been effected as though a company were incorporated.204 By implication and in accordance with §§ 36a para. 1, 37 para. 1 AktG all SPAC founders and all members of both management board and supervisory board shall affirm that the stipulated capital contributions was demonstrably effected and se-

202 Compare Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 46, who holds that a mere filing on the part of the management board or the chairman thereof would be insufficient. 203 Compare with further references Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 46. 204 Compare Hüffer, AktG, 10th edition 2012, § 23 AktG para. 27a; Pentz in: Goette/ Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 102; Arnold in: Zöllner/ Noack, KölnKommAktG, 3rd edition 2010, § 23 AktG para. 103; Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47.

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cured upon the disclosure of the “economic re-incorporation” to the register court.205 Apart from that, the provisions pertaining to the incorporation of a company also apply to SPACs subject to two conditions identified by Limmer and Pentz: (1) the amendment of the articles of association is to substitute the establishment of the articles pursuant to § 23 AktG, and (2) the filing of such amendments is to substitute the registration filings according to § 37 AktG.206 The same authors point out that an examination and control thereof shall be effected by the register court according § 38 AktG.207 In addition and analogous to § 32 AktG the members of the management board and the supervisory board have to compile a so called formation report.208 Closely linked thereto is the implementation of a formation audit pursuant to § 33 para. 1 AktG, which shall examine the course of events and transactions which led to the SPAC shell utilisation.209 Limmer adds that the extent of the formation audit is stipulated in § 34 AktG, although with regard to off-the-shelf shells this audit is limited to the duly effected stipulated capital contribution.210 It can be inferred that an extension of the formation audit report in the event of contributions in kind analogous to § 34 para. 1 sub. 1 and 2, para 2 AktG would not apply to SPAC transactions.211 Finally, according to §§ 36a para. 1, 37 para. 1 AktG the founders and all members of both management and supervisory board have to furnish an insurance and proof thereof, that upon its disclosure each share contribution for every issued share was duly effected and that the called share capital is at free 205

Compare Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47. Compare Pentz in: Goette/Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 102 and Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47 who use identical texts: “Im Übrigen gelten die Bestimmungen über das Gründungsverfahren bei der Neugründung entsprechend mit der Maßgabe, dass der Beschluss über die Satzungsänderung an die Stelle der Satzungsfeststellung nach § 23 AktG tritt und die Anmeldung der Satzungsänderung an die Stelle der Anmeldung nach § 37 AktG tritt, hierbei müssen die §§ 36 para. 2, 36a, 37 AktG beachtet werden, die Prüfung durch das Handelsregister der nach § 38 AktG entspricht.” 207 Ibid. Also see Arnold in: Zöllner/Noack, KölnKommAktG, 3rd edition 2010, § 23 AktG para. 105. 208 Compare Hüffer, AktG, 10th edition 2012, § 23 AktG para. 27; Pentz in: Goette/ Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 103; Arnold in: Zöllner/ Noack, KölnKommAktG, 3rd edition 2010, § 23 AktG para. 105; Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47. 209 Compare Hüffer, AktG, 10th edition 2012, § 23 AktG para. 27; Pentz in: Goette/ Habersack, MünchKommAktG, 3rd edition 2008, § 23 AktG para. 103; Limmer in: Spindler/ Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47; Gerber, Der Deutsche Rechtspfleger 2004, p. 469 etseqq., 470. 210 Compare Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47. 211 Ibid. 206

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disposal of the management board212 . The latter has to append duplicates of such subscription forms upon filing and registering the implementation of the share capital increase (§§ 188 para. 2 and 37 para. 1, 2nd sentence AktG). According to commentaries, called contributions that are transferred into a trust account are deemed to be at free disposal of the management board provided that it either has free access to the underlying funds held in trust or that the funds may be released at free disposal of the management board.213 However, trust accounts set up during a SPAC IPO do not meet the aforementioned conditions.214 In fact, Selzner holds that such trust accounts are maintained well beyond the stage of filing and registration of the shell and the share capital increase whilst the managment board may only dispose the funds under special circumstances, e.g. during the liquidation thereof.215 Thus Selzner correctly infers that SPAC funds held in trust cannot be deemed to be at free disposal of the management board as required pursuant to §§ 36 para. 2, 37 para. 1 AktG.216 It follows that the disclosure requirements analogous to the BGH judgments on shell utilisations cannot be fulfilled for a SPAC. b) Adverse Balance Liability The principles of the adverse balance liability model would also potentially apply to the SPAC transaction practice. Hence the shareholders will be liable for settling the difference between the stipulated capital contribution and the actual asset value of the corporation upon the effective date of disclosure of the “economic re-incorporation” to the register court. In the event of a failure to properly disclose the “economic re-incorporation”, the liability is limited to the amount of any adverse balance that exists at the time when the re-incorporation appears externally.217 The effective date of such external appearance shall depend on whether the “economic re-incorporation” was linked to an amendment of the articles of association or not.218 In the former case this would depend on the register court application, in the latter case it 212 Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47; K. Schmidt, NJW 2004, p. 1345 et seqq., 1348. 213 Compare with further references Selzner, ZHR 174 (2010), p. 318 et seqq., 332. 214 Compare Selzner, ZHR 174 (2010), p. 318 et seqq., 332; Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 228; Schanz, NZG 2011, p. 1407 et seqq., 1411. 215 Selzner, ZHR 174 (2010), p. 318 et seqq., 333. Also compare Zanner/Siebert, Corporate Finance Law 2010, p. 224 et seqq., 228; Schanz, NZG 2011, p. 1407 et seqq., 1411. 216 Ibid. 217 See para. 14 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1876. 218 Analogous to guiding principle 1 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq.

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would depend on the time of commencement of SPAC business operations.219 Moreover, the burden of proof will be of particiular relevance for the SPAC shareholders: In the event of an undisclosed “economic re-incorporation”, the burden of proof rests with the partners (shareholders) to show that at the point of its external appearance, the difference between the stipulated share capital and asset value of the company equalled zero.220 c) Action Liability Analogous to § 48 para. 1 AktG any person who acts on behalf of the company prior to its registration shall be personally liable; if more than one person so acts, such persons shall be jointly and severally liable. Hence the SPAC management board shall not commence business operations ex ante the aforementioned disclosure unless the shareholders have consented to such activities. In fact, the board or any other person shall be liable for all obligations that arise from any legal act up to the point of disclosure of the shell utilisation. In practice, SPAC managers should be aware of this liability risk which can potential take significant extents.

4. Interim Result and Critique on the BGH Judgments According to the above analysis a SPAC transaction can potentially involve a shell utilisation. By implication the implementation and use of SPAC shells is analogously bound by the legal consequences of the BGH judgments on shell utilisations, which have become jurisdictionally anchored in Germany on the basis of the assumption that they equate the act of legally incorporating a company (doctrine of an “economic re-incorporation”).221 This bears several obstacles to the transactional practice of SPACs in terms of (1) disclosure requirements which cannot be fulfilled during a SPAC transaction (e.g. free disposability of funds analogous to §§ 36a para. 1, 37 para. 1 AktG) and (2) a set of strict liability risks which have to be taken into due consideration on the part of all SPAC stakeholders (founders, management board, supervisory board and schareholders) such as the adverse balance liability and liability of action.

219

Analogous to guiding principle 1 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq. 220 See para. 42 of BGH judgment 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1880. 221 BGH, judgment of 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. Also compareK. Schmidt, ZIP 2010, p. 857 et seqq., 857.

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To that extent the doctrine of an “economic re-incorporation” during shell utilisations and the strict adverse balance liability model resulting therefrom have also been fundamentally criticised in literature, such that the abolishment of the doctrine and its consequential risks has been continuously demandend.222 Despite the recent ease with regard to ending the perpetual liability by order of 6 March 2012, critics have described this BGH ruling223 as a mere “half step forward” and continue to demand the abandonment of the doctrine in its entirety.224 The analogous application of the provisions governing the formation of a company including the control measures of the register court225 to shell utilisations, has been crtiticised for a number of reasons: (1) No identifiable factual basis exists in order to justify that a shell utilisation is any different from the common restructuring practices of companies which becomes especially obvious from a practical point of view226 ; (2) no identifiable factual basis exists in order to justify the abovementioned analalogous application on the basis of creditor protection measures, with no such application being required for (active) operating businesses during e.g. assest deals or similar activities227 ; (3) the German corporate capital markets law does not address the incoporation, liquidation and transfer of companies228 . It does, in fact, address the establishment (§§ 23 et seqq. AktG), the liquidation and termination (§§ 262 et seqq. AktG), the merger (§§ 2 et seqq. UmwG) and de-merger (§§ 123 et seqq. UmwG) of legal entities and even adresses the problems of capital protection (§§ 36 et seqq. AktG).229 However, it provides no legal basis upon which the concept of an “econonmic re-establishment” and the consequential application of the provisions governing the incorporation of companies can be derived from the underlying statutes.230 The declaration analogous to §§ 36a para. 1, 37 para. 1 AktG has also been subject to critique: as stated above, all founders and all members of the man222 K. Schmidt in: Scholz, GmbHG, 11th edition 2012, § 11 GmbHG para. 29, 67, 84, 140; Kleindieck in: FS Priester, 2007, p. 369 et seqq.; Habersack, AG 2010, p. 845 et seqq.; Altmeppen, DB 2003, p. 2050 et seqq.; K. Schmidt, NJW 2004, p. 1345 et seqq.; K. Schmidt, ZIP 2010, p. 857 et seqq.; K. Schmidt, JuS 2010, p. 545 et seqq. 223 BGH, judgment of 6 Mar. 2012 – II ZR 56/10 = NJW 2012, p. 1875 et seqq., 1876. 224 K. Schmidt in: Scholz, GmbHG, 11th edition 2012, § 11 GmbHG para. 140. 225 See guiding principle 2 of the BGH judgment 9 Dec. 2012 – II ZB 12/02, BGHZ 153, 158 = NJW 2003, p. 892 et seqq. 226 Emmerich in: Scholz, GmbHG, 11th edition 2012, § 3 GmbHG para. 25; K. Schmidt, NJW 2004, p. 1345 et seqq., 1350 et seq.; K. Schmidt, ZIP 2010, p. 857 et seqq., 864; Habersack, AG 2010, p. 845 et seqq., 846. 227 K. Schmidt, ZIP 2010, p. 857 et seqq., 864; K. Schmidt, NJW 2004, p. 1345 et seqq., 1351. 228 K. Schmidt, NJW 2004, p. 1345 et seqq., 1351. 229 K. Schmidt, ZIP 2010, p. 857 et seqq., 864; K. Schmidt, NJW 2004, p. 1345 et seqq., 1350. 230 Ibid.

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Chapter 3. SPACs and the Applicable German Law

agement board and the supervisory board have to furnish an insurance that the called share capital is at free disposal of the management board,231 else they are liable for damages according to § 48 AktG. According to critic, it is hardly apparent why this concept is analogously applicable to shell utilisations since the (freely diposable) capital contribution is not a financing status but a capital transfer.232 In fact, the declaration analogous to §§ 36a para. 1, 37 para. 1 AktG has been derived as an audit rule for the register court to control whether or not the corporation carried forward an adverse balance liability from the time prior to its registration.233 Thus it should bee seen as an extension of law making which has been applied to the disclosure procedure of shell utilisations, which is nonexistent by law.234 Despite these significant shortcomings and flaws inherent in the concept of an “economic re-incorporation”, the most recent BGH judgments have shown that this doctrine will be upheld for the forseeable future. Hence the jursidiction will have to continue passing adaptations, restrictions and casuistic clarifications in order to accommodate the legal uncertainty it has triggered since the introduction of that doctrine. The alternative would be – as stated above – to abandon it entirely, which would not least be beneficial to the transactional practice of SPACs.

IV. Summary From a capital markets perspective, the transformation of a SPAC model through the listing on a German stock exchange is possible when taking into consideration the exceptions inherent within the underlying stock exchange. Furthermore, the successful listing of the Helikos SE is a proven practical example thereof. However, some distinctive characteristics specifically pertaining to SPACs which have been developed through international market practice cannot be realised against the statutory background of the AG. The counter-suggestion could claim to adjust the SPAC model to such an extent that it suits the statutory provisions of the respective German business forms. However, sacrificing any of the corporate governance features instilled within the SPAC model and thus forgoing investor protection, would fundamentally undermine some principal characteristics of the SPAC model. Ultimately this would subvert the very foundation upon which the SPAC 231 Limmer in: Spindler/Stilz, AktG, 2nd edition 2010, § 23 AktG para. 47; K. Schmidt, NJW 2004, p. 1345 et seqq., 1348. 232 K. Schmidt, NJW 2004, p. 1345 et seqq., 1348. 233 Ibid. 234 Ibid.

IV. Summary

75

model has been successfully developed and implemented internationally. In fact, the German stock corporation (AG) as an example does not provide such advantages that would principally justify the amendment or abolition of the investor protection mechanisms within a SPAC framework to suit that business form. More so, the choice of a specific business form should not without reason question the market acceptance and thus the relevant success factors of such business form. Therefore one cannot reasonably expect the transactional practice to bend the SPAC model in favour of the AktG, not least because there are no significant advantages in doing so. In the short to medium run one would rather expect such transactional practice to follow the examples of Germany1 Acquisition Limited and Helikos SE by utilising foreign (European) business forms which provide sufficient flexibility and which are thus conducive to the SPAC model.235 The utilisation of foreign (European) business forms for a SPAC shell company would certainly not undermine potential sponsors’ or investors’ interest to focus on the German market. In fact, it is likely forseeable that listed SPAC shells with non-German seats will be incorporated with a specific focus on acquiring targets from the German Mittelstand. This would ultimately lead to a high frequency of future foreign SPAC shell acquisitions within Germany. Last but not least it was demonstrated above that the implementation of a SPAC shell could potentially involve a shell utilisation as stipulated by the BGH. Hence the above mentioned challenges in terms of practically implementing a SPAC within the confines of the German legal landscape are potentially aggravated as a result of the legal consequences pertaining to shell utilisations. In particular the founders, management board, supervisory board and the shareholders are potentially faced with substantial liability risks which are to be taken into due consideration during the implementation of a SPAC.

235 Same view Just, ZIP 2009, p. 1698 et seqq., 1703; Harrer/Janssen, FB 2009, p. 46 et seqq., 48; Simmat/Siebert, Corporate Finance Law 2010, p. 13 et seqq., 23.

Chapter 4

Statistical Analysis of SPACs The following chapter seeks to provide a rigorous analysis of the relative performance of SPACs against various benchmarks. Hence the underlying data sets will not merely be scrutinised with the aim of comparing relative return performances but also with the aim of evaluating the efficiency of SPACs as an alternative IPO model within the landscape of German capital markets. Sections II.2. and IV. of chapter 4 follow the methodology and approach adopted by Lewellen (2009).1 However, the sample period has been expanded with data from 1 June 2008 to 31 December 2011 and thus the added value thus needs to be judged in terms of the timeliness of the data.

I. SPAC IPO and Execution Statistics Table 72 provides some key IPO statistics pertaining to SPACs from 2003– 2011. A total of 2583 US SPACs raised a total amount of almost $32 billion through SPAC filings, the peak of which was reached during 2007–2008 with $156 million and $243 million respectively. Notably the sponsors’ promote percentage and thus the sponsors’ capital at risk rose from 0% in 2003 to 3.8% in 2011, thus implying a significant improvement in the corporate governance structures discussed in chapter 3. Underwriting fees have declined since 2003 and thus present with an inverse development in comparison to the sponsors’ capital at risk percentage. This decline is characteristic of the entrance of large investment banks and underwriting institutions into the SPAC market, as a result of which the underlying competition has reduced margins. In 2008 SPAC IPOs in the US reached a peak with almost one fifth of the total IPO volume accounted for by SPACs. This trend declined in the subsequent (financial crisis) years with investors seeking safer investment harbours such as gold and property. 1 See Lewellen, SPACs as an Asset Class, Yale University, 2009. Also see Boyer/Baigent, Journal of Private Equity, Vol. 11 (2008), p. 8 et seqq. 2 Also compare Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 32. 3 241 SPACs obtained from the data filtering process described in chapter 2 plus an additional 17 SPAC filings in the post 2008 period.

78

Chapter 4. Statistical Analysis of SPACs

Table 7: SPAC IPO Statistics (2003–2011)

SPAC filings ($m) ¿ Share Price ($) ¿ Warrant Strike ($) ¿ IPO Size (excl. greenshoes) ($m)

03–05

2006

2.7k 6.5 5.1

3k 7.7 5.8

65

82

2007 17.6k 9.6 6.7 156

2008

2009

7k 9.7 7.2 243

0.5k 10 11.5 50

2010 0.5k 8.6 9.7 78

2011 0.8k 10 10.9 92

¿ Sponsor Promote Percentage

0.1

2.6

2.7

3.5

3.0

3.6

3.8

¿ IPO Underwriting Fee Percentage

8.8

5.0

4.0

3.0

2.9

2.4

2.4

SPAC’s % of total IPO mkt. (size)

2

7

24

19

8

11

7

SPAC’s % of total IPO mkt. (no.)

7

20

33

58

15

12

18

According to table 84 the mean market value multiple of 2.1x confirms the upholding of the requirement to retain no less than 80% of the underlying trust fund reserves for a successful takeover.5 Moreover, the calculated multiples in the various acquisition phases demonstrate the significant capital leverage required to execute the respective deals. The deal size ranges from a value exceeding $3.4 billion to a minor $13 million, thus demonstrating the broad applicability of a SPAC model to virtually any deal size. Table 8: SPAC Execution Statistics (2003–2011)

IPO Proceeds ($m) Deal Value ($m) Multiple

No.

Mean

Median

Std. Dev.

Max.

Min.

112 – –

120 254 2.1x

131 380 2.9x

351 486 1.4x

900 3403 3.8x

15.8 13 0.8x

– 2.3x

– 1.6x

– 1.9x

– 10.8x

– 0.3x

2.4

1.7x

1.7x

7.4x

0.3x

2.0x

1.4x

2.2x

Acquisition Phase Going Public (GP) Announced Acquisition (AA) Completed Acquisition (CA) Rejected Acquisition (RA)

11x

0.5x

Figure 4 illustrates the acquisition focus of all SPAC acquisitions since 2003, almost 50% of which can be attributed to financial industry groups (FIG), 4 5

Layout adopted from Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 33. See discussion in chapter 2, section II.6.

79

II. SPAC Excess Return Patterns: Shares and Warrants

industrials, natural resources and healthcare sectors. According to figure 5, one third of all SPAC acquisitions were completed within a range of only 400– 500 days yet a majority of 38% of SPAC takeovers required a time horizon in excess of 500 days. Business Services 6% Real Estate 5%

Media 6% Natural Resources 9%

500 days 38%

200-300 days 6%

Financial Institutions 13%

Unspecified 20%

300-400 days 6%

Telecom 2% Technology 7% Consumer 4%

Industrials 20%

Healthcare 7%

Source: Bloomberg

Figure 4: SPAC Acquisition Focus since 2003 (Based on the Vol. of IPOs as at 31/12/2011)

100-200 days 5%

400-500 days 35% Source: Bloomberg

Figure 5: Average No. of Days Utilised until Takeover Execution (as at 31/12/2011)

To conclude, the IPO and execution statistics presented above have demonstrated the broad applicability of SPACs as an alternative means to access the capital markets. The post financial crisis decline in SPAC filings presents a firm upward trend, thus suggesting that SPAC shells seem to steadily reposition themselves as a competitor to the classical IPO model. The relative performance of SPACs will be analysed in the following section.

II. SPAC Excess Return Patterns: Shares and Warrants 1. The CAPM Approach The Capital Asset Pricing Model (CAPM) is a model for pricing individual securities or portfolios. The theoretical foundation of the CAPM was laid by Treynor (1962), Sharpe (1964), Lintner (1965) and Mossin (1966) and builds extensively on Markowitz’s (1952) work on diversification and modern portfolio theory.6 According to this theory the risk of an individual share 6 See Markowitz, Portfolio Selection, Journal of Finance, Vol. 7 (1952), p. 77 et seq.; Treynor, Toward a Theory of Market Value of Risky Assets, unpublished manuscript (1962), a final version of which was published in: Korajczyk (editor), Asset Pricing and Portfolio Performance: Models, Strategy and Performance Metrics (1999), p. 15 et seq. Also see Sharpe, Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, Vol. 19 (1964), p. 425 et seq.; Lintner, The Valuation of Risky Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics, Vol. 47, No. 1 (1965), p. 13 et seq.; Mossin, Equilibrium in a Capital Asset Market,

80

Chapter 4. Statistical Analysis of SPACs

is proxied by the standard deviation of its returns, from which it follows that an increase in the standard deviation of security returns would imply an increase in its risk.7 Markowitz was the first to devise such a measure of risk on share portfolios by deriving an expected risk/return profile known as the efficient frontier. More specifically Markowitz was able to show that the standard deviation of a combination of two or more assets had a lower standard deviation than the sum of their individual standard deviations.8 Sharpe (1964) developed the so called single index model according to which the cross section of returns earned on individual securities is based on the return on a common index. According to Sharpe this index would be best proxied by a broad market index which tracks the majority of shares traded on a securities exchange. Most importantly, Sharpe’s single index model was also applicable to portfolios using weighted averages.9 The fundamental idea developed by Black (1972) with regard to the CAPM was the division of total risk into two sources of risk:10 The first source is known as the systemic or market risk, which captures the movements of the general market as a whole and cannot be diversified away through portfolio selection. The second source of risk is known as the non-systemic risk11 , which can be eliminated by increasing the portfolio size through diversification across different types of shares. a) A Cursory Note on the Mathematical Framework This dissertation does not place itself in the realm of mathematically deriving the CAPM.12 The derivation of the latter is fairly intuitive, the proofs of which are based on (1) fundamental economic utility theory, (2) the investment opportunity set of a risk averse investor, (3) portfolio and riskless asset theory and (4) the economics of risk/return optimisation.13 Ultimately, the interplay Econometrica, Vol. 34, No. 4 (1966), p. 768 et seq.; Black, Capital Market Equilibrium with Restricted Borrowing, Journal of Business, Vol. 45, No. 3 (1972), p. 444 et seq. 7 Markowitz, Portfolio Selection, Journal of Finance, Vol. 7 (1952), p. 77 et seqq. 8 Markowitz, Portfolio Selection, Journal of Finance, Vol. 7 (1952), p. 77 et seq. 9 Sharpe, Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, Vol. 19 (1964), p. 425 et seqq. 10 Black, Capital Market Equilibrium with Restricted Borrowing, Journal of Business, Vol. 45 No. 3 (1972), p. 444 et seqq. 11 Sometimes also referred to as “unsystemic” risk. 12 See – amongst others – the following corporate finance textbooks: Reilly/Brown, Investment Analysis and Portfolio Management, 2002, p. 131 et seqq.; Grabowski/Pratt, Cost of Capital, 2008, p. 79 et seqq.; Erhardt/Brigham, Corporate Finance: A Focussed Approach, 2003, p. 121 et seqq. 13 See primarily Markowitz, Portfolio Selection, Journal of Finance, Vol. 7 (1952), p. 77 et seq.; Sharpe, Capital Asset Prices: A Theory of Market Equilibrium under Con-

II. SPAC Excess Return Patterns: Shares and Warrants

81

of these mentioned theories yields the classical linear Capital Asset Pricing Model: E.Ri / D Rf C ˇi ŒE.Rm /

Rf 

where E.Ri / is the expected return on asset i and Rf is the risk-free rate, ˇi is the sensitivity of the expected excess asset returns to the expected excess market returns and E.Rm / is the expected return on the market. b) A Cursory Note on Market Efficiency One key assumption underlying the use of any asset pricing model is the fact that it has to be used in the context of an assumption about the efficiency of the market itself, i.e. the degree to which prices reflect all available information. This is more commonly known as the joint market hypothesis, which Fama (1991) describes as the following relation:14 E.Rit C1 j˝t / D Œ1 C E.Ri tC1 j˝t /Pi t Note: E is the expectations operator, Pi t is the price of asset i at the beginning of period t, Rit is the return on asset i in period t and ˝t represents the information set available to investors at time t . Based on the above relation, the following adjustment process is postulated: 1. At time t investors utilise ˝t in an attempt to evaluate the probability distribution of PitC1 . Here Pit is used as a measure of the expected return E.Rit / D ŒE.RitC1 j˝t / Pit =Pit . Dividends are ignored for simplicity. 2. Pi t is then assumed to adjust such that the expected returns are equal to those predicted by the asset pricing model. The efficient market hypothesis (EMH) on its own can be described in terms of three different versions: The strong version assumes that information and trading costs are always zero.15 Now let xit D PitC1 ait D Rit

E.Pi tC1 j˝t / E.Ri t j˝t /

If E.xit C1 / D E.ait / D 0 then the series xi t C1 and ai t are described as fair games and it will be impossible to earn abnormal returns given the shared information set ˝t . ditions of Risk, Journal of Finance, Vol. 19 (1964), p. 425 et seq.; Lintner, The Valuation of Risky Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics, Vol. 47, No. 1 (1965), p. 13 et seq. 14 See Fama, Efficient Capital Markets II, Journal of Finance Vol. 45 (1991), p. 1589 et seqq. 15 See Grossmann/Stiglitz, On the Impossibility of Informationally Efficient Markets, American Economic Review Vol. 70 (1980), p. 393 et seqq.

82

Chapter 4. Statistical Analysis of SPACs

The semi-strong version of the EMH assumes that all publicly available information is immediately reflected in market prices as described by Grossmann & Stiglitz (1980).16 However, the weak-form EMH assumes that information will be reflected in the in prices up to the point where the marginal gain of acting on price information will not exceed the marginal cost thereof.17 For the purposes of the underlying analysis the weak form EMH will be assumed on the basis that all regressions are run on historical data. Hence under the weak form EMH the CAPM that will be constructed can only be used to make predictions about future returns based on past returns (ex post Rit ). The rate at which public information is reflected in security prices or the (potential) existence of private information that is not reflected in the prices will be ignored. c) A Cursory Note on the Estimation of Rf and Rm It was decided to use the one month treasury bill rate (TB1M) as a proxy for the risk-free rate. This US treasury bill is a government bond with a maturity that is short enough to avoid the effects of interest rate fluctuations. Since the TB1M rate is quoted as an annual rate, it was necessary to obtain the effective monthly rate by means of the following manipulation: Rf; effective D Œ.1 C TB1M/1=12 

1

In essence, when using a single index model all relevant economic factors are summarised by one macroeconomic indicator i.e. it is assumed that there is one factor that reflects the securities market as a whole. This factor (Rm ) is commonly proxied by a major share index such as the S&P500, which essentially reflects the majority of share price movements on the stock market since it captures the movements of the 500 largest NYSE listed corporations. This practice was adopted for the underlying anaylsis.

2. Results: Excess Returns on SPAC Shares and Warrants The CAPM is devised in terms of excess returns rather than in terms of absolute returns, since the returns represent the state of the macro economy only to the extent that the returns exceed or fall short of the rate of return 16 See Grossmann/Stiglitz, On the Impossibility of Informationally Efficient Markets, American Economic Review Vol. 70 (1980), p. 393 et seqq. 17 See Jensen, Some Anomalous Evidence Regarding Market Efficiency, Journal of Financial Economics, Vol. 6 (1978), p. 95 et seqq.

83

II. SPAC Excess Return Patterns: Shares and Warrants Table 9: Monthly Excess Return (ER) Statistics on SPAC Shares and Warrants (%) ’03 ERsh;total ERsh;GP ERsh;AA ERsh;CA ERsh;RA

0:6 0:6 – – –

’04

’05

2.0 1.1 10.3 0.7 –

0.4 0.03 1.6 1.7 –

’06 0.1 0.1 0.8 1:9 0.2

’07 0:6 0:1 0.8 2:6 0.04

’08 2:0 0.2 0.3 6:2 0.2

Rshare;x

No.

Mean

Med.

S.D.

Max.

ERsh;total ERsh;GP ERsh;AA ERsh;CA ERsh;RA

169

0:4 0:2 1.1 4:1 0:1

0.6 0.4 0.3 2:5 0:1

10.1 3.1 6.3 13.2 0.9

197 44 83 197 5.3

77 20 35 77 6:2

163

1:2 0:1 3.2 5:8 19

2:7 1:8 0:8 8:9 24

25.1 22.3 32.9 44.1 29.4

580 163 212 580 105

92 80 90 83 92

’09 2:3 0.8 0:3 3:1 0.2

’10 0.2 0.6 0:5 2:4 0.3

’11 1.3 1.0 0.6 0.5 0.7

Min.

Rwarrant;x ERwar;total ERwar;GP ERwar;AA ERwar;CA ERwar;RA

on the risk free asset (bond). Table 918 contains calculations of the monthly excess returns earned on SPAC shares and warrants respectively. The annualised returns19 on SPAC shares in the Going Public (GP) phase is 3.16%, whilst in the Announced Acquisition (AA) phase, SPAC shares earned a return of 14% over and above the risk-free rate of return. The latter bears testimony to the fact that announced SPAC acquisitions are well received by market participants. However, the data also reveals that annualised returns dramatically decline to an average of 8:9% in the Completed Acquisition (CA) phase (ex post). Intuitively this decline is attributable to the post merger equity dilution invoked as a result of the sponsor promote release at the time of the takeover execution. This highly significant dilution hurdle will be addressed in the following subsection. Theoretically the market should account for the mentioned dilutive effect by means of an adjustment of the underlying equity value. In fact, on the basis of efficient capital markets, this expected dilutive effect should be factored into the equity value prior to the actual occurence of such dilution. However, the data evidently reveals that such future expected dulition has not been 18

Also compare Table II in Lewellen, SPACs as an Asset Class, Yale University, 2009,

p. 34. 19 The annualised returns were calculated from the monthly excess returns presented in table 9.

84

Chapter 4. Statistical Analysis of SPACs

fully accounted for until the shareholders have voted on the takeover in conclusion.20 Also, were the equity value to adjust earlier and potentially fall below the trust account value, this would invoke a riskless profit arbitrage opportunity, since investors could buy the undervalued SPAC share and subsequently vote against the proposed takeover. This negative vote would be compensated through the compulsory payment of the relatively inflated pro rata trust fund amount, thus resulting in arbitrage profits. A scrutiny of the annualised returns on SPAC warrants reveals that those are closely correlated with the annualised excess share returns, especially in the GP, AA and AC phases. However, in the AR phase warrant returns plummet disproportionately with a rate of 19%.21 Intuitively this can be explained on the basis of the very nature of the underlying warrants, which expire worthlessly if the porposed acquisition is rejected. a) The SPAC Dilution Hurdle As alluded to in chapter 3 as well as the section above, a key challenge within the SPAC framework is the valuation dilution created by the promote and warrant overhang upon completion of the SPAC acquistion and the ensuing exercising of the underlying warrants. Figure 6 presents a calculated example: Dilution scenarios on $100m SPAC • • •

Sponsor shares at $10.00 each “In the money” warrants (50m @ $2.00 in the money) Private placement warrants (15m @ $2.00 in the money)

$125.0m $125.0m $ 37.5m $287.5m

15.75x 11.5x 10.0x

Shareholder TEV / EBITDA $500m deal

Purchase TEV / EBITDA

Shareholder TEV / EBITDA $100m deal

Assumptions: $7.50 warrant strike price, TEV/EBITDA of 10x, $50m and $250m EBITDA respectively

Figure 6: The SPAC Dilution Hurdle – A Calculated Example 20 21

Compare Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 12. Compare Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 12.

II. SPAC Excess Return Patterns: Shares and Warrants

85

Assume a $500 million SPAC merger has been announced with 12.5 million sponsor shares (par value of $10.00) and a total of 65 million warrants, of which 50 million are held by investors and the remaining 15 million are held by the sponsors. Also assume that the warrants are “in the money” at $2.50 and have a strike price of $7.50. The total overhand resulting from the takeover execution amounts to 287.5 million or 57.5% of the IPO value which have to be absorbed through some form of value creation or leverage. In practice there are two ways in which the dilution can be mitigated: 1. Find a target which offers a large private-to-public arbitrage22 opportunity. 2. Pursue an acquisition of a target in a size range significantly greater than the size of the SPAC, and subsequently use SPAC shares or leverage to finance the acquisition beyond the SPAC’s available cash. The ensuing sensitvity analysis in the following subsection provides some form of practical guideline with regard to the above mentioned options. b) Sensitivity Analysis: Addressing the SPAC Dilution Hurdle A sensitivity analysis was conducted with the aim of testing varying SPAC sizes against a constant level of 20% private-to-public arbitrage, the results of which are presented graphically in figure 7. For simplicity assume that 100% of the funds held in trust are available to fund the proposed acquisition. Also assume that the market offers a 20% private-to-public arbitrage opportunity with a varying SPAC size of $200m, $300m and $400m respectively. Hence the sensitivity analysis reveals that the dilution hurdle is best mitigated when the target equity value (TEV) has a multiple of about 2.5x for each respective SPAC size. Likewise a breakeven is achieved at around 155% of the underlying SPAC size. Evidently a large enough private-to-public arbitrage would thus be able to broadly absorb the mentioned dilution. Similarly, by selecting a target with a TEV that is significantly larger than the SPAC itself, the dilution hurdle can be broadly mitigated. This can be verified by a simple calculation of the pre- and post-acquisition TEV/EBITDA multiples as demonstrated in figure 6 above. Given an acquisition TEV/ EBITDA of 10.0x, a TEV of $500 million and $ 2.5 billion respectively and 22 Studies have revealed that a private-to-public arbitrage opportunity typically arises as a result of privately held companies being valued at a return on investment (ROI) of 25% whilst publicly listed companies trade at a Price-Earnings (P/E) ratio of 10, being approximately equivalent to a 10% ROI. Evidently this bears an arbitrage opportunity which can be exploited during the process of listing a private company on the stock exchange; Shleifer/Vishny, The Limits of Arbitrage, Journal of Finance Vol. 52, No. 1 (1997), p. 35 et seq.

$400m SPAC

$300m SPAC

70% 60% 50% 40% 30% 20% 10% 0% (10%)

70%

70%

(a)

$78.2

300

500

13%

64.0

93.6

400

(8%)

75.8

400

(3%)

81.5

500 99.2

(4%)

500

2%

Breakeven $462.80

58.2

400

6%

87.1

69.7

600

(1%)

104.8

35%

16%

7%

110.4

700 800 Target equity value ($m)

3%

92.8

700 800 Target equity value ($m)

11%

75.5

700 800 Target equity value ($m)

28%

Breakeven $614.00

600

7%

600

21%

116.0

98.4

81.3

900

10%

900

21%

900

121.6

104.1

87.0

1,000

14%

1,000

26%

1,000

49%

127.3

109.8

92.8

Assumes 100% of available cash in trust utilized in acquisition and 100% of remaining consideration funded by issuing SPAC shares.

Memo: Sponsor Profit ($m) 138.5

(10%)

0%

10%

20%

30%

40%

50%

60%

$70.1

300

(10%)

Memo: Sponsor Profit ($m) 121.1

(8%)

0%

10%

20%

30%

40%

50%

60%

$52.4

300

(1%)

Breakeven $311.50

42%

1,100

17%

1,100

30%

1,100

56%

63%

35%

1,200

21%

115.4

1,200

98.6

1,200

(a)

132.9

SPAC returns – sensitivity analysis at various sizes (assuming 20% private-to-public arbitrage)

Memo: Sponsor Profit ($m) 104.3

Return to SPAC investors

$200m SPAC

Return to SPAC investors

The SPAC dilution hurdle

Figure 7: SPAC Sensitivity Analysis

Return to SPAC investors

86 Chapter 4. Statistical Analysis of SPACs

finally an identically scaled EBITDA of $50 million and $250 million for the respective scenarios, the shareholder TEV/EBITDA rises significantly less in the $2.5 billion TEV deal than in the $500 million TEV deal.

III. Comparative Single Factor Portfolio Regression

87

3. Interim Results The data revealed that the excess returns on SPAC shares and warrants were closely correlated. In the Going Public (GP) and the Announced Acquisition (AA) phase SPAC shares achieved positive excess returns which turn negative in the Completed Acquisition (CA) phase. This development is broadly attributable to the dilutive effect initiated by the promote and warrant overhang upon execution of the SPAC acquition. It has been demonstrated that the dilution hurdle can be mitigated through either a large private-to-public arbitrage opportunity or by selecting a target company with a significantly larger TEV than the SPAC itself. The practicability of such mitigative measure was demonstrated by of calculated examples.

III. Comparative Single Factor Portfolio Regression 1. Determining the Beta Equation In this section linear regression techniques will be used to derive two so called beta equations for two distinctive portfolios consisting of SPAC shares and non-SPAC shares respectively. It will be shown that the regression that summarises the results is given in the form: RPortf D ˛Portf C ˇPortf
RM C uPortf The independent variable RM is defined as the excess return earned on the market (S&P500) whilst the dependent variable RPortf is defined as the excess portfolio return. The excess return is calculated as the difference between the monthly (periodic) return of the portfolio and the effective monthly risk free rate Rf . All other definitions apply as previously defined. a) Automatic Rebalancing of Portfolios The process of rebalancing a portfolio is important in order to ensure that the desired asset allocation among the chosen shares is maintained, which in the underlying case is 1% per share. For the purposes of analysing this equally weighted portfolio it is assumed that this rebalancing occurs automatically. Hence it can be assumed that the underlying portfolio remains effectivley diversified across the different share types and thus the desired risk/reward pattern persists. The assumption of infinite divisibility of the underlying assets is also applied.

88

Chapter 4. Statistical Analysis of SPACs

b) Additional Considerations The above model is devised in terms of excess returns rather than in terms of absolute returns, since the returns represent the state of the macro economy only to the extent that such returns exceed or fall short of the rate of return on the risk free asset (bond). The companies under consideration did not have share splits during the period specified above. This would have resulted in distorted returns which in turn would have negatively impacted on the accuracy of the regression analysis. Moreover, the assumptions with regard to the efficient market hypothesis discussed in chapter 4, section II.1.b as well as the estimations of Rm and Rf apply analogously to the underlying analysis.

2. Comparative Regressional Outputs and Interpretation thereof According to the regression outputs the beta equations for the equally weighted SPAC and Non-SPAC portfolios can be presented as follows: RSPAC D

SPAC-Portfolio: 0:0089 C 0:588
RM C 0:0427

Non-SPAC Portfolio: RNon-SPAC D 0:000 C 0:3569
RM C 0:0492 The figures below illustrate the so called “best fit line” for the combination of cross sectional and time series data. In this case the cross-sectional data are the observed prices of the two portfolios and the S&P500 for the same

Figure 8: Beta Equation for a SPAC Portfolio

Figure 9: Beta Equation for a Non-SPAC Portfolio

III. Comparative Single Factor Portfolio Regression

89

time period (i.e. for the same month) whilst the time series data contain all observed prices over several periods of time (139 months for the given scenario) which were then used to compute the excess returns over and above the risk-free rate. EViews was then used to compute the beta equation that best fits these excess returns. Essentially this is a process that involves choosing values for the intercept (˛) and the slope (ˇ) that minimise the sum of the squared vertical distances between the observations (actual values) and the regression line which runs through the predicted values. Mathematically this process involves minimising the following equation: X .˛Portf C ˇPortf
RM /2 In this equation (˛Portf + ˇPortf
RM ) means (dependent variable less predicted value of dependent variable). Ultimately ˛Portf and ˇPortf are estimates of the population parameters. a) Significance of Beta and Risk-adjusted Performance The beta can be viewed as a standardised measure of the systemic risk.23 The primary interest rests with the covariance of a portfolio with the index, as this is the relevant risk measure. Ultimately, the beta is a measure of that risk because it relates the covariance to the variance of the utilised index: 2 ˇPortf D .CovPortf;SP500 /=SP500

So it is clear that the S&P500 has a beta of 1 because it should be consistent with its own risk and hence the beta of the two portfolios need to be compared against this standardised measure of systemic risk. The SPAC portfolio beta is 0.588 which is a value below 1. This means that the systemic risk is less than the risk associated with the S&P500 and hence the security is less volatile than the S&P500. The non-SPAC portfolio has an even lower beta or systemic risk of 0.3569 which implies that it is less volatile than the SPAC portfolio. Clearly these results have implications on the expected returns of the two portfolios. Since both securities’ betas are below 1, the respective expected returns should not be as high as the return on the S&P500. In fact the expected return on the SPAC portfolio will lie above the expected return on the nonSPAC portfolio since ˇSPAC > ˇNon-SPAC . This conclusion is derived from the theoretical framework of the CAPM model discussed in the previous section. 23

Systemic risk is defined as the risk imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. See Schwarcz, Georgetown Law Journal, Vol. 97, No. 1 (2008), p. 1 et seqq.

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The final step is to test whether the betas of the respective securities were accurate predictors of the respective companies’ performance against the ASLI: H0 W

ˇPortf D 0

H1 W

ˇPortf ¤ 0

The regression statistics reveal that the p-values for the two respective portfolios were less than 0.05 at a 95% confidence level. This indicates that there is sufficient evidence to reject the null hypothesis. Therefore it can be concluded that the betas are significantly different from zero and equal to 0.588 and 0.3569 respectively. The obtained beta equations can be assumed to be statistically significant models. b) Significance of Alpha The portfolio alpha is defined as the abnormal rate of return on a portfolio in excess of what would be predicted by an equilibrium model.24 Hence ˛Portf is a measure of the expected excess return earned on the portfolio assuming no unexpected changes in the return on the underlying index (S&P500). The expected value of ˛ is zero which is confirmed by the regression results: H0 W

˛Portf D 0

H1 W

˛Portf ¤ 0

The relevant test statistic is the t-statistic and the significance level is a 5% probability of rejecting the true null hypothesis. P -values of 0.72 an 0.65 suggest that there is sufficient evidence to accept the null hypotheses and to conclude that ˛Portf;SPAC and ˛Portf;Non-SPAC are insignificantly different from zero. The negative value for ˛Portf;SPAC ( 0:0089) suggests that the portfolio is overpriced, as it generates excess returns which are less than zero when there are no unexpected changes in the market. This result will be further investigated in chapter 4, section IV below. Moreover, in conjunction with the above mentioned test, ˛Portf is statistically insignificant, and can be regarded as being zero. Therefore the ultimate conclusion is that both portfolios are fairly priced thus presenting statistically significant return patterns. In fact, the SPAC portfolio seems to slightly outperform the portfolio consisting of non-SPAC shares. 24 See hhttp://www.investopedia.com/terms/a/alpha.asp#axzz22sTAbbeAi (accessed 13 Jun. 2013).

III. Comparative Single Factor Portfolio Regression

91

c) Coefficient of Determination (R2 ) It is also pertinent to note that the R2 of the respective portfolios in this regression are 0.54 (non-SPAC portfolio) and 0.75 (SPAC portfolio). These results imply that about 54% and 75% of the repsective total variation in the risk-adjusted excess returns on the portfolios can be explained through the risk-adjusted excess returns on the market. The remaining percentage of the excess return variation is due to the non-systemic risk component which is attributable to portfolio specific risks. In this regard, the non-SPAC portfolio outperform the SPAC-portfolio in terms of volatility. To conclude, portfolios will perform better with as little non-systemic risk exposure as possible, as only systemic risk is rewarded. Therefore the SPAC portfolio with an R2 of 0.75 has a lower exposure to non-systemic risk, and is therefore preferred over the non-SPAC portfolio. d) Comment on the Standard Error of Estimate The standard error of estimate measures how well the obtained regression models (beta equations) explain the relationship between the dependent variable (RPortf ) and the independent variable (RM ). For example, the obtained betas could be utilised to make predictions about the portfolio’s return based on changes in the return on the market (RM ). Hypothetically, if the RM on the market were to increase by 0.5% then the expected return on the SPAC portfolio should increase by 2.94%25 . However, one cannot be certain that the used beta values are a precise reflection of the above mentioned relationship between dependent and independent variable in the underlying regression model. The standard error of estimate measures this uncertainty by focusing on the difference between the actual and predicted values of the dependent variable. This difference is also known as the regression residual. It can be seen from the respective beta equations that SPAC portfolio has a regression residual of 0.0427 or 4.27% whilst the non-SPAC portfolio has a regression residual of 0.0492 or 4.92% which suggests that the level of uncertainty is fairly small for both portfolios.

3. Interim Results From the above results it follows that the non-SPAC portfolio has demonstrated less volatility in terms of systemic risk, yet the SPAC portfolio has a comparatively lower exposure to non-systemic risk. Both portfolio alphas were insignificantly different from zero and thus both portfolios were fairly 25

0:588
0:005.

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priced. Hence it may be concluded that the SPAC share performance was by no means inferior to the performance of shares which had been listed through the classical IPO model. Undoubtedly the estimation of the respective beta values is a “snap-shotview” of the current data, the dynamic of which is undeniable. Hence the beta values will change over time and thus the obtained results should be interpreted as such.

IV. Analysing the Trading Behaviour of SPACs In addition to the comparative approach between SPAC and non-SPAC portfolios above, the following section seeks to analyse the trading behaviour of SPAC portfolios. Specifically the share price behaviour of SPACs can be summarised by three intuitive economic assumptions:26 1. Prior to the shareholder vote, the SPAC spot price should always be no less than the present value of the pro-rata trust account value per share: PSPAC;spot  PVŒTrustshare

j prior to vote

Shareholders are entitled to redeem the pro rata share contribution from the funds held in trust upon casting a negative vote on the proposed takeover transaction.27 Hence the per share present value of the trust account should be less than or equal to the current share price else arbitrageurs would face the prospects of riskless profits.28 2. On the day of the shareholder vote, the expected SPAC spot price should be no less than the present value of the pro-rata trust account value per share: EŒPSPAC;spot   PVŒTrustshare j on vote date In order to vote in favour of the proposed takeover, a shareholder acting as rational economic agent must expect the post acquisition share price to be no less than the per share present value of the funds held in trust. 3. In the post acquisition phase, a SPAC share should achieve positive excess returns, provided the underlying share has a positive market beta: EŒRSPAC   EŒRM  26

j post acquisition

Definitions and approach adopted from Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 13 et seqq. 27 See chapter 2, section II.3. 28 As an example, suppose that the pro rata trust account value exceeded the current share price, then arbitrageurs could reap riskless profits through a long position in SPAC shares, then vote against the proposed acquisition and subsequently redeem the shares at an inflated trust account value.

IV. Analysing the Trading Behaviour of SPACs

93

In order to compensate the SPAC specific (non-systemic) risks, shareholders should expect to earn positive excess returns over and above the risk free rate of return. Against the background of efficient capital markets29 the above mentioned properties should be upheld and will be tested below by means of multi-factor regression techniques.

1. Fama–French Four Factor Regressional Approach The Fama–French four factor model builds on the regression techniques employed in the previous section and is based on Eugene Fama’s asset pricing techniques for which he – along with Robert Shiller and Lars Peter Hansen – was awarded the 2013 Nobel Memorial Prize in Economic Sciences. A regression equation was set up according to to the Fama–French approach30 : RPortf D ˛Portf C ˇ1
RM C ˇ2
SMB C ˇ3
HML C ˇ4
UMD C uPortf RPortf is the excess return on the SPAC portfolio, SMB, HML and UMD refer Fama–French factors for small stocks, value stocks and momentum, respectively.31 All other definitions apply as previously defined. a) Market Weighted vs. Equal Weighted Portfolio Regressions It was decided to compute excess returns by means of the Fama–French approach on both market weighted and equal weighted portfolios.32 The process of portfolio rebalancing applies as defined in chapter 4, section III.1.a coupled with the assumption of infinite divisibility of the underlying assets. Table 1033 below presents the monthly excess returns of market weighted SPAC portfolios in various categories: The GP phase, AA phase, CA phase and the RA phase. The All SPACs category collectively combines all phases in one regressional output. Statistical significance at the 5% level is indicated by bold numbers. 29

See definition in chapter 4, section II.1.b. Fama/French, Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, Vol. 33 (1993), p. 3 et seqq. 31 Adopted from Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 18. Also see Fama/French, Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, Vol.33 (1993), p. 3 et seqq. 32 Market weighted portfolios are asset weighted portfolios, with asset weights representing the proportions that actually exist in the market. Equally weighted portfolios apply an equal percentage to every asset contained in a portfolio. 33 Also compare the results for 2003–2008 in Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 39. 30

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Chapter 4. Statistical Analysis of SPACs

Table 10: Value Weighted Fama–French Excess Returns (2003–2011) Phase

No.

Alpha

Total

79

GP

58

0:0041 .0:38/ 0:0072 .0:62/ 0:0143 .0:66/ 0:0063 . 0:35/ 0:0156 .0:84/

AA CA RA

46 49 28

Mkt. 0:1636 .0:61/ 0:0103 . 0:83/ 0:0559 .0:77/ 0:0203 .2:34/ 0:0188 . 0:49/

SMB

HML

UMD

Adj. R2

0:1379 .0:54/ 0:2366 .1:87/ 0:0068 .0:48/ 0:0193 . 0:89/ 0:0965 . 0:37/

0:0426 . 0:41/ 0:0187 . 0:38/ 0:1132 .1:98/ 0:0038 . 0:65/ 0:0318 .0:75/

0:0490 .0:19/ 0:0076 0:14/ 0:0261 1:24/ 0:0225 0:47/ 0:0478 1:42/

0:0465

. . . .

0:2771 0:0351 0:4097 0:2636

A value weighted portfolio of SPAC shares in the AA phase earns statistically significant positive alpha returns of 1.4%. SPAC portfolios in the All SPAC, GP and RA categories also earned positive alphas, though the obtained results were statistically insignificant. The CA phase revealed a negative and statistically significant excess return of 0.6%. By implication this is a violation of the third economic assumption with regard to SPACs’ trading behaviour as defined above. Moreover, a statistically significant negative return on the market of 1.9% was earned in the RA phase, thus indicating that the SPACs were significantly overpriced once the proposed acquisition had been rejected. According to table 1134 below, equally weighted SPAC portfolios also earned a statistically positive alpha in the GP phase whilst in the CA phase such returns were negative (-0.4%) and statistically significant. The latter re-confirms the violation of proposition three above. Moreover, excess returns on the market were again statistically significant and negative in the RA phase and are thus indicative of an overpriced portfolio. The opposite conclusion applies to the CA phase, in which returns over and above the market were positive an statistically significant. The beta values with regard to momentum (UMD) and value stocks (HML) showed no statistically significant explanatory power in any of the constructed portfolios, regardless of the weighting. However, the factor loading on small stocks (SMB) showed statistical significance in the AA phase of value weighted portfolios as well as in the RA phase of equally weighted portfolios. This implies that there exists a significant explanatory power of small stocks over big stocks in the respective categories. 34 Also compare the results for 2003–2008 in Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 38.

95

IV. Analysing the Trading Behaviour of SPACs Table 11: Equal Weighted Fama–French Regression Results (2003–2011) Phase

No.

Alpha

Total

79

GP

58

0:0038 .0:52/ 0:0059 .0:62/ 0:0157 .0:48/ 0:0041 . 0:37/ 0:0277 .0:18/

AA CA RA

46 49 28

Mkt. 0:1876 .0:39/ 0:0033 . 0:83/ 0:0636 .0:36/ 0:0131 .3:01/ 0:0169 . 0:52/

SMB

HML

UMD

Adj. R2

0:1135 .0:68/ 0:2877 .1:41/ 0:0098 .0:38/ 0:0196 . 1:57/ 0:1084 . 0:73/

0:0529 . 0:47/ 0:0264 . 0:38/ 0:1335 .2:82/ 0:0074 . 0:38/ 0:0251 .0:91/

0:0532 .0:23/ 0:0094 0:14/ 0:0269 1:03/ 0:0287 0:22/ 0:0636 2:04/

0:0897

. . . .

0:1736 0:0632 0:4266 0:1486

b) Interim Results Proposition three was violated as a result of negative excess returns in the Acquisition Completed (AC) phase. This result confirms the negative returns obtained in chapter 4, section II.2 which are attributable to the dilutive effect discussed in section II.2.b. The four factors inherent in the Fama–French regression approach demonstrated little to no explanatory power with regard to the various weighted portfolios constructed above. The All SPAC category showed no statistically significant results in either of the above constructed weighted portfolio.

2. Trust Account Statistics The underlying statistics are devoted to testing proposition one and two of the three economic assumptions defined above. Table 1235 presents the premium or discount to the pro rata present value of the funds held in trust at which SPAC shares traded in the respective years. It was assumed that 100% of the underlying IPO volume was held in trust. Intuitively, the values were only computed for the GP, AA and RA phase respectively. Statistically, SPAC shares traded at a discount of 0.18% to the pro-rata present value of the funds held in trust.36 Moreover, as a combined total SPAC shares traded at a premium to the trust value on merely 32% of all days within the sample period. This evidence presents a clear violation of the first proposition. 35 Also compare the results for 2003–2008 in Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 36 et seqq. 36 This result is consistent with the results for the years 2003–2008 which were computed by Lewellen, SPACs as an Asset Class, Yale University, 2009, p. 15.

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Chapter 4. Statistical Analysis of SPACs

Table 12: Comparative Share Price and Trust Value Statistics (2005–2011) 2005

2006

2007

2008

2009

2010

2011

GP Phase Prem. on Trust (%) Stand. Dev. (%) Days with Prem. (%)

0:8 5:7 42:9

1:1 9:3 32:3

5:3 10:2 13:2

6:7 3:7 3:6

5:8 4:9 11:8

3:2 3:7 13:7

2:5 4:2 18:2

AA Phase Prem. on Trust (%) Stand. Dev. (%) Days with Prem. (%)

21:9 26:4 100

10:3 24:1 71:9

9:6 22:3 66:6

1:5 18:9 42:0

0:9 20:5 41:4

4:7 17:3 52:6

5:2 18:0 48:9

4:2 1:1 100

5:0 1:6 98:6

2:3 3:4 62:6

3:4 2:9 59:5

2:9 3:5 64:2

3:8 2:8 65:3

05–11

GP

AA

RA

0:2 14:8 32:0

4:2 7:8 22:0

7:5 24:9 58:2

5:1 4:8 68:3

RA Phase Prem. on Trust (%) Stand. Dev. (%) Days with Prem. (%) Comb. Statistics Prem. on Trust (%) Stand. Dev. (%) Days with Prem. (%)

A scrutiny of the share price performance in the AA phase revealed that SPAC shares continuously traded at a premium from 2005–2007 as well as during 2010–2011. The observed discount from 2007–2008 is attributable to severe stock market turbulences as a result of the financial crisis. Moreover, SPAC shares continuously traded at a premium to the trust value in the RA phase. By implication, the discounts obtained in the GP phase outweighed the premia in the AA and RA phases, thus producing a routine violation of the first proposition. This result is inconsistent with common market efficiency as well asset pricing theory. One explanation might be that transaction costs are too high to allow arbitrageurs to take a long position in SPAC shares whilst ultimately redeeming such shares at an inflated trust account value (post the shareholder vote date). However, a further scrutiny of the available data revealed that on the shareholder vote date SPAC shares traded at a premium of 8.2% to the trust value. This result confirms proposition two and thus confirms that the principles of market effiency are upheld.

V. Pre-IPO SPAC Statistics

97

V. Pre-IPO SPAC Statistics 1. Comparative IPO Time and Cost Structure Whilst the previous sections focused primarily on post-IPO statistics and performances of SPACs, the following section addresses some important pre-IPO statistics (GP or Going Public phase). Specifically, table 13 below was compiled in order to assess the cost feasibility of the SPAC model in comparison to the classical IPO model. Table 13: Average IPO Statistics Cost Type

SPAC IPO

Classical IPO

Legal ($) Accounting ($) Audit ($) Printing ($) Fees ($) Commission (%)

130,000 90,000 180,000 90,000 20,000 3

150,000 75,000 200,000 80,000 30,000 3

Total

510,000

535,000

It is evident from the numbers that on average a SPAC IPO is only marginally cheaper in terms of the IPO costs involved.37 Intuitively this has to be true since both IPO models are ultimately required to fulfill the same formalities if listed on the same stock exchange. However, from table 14 it follows that a SPAC IPO requires an average of at least 5 months38 for the listing procedure whilst the classical IPO procedure requires at least 8 months39 until the successful listing of the underlying corporation. This is due to the fact that many formalities that need to be fulfilled within the classical IPO model do not form part of the SPAC listing process [.t 90/ to t], hence resulting in a time gain when using the latter model. Consequently the time value of the IPO costs in table 13 needs to be calculated in order to obtain the present value: using a discount rate of 5%, it turns out that the IPO costs for the classical IPO model are significantly higher ($510.000) than for the SPAC model ($460.000). Hence when considering the time value of money for both models, SPAC shells are significantly more cost efficient than their rival model. 37 The figures were obtained from screening multiple SPAC and non-SPAC issuance prospectuses for similar sizes deals. 38 145 days amount to approximately 5 months, based on a best case scenario. 39 145 days plus 90 days amount to approximately 8 months, based on a best case scenario.

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Chapter 4. Statistical Analysis of SPACs

Table 14: Illustrative SPAC Execution Time Line Phase

Pre Announc.

Date

Activity

t

Due Diligence

90

Determine applicability of laws t

60

t

20

Prepare audited financial statements Draft acquis. agreement and ancillary agreements Negotiate acquisition agreement and ancillary agreements Prepare financial evaluation and fairness/valuation opinion

Announc. date

t

Execute acquisition agreement and ancillary agreement Announc. to stock exchange supervisory authority & press

t C 20

File preliminary proxy statement with supervisory authority Conduct investor roadshow

Post Announc.

t C 30

Receive supervisory authority’s comments on proxy statement

t C 70

Clear comments and finalise proxy statement Notify stock exchange on voting and shareholder meeting date

t C 120

Issue press release with shareholder meeting and voting date Print and mail SPAC proxy statement to SPAC shareholders

t C 140

Obtain new listing identification number for company Conduct shareholder meeting to approve acquisition agreement Coordinate issuance of SPAC shares with transfer agent

t C 145 Closing

File amended and restated certificate of incorporation Notify trustee regarding termination of trust & release funds Pay acquisition consideration to selling shareholders Issue press release: shareholder approval and closing transaction Notify stock exchange of effectiveness of acquisition

2. Pre-IPO Target Focus of SPACs The underlying figures illustrate that SPAC shells in the Going Public (GP) phase have sought almost one third of their targets in the industrial sectors, followed by health care and financial industry groups (FIG). The technology sector, business services and natural resources accounted for approximately 30% of the total number of targets sought for a SPAC takeover. A comparison

99

VI. Summary

of figure 11 with the post IPO statistics shown in figure 5 of section I. reveals a close correlation between the targets sought and the actual acquisition of such targets in the respective industries. The majority of transactions occurred in the private sector (almost two thirds), thus indicating that SPACs are particularly conducive to to the private sector environment. Technology 8% Healthcare 13% Natural Resources 9% Media 11%

Telecom 4%

Financial Industries 12% Consumer 7%

Mixture 11%

Public 24%

Business Services 10% Industrials 26%

Source: Bloomberg

Source: Bloomberg

Figure 10: SPAC Target Sectors since 2003 (as at 31/12/2011, Based on 94 Successful Acquisitions)

Private 65%

Figure 11: SPAC Target Type since 2003 (as at 31/12/2011, Based on 94 Successful Acquisitions)

VI. Summary The IPO and execution statistics presented in this chapter have demonstrated the broad applicability of SPACs as an alternative means to access the capital markets. The post financial crisis decline in SPAC filings has shown a steady upward trend, thus suggesting that SPAC shells seem to firmly re-position themselves as a competitor to the classical IPO model. Based on the CAPM approach it was found that excess returns on SPAC shares and warrants were closely correlated. Excess returns in the Completed Acquisition phase (CA) were negative as a result of the dilutive effect caused by the promote and warrant overhang upon the execution of a SPAC takeover. The mitigative methods to overcome this hurdle were discussed in detail. The pre-IPO statistics present a favourable picture of SPACs in comparison to the classical IPO model. SPAC shells are evidently more cost efficient and have demonstrated a good conversion rate in terms of the targets sought and the actual acquisitions made. SPAC shells are particularly well suited for the private sector.

Conclusion and Outlook Special Purpose Acquisition Companies or SPACs are descendants of the historically fraudulent blank cheque company listings on US capital markets during the 1980s. Recently SPACs have emerged as a strong alternative to the classical Initial Public Offering (IPO) model of companies, which seeks to subsequently place an unlisted company on the stock exchange by means of a shell company. In light of the fact that a SPAC does not have any operations, the sole purpose of the shell is to find an operating company which is ultimately merged with or acquired from the proceeds of the initial SPAC listing. In practice SPACs have thus developed into a highly popular investment vehicle, having raised capital in excess of $20 billion since 2003. Lately SPACs have also reached Europe and have since steadily penetrated into multiple European countries, including Germany. At its core a SPAC shell consists of three important stakeholder groups, namely the SPAC managers, the SPAC shareholders and the owners and managers of the target firm. The interaction of these stakeholders needs to be optimised in such manner that all interests are aligned during the planning, implementation and execution of a merger transaction between the SPAC shell and at least one operating company (target). Hence the economic interplay among the stakeholder groups is governed by a rigorous set of corporate governance features which are primarily aimed at (1) protecting the IPO proceeds through a trust account, (2) implementing a shareholder vote and right to opt out of a proposed merger transaction and (3) stipulating a time frame within which a SPAC deal closure has to occur, else the SPAC is dissolved. This book has attempted to broadly answer the dogmatic questions pertaining to SPACs from a law and economics perspective as well as the transactional practice within Germany. From a transactional point of view an IPO through a SPAC presents a time efficient alternative way of accessing capital markets. During the merger between the shell and the target, the former is filled with the target’s operative business. This bears several advantages: a target firm can obtain access to capital markets during times in which the stock market climate is rather unfavourable for IPOs. Moreover, in comparison to the classical IPO model, the opportunity costs resulting from potentially under-

102

Conclusion and Outlook

pricing a target firm can be significantly reduced through a SPAC IPO. In fact, underpricing commonly occurs within the classical IPO model as a result of asymmetric information between issuers and underwriters on the one hand and the initial share subscribers on the other hand. Such informational asymmetry is usually non-existent in a SPAC framework. SPAC transactions also bear economic risks and costs. In particular, there are four economic factors pertaining to a SPAC merger that need to be closely monitored during the transactional progress: (1) the net present value of the merger transaction between the SPAC shell and the target firm, (2) the contractual liability provisions of the underlying merger transaction, (3) the signalling costs incurred for securing the transaction and (4) the time value of money in terms of transactional speed. As a result of asymmetric information and on the basis of principal-agent theory, a SPAC merger transaction also bears potential for moral hazard among the stakeholders which can be described as a “twofold double trust dilemma”: In order to successfully execute a SPAC transaction, the shareholders must trust the SPAC management team to find a profit-maximising target firm, and the management team must trust the shareholders not to vote against the proposed merger. Simultaneously the target firm’s management team must trust that the SPAC managers will achieve a majority vote from the SPAC shareholders, whilst the SPAC managers must trust that the target firm will ultimately agree to the SPAC merger. The transactional strategies to overcome the “twofold double trust dilemma” are manyfold. At the outset of planning a SPAC IPO, the founders and managers have to carefully decide on the volume of shares to be issued as well as the pool of investors to whom such shares shall be issued. Ultimately these considerations will be crucial in terms of avoiding potential greenmailing activities by building an investor base which primarily pursues “long-only” investment strategies. Also such investors should ideally signal their willingness to sign into an irrevocable undertaking towards a potential transferor in order to secure the required participation and majority vote for the proposed merger transaction. Moreover during the incorporation of a SPAC, the underlying management team will have to conduct extensive research as to the current potentials of the M&A market in general as well as the potential of specifically finding target firms. Ultimately a comprehensive and early evaluation of potential merger candidates is crucially important for the success story of a SPAC. Hence the SPAC management team will have to ensure that the common time frame of 24 months is utilised to the best possible extent. Furthermore, the management team should seek such targets whose transferors are able to engage in de facto exclusive negotiations with the SPAC management. In fact the latter should rather refrain from entering

Conclusion and Outlook

103

into (highly) competitive M&A auctions as the investor protection mechanism instilled within a SPAC model could place the SPAC in a disadvantageous position among potential acquirors. Also the substantial risk of losing an auction could lead to the loss of precious time during the available 24 months of finding a target. Moreover, the management team should undertake parallel target searches all of which should ideally have the potential for a deal closure, thereby avoiding dependence on one specific target especially towards the end of the stipulated time frame. Under perfect circumstances, the board should manage to implement a uniform acquisition procedure, also known as reverse auction, whereby alternative merger transactions could be interlocked and pursued procedurally. With regard to the shareholders’ right to reserve approval, one should aim to implement the vote prior to compiling the merger documents for the proposed transaction. In the event that such provision cannot be realised according to applicable law, the board should consider implementing a so called irrevocable undertaking in order to minimise the transferor’s execution risk, which would otherwise place the SPAC in an unfavourable position as potential acquiror. The composition of SPAC shareholders should be carefully considered especially with regard to the execution of the proposed merger. Hence the planning and steering of the SPAC transaction process should always be based on a careful consideration of the fundamental characteristics of a SPAC model as well as the immanent aspects pertaining to the business and corporate law of SPACs. Ultimately this would include an optimisation of potential negotiation disadvantages due to the extensive investor protection mechanisms. In order to achieve a successful deal closure and execution thereof, the board ought to pursue a cautious and foresighted management strategy. The econometric analysis demonstrated that non-SPAC portfolios were less volatile in terms of systemic risk, yet the SPAC portfolio demonstrated a comparatively lower exposure to non-systemic risk. Both portfolio alphas were insignificantly different from zero and thus both portfolios were fairly priced. Hence the performance of SPAC shares can by no means be classissified as inferior to shares which had been listed through the classical IPO procedure. The pre-IPO statistics presented a favourable picture of SPACs in comparison to its rival model. Specifically, SPAC shells have demonstrated a good conversion rate in terms of the targets sought versus the number of actual acquisitions made. It was revealed that SPAC shells are particularly well suited for the private sector. Moreover, the IPO and execution statistics further substantiate the broad applicability of SPACs as an alternative means to access the capital markets. Based on the CAPM approach it was found that excess returns on SPAC

104

Conclusion and Outlook

shares and warrants were closely correlated. Excess returns in the Completed Acquisition phase (CA) were negative as a result of the dilutive effect caused by the promote and warrant overhang upon the execution of a SPAC merger. The mitigative methods to overcome this hurdle were discussed in detail. Finally, SPACs exhibit significant time and cost efficiency gains in comparison to the classical IPO model, both in terms of opportunity costs as well as IPO costs. The dynamic of the changes that SPACs have undergone from the first generation model during the 1990s to the present (post-crisis) third generation were scrutinised. At this stage, the current third wave of SPACs has not yet taken its full dimension and it remains to be seen how this alternative investment model will re-assert its previous position in the (pre-crisis) IPO market. To this date both second and current early third generation SPACs have presented with highly diverse and adaptable investment strategies. Underlying merger transactions have been executed in all major industries such as technology, shipping, natural resources, advertising and health care. Consequently, the post financial crisis decline in SPAC filings has shown a steady upward trend, thus suggesting that SPAC shells seem to firmly re-position themselves as a competitor to the classical IPO model. Fundamentally, German capital markets law is sufficiently flexible in terms of enabling both a public offer of SPAC securities as well as the subsequent permission to list such securities on a regulated market. In particular the stock exchange regulations, prospectus and post admission requirements have to be fulfilled, such as the duties of the issuers towards the shareholders, the rules with regard to the disclosure and issuance of financial reports. SPAC IPOs can be conducted through either the OTC market or the regulated market. However, there are some fundamental and very distinctive characteristics pertaining to a SPAC model which cannot be implemented in practice. The IPO funds held in trust cannot be deemed to be at free disposal of the management board as required by the statutes. In fact trust accounts set up within the framework of a SPAC model are primarily designed as a shareholder protection measure, yet the implementation thereof collides with the enshrined statutory principle of creditor protection envisaged during a share capital increase. The difficulties with regard to the (potential) issuance of naked warrants in a SPAC framework have also been highlighted. Additionally, the restriction with regard to the volume of a capital increase poses a problem to both authorised and conditional share capital and is thus not compatible with the customary SPAC model. The opt-out instrument fails due to the fact that the corporation will have to provide sufficient creditor protection measures by granting the latter (preferred) securities to such an extent, that shareholders may only be paid after a period of six months post the announcement of a

Conclusion and Outlook

105

mandatory redemption. Also, the statutory restriction that a corporation may purchase a total share volume of no more than 10 per cent of the share capital held by the corporation poses another drawback to the SPAC model. Finally, the consideration to issue naked warrants for the purposes of financing rather than as a means of remuneration without being linked to a bond, is still a highly disputed and unresolved issue which would certainly not facilitate the desired implementation of a SPAC model in Germany. Hence from a business law perspective, SPACs can neither be implemented entirely on the basis of the Stock Corporation Act (AktG), nor through alternative business forms e.g. a partnership limited by shares (KGaA) or the Societas Europaea (SE) with headquarters in Germany. The countersuggestion could claim to adjust the SPAC model to such an extent that it suits the statutory provisions of the respective German business forms. However, sacrificing any of the corporate governance features of the SPAC model and thus forgoing investor protection, would fundamentally undermine some principal characteristics of the SPAC model. Ultimately this would subvert the very foundation upon which the SPAC model has been successfully developed and implemented internationally. In fact, the German stock corporation (AG) as an example does not provide such advantages that would principally justify the amendment or abolition of the investor protection mechanisms within a SPAC framework to suit that business form. More so, the choice of a specific business form should not without reason question the market acceptance and thus the relevant success factors of such business form. Therefore one cannot reasonably expect the transactional practice to bend the SPAC model in favour of the AktG, not least because there are no significant advantages in doing so. It has also been demonstrated that the implementation of a SPAC shell could potentially involve a shell utilisation as stipulated by the BGH. Hence the above mentioned challenges in terms of practically implementing a SPAC within the confines of the German legal landscape are potentially aggravated as a result of the legal consequences pertaining to shell utilisations. In particular the founders, management board, supervisory board and the shareholders are potentially faced with substantial liability risks which are to be taken into due consideration during the implementation of a SPAC. From the above it follows that the legal status quo in Germany does not allow for a full exploitation of the benefits inherent in the SPAC model and these benefits should not be underestimated. In fact, the rigidity of the AktG must be viewed as the primary culprit since it has thus far thwarted the successful introduction of SPACs in Germany. To this date, German investors and capital market participants have thus been deprived of prosperous and highly lucrative investment alternatives, which investors on foreign capital

106

Conclusion and Outlook

markets have been able to exploit for almost two decades. Rodrigues & Stegemoller (2011) state that the story of SPACs is a story of legal innovation. The success of SPACs will thus crucially depend on the degree to which such legal flexibility and innovation will be allowed for in Germany, rather sooner than later.

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Index accrued interest 7, 14, 19, 53 acquisition phase 20, 78, 92, 99, 104 Alternative Initial Public Offering Model, see Special Purpose Acquisition Company approval, see transaction approval articles of association 46 et seqq., 51 et seqq., 61 et seqq., 70 et seq. asymmetric information 20 et seq., 24, 31, 102 Blackstone Group 28, 30 blank cheque company, see Special Purpose Acquisition Company blank clause 39 break fee agreement 25 capital maintenance rule 53 compensation, see managerial compensation corporate governance 12 et seqq., 20 et seqq., 53, 74, 77, 101 Deutsche Börse Listing Guide 42 dissolution, see Special Purpose Acquisition Company double trust dilemma 20 et seqq. economic risks, see Special Purpose Acquisition Company excess returns, see Special Purpose Acquisition Company execution risk 103 failure, see transaction failure Fama French test – equal weighted 93 et seqq. – value weighted 93 et seqq. Frankfurt Securities Exchange 41 et seq.

Graham Packaging 27 et seqq. greenmailing 22, 25, 27, 102 Hick Acquisition Company 27 et seqq. history – financial history 34, 38 et seq. – history of shell companies, see Special Purpose Acquisition Company Holzmüller/Gelatine doctrine 50 et seqq. initiators,

see sponsors

law – capital markets law 33 et seqq. – corporate (business) law 43 et seqq. managerial compensation, see Special Purpose Acquisition Company mediatisation effect 51 merger – negotiations 23 et seqq. – transaction 11, 13, 15 et seqq., 25 et seqq., 45 et seqq., 49 et seqq., 67 et seq., 101 moral hazard 21, 23 et seq. net present value

20, 31, 102

Pan-European Hotel Acquisition Company 3 partnership limited by shares 43, 105 penny stock – penny stock market 4 et seqq. principal-agent scenario 20 et seq. prospectus – content 37 et seqq.

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–

German Securities Prospectus Act (WpPG) 34 et seqq. – independent prospectus 35 – joint prospectus 37 – public offers 36 – statutory prospectus requirements (ProspektVO) 33 et seq. pump and dump trading 4 regulated market – Over The Counter (OTC)

9, 40

Securities and Exchange Commission – German Securities and Exchange Commission (BaFin) 39 et seq. – SEC Rule 419 6 et seqq. share – definition 35 – investor share 45 et seqq. – levelling of share classes 48 et seq. – non-voting preference share 48 et seq. – preference share 48 et seq. – share redemption 15 et seq., 53 et seqq. shareholder – shareholders’ meeting 42, 47 et seqq. – shareholder rights 37, 45 et seqq., 50 et seq., 57 et seq. – vote 14 et seq., 21, 23 et seqq., 31 shell – shell companies, see Special Purpose Acquisition Company – listing, see Special Purpose Acquisition Company – utilisation 60 et seqq., 69 et seqq. Societas Europeae 43, 59, 105 Special Purpose Acquisition Company – anatomy 11 et seqq. – dilution hurdle 84 et seqq. – dissolution 23, 55 et seqq. – economic risk 23 et seqq. – excess returns 79 et seqq., 92 – execution statistics 77 et seqq. – first generation 7 et seq. – founders 11 et seq. – history 3 et seqq. – IPO statistics 77 et seqq.

– –

management team 11 et seq. managerial compensation 15 et seqq. – second generation 9 et seq. – sensitivity analysis 85 et seq. – shareholder vote 14 et seqq. – sponsors’ “at risk capital” 16 et seq. – third generation 9 et seq. – time frame 8, 13, 18, 21 et seqq., 27, 31, 42 et seq., 48, 55 et seq., 67 et seq., 101 et seqq. – transactional practice 11 et seqq. – trust accounts 14, 26, 45, 59, 71, 104 sponsors – differing share classes 45 et seqq. stakeholders 11 et seqq., 20 et seqq., 30 et seq., 72 start-up 39 stock corporation – German stock corporation (AG) 33, 62 – German Stock Corporation Act (AktG) 33 et seqq., 43 et seqq., 48 et seqq., 55 et seqq., 69 et seqq., 105 Supreme Court – German Federal Supreme Court (BGH) 34, 50 et seqq., 70 et seqq. takeover transaction – approval 22 et seq., 49 – failure 27, 56 threshold – threshold rule 7, 15, 22 et seq., 27 time frame, see Special Purpose Acquisition Company transactional speed 20 et seqq., 31, 102 transferor 12, 22, 24 et seqq., 102 trust accounts, see Special Purpose Acquisition Company units,

see warrants and shares

warrant 12, 16 et seq., 28, 35, 37, 41, 57, 79, 81 et seqq., 99, 104