Valuation Considerations for Special Purpose Acquisition Corporations (SPACS)

This video describes the valuation considerations for Special Purpose Acquisition Corporations. (SPACS).

Speakers: Nainesh Shah, CFA, CVA, Evan Levine, ChFC and Martin M. Shenkman, Esq.

Transcript

Marty Shenkman (00:09):

Welcome to Law Easy. My name’s Marty Shenkman and I’m joined by Nainesh Shah and Evan Levine, both with a company called Complete Advisors and we’re going to talk about really SPACs, SPAC valuation, and it’s really in part the valuation considerations for estate planning for sponsors. As SPACs as with all video clips and other information on Law Easy, please bear in mind that they’re for educational purposes only, don’t take any legal action or financial tax or other steps without consulting appropriate advisors. So how about we jump in?

Evan Levine (00:49):

Okay.

Nainesh Shah (00:49):

Great. Yeah, sure.

Marty Shenkman (00:53):

Go for it.

Evan Levine (00:54):

Good. Okay. Hi, Marty. Great to see you again. I guess I’ll start with the first bullet. What is a SPAC? A SPAC is a special purpose acquisition corporation. First created in 1993 by somebody named David Nussbaum. They peaked in popularity in 2020 and 2021, have since calmed down a little bit, but a special purpose acquisition corporation turns the traditional IPO process upside down. So traditionally you start a business, you grow the business, and then when you hit a certain point and you need to raise more capital you list and go public. The SPAC does it the other way. First they list and go public and then raise cash for the purpose of going out to purchase a business. Again, the special purpose is to make it acquisition. And I’m going to turn it over to Nainesh now to talk about why a sponsor of a SPAC who’s affluent in doing an estate planning might want to consider having that interest valued professionally before a business combination or an acquisition. Nainesh.

Nainesh Shah (02:02):

Great. Yeah. So the way SPACs are created is that is a sponsoring entity. The sponsoring entity behind that entity might be financial people or some operational people, but the sponsoring entity pulls money, about 20% of the total capitalization of the SPAC and invest in the SPAC to create the SPAC. Public invest with this investor because they believe in them, because they have done this in past, in some form. Now the sponsors, once they bring the company SPAC public, they have to decide what do they do with their investments. So there are two main aspects there to think about. One is what do they do with their own investments and how do they go out and find an operating entity within whatever field they have put it out in the public, in the documents, meaning it can be technology company, it can be biotech, It can be some futuristic AI related, but that has to be in the documents, so they have to go and combine with the companies.

So the SPACs have two different type of securities that it is built on. One is common shares and there are two types of common shares. One is type A, which is public common shares, and then type B, which is what sponsor is on and then the warrants. And the idea of combining the defined time the sponsor usually has is two years. So from the time the SPAC is introduced to the time they have to combine with some kind of outside entity is two years. If it is not done within those two years timeframe, then the sponsor has to give them the public’s money back and the sponsor loses their own investments.

So it’s really highly in their interest to make the combination happen. So let’s go back to the investments that they have and why they should create some kind of estate planning so that they can manage their taxes. If the SPAC doesn’t combine, they lose money. But if SPAC combines with a good operating entity, then there’s a significant upside. So let’s say a SPAC is worth a hundred million dollars and the sponsor has put in 20 million dollars of that. And if they find a great operating company, then market will recognize that and market will say, okay, the company’s about 2 billion dollars. Now, suddenly the 20% that sponsor has is worth about 400 million dollars. That’s a significant capital gain. So as soon as the SPAC is created, one needs to think about valuing the sponsors portion of it.

Marty Shenkman (05:13):

Nainesh, let me just interject a comment. One thing you have to be careful of, what human nature is, with anyone that has a business that they may sell or combined is, well, nothing’s happening yet. I’m going to wait and see if it’s going to happen. And the problem with that is the further you go towards the combination, the ultimate combination that’s going to enhance the value, as Nainesh said, the more difficult, if not impossible, it becomes to value the interest of the sponsor at a lower amount. Once you’ve started to move down that continuum, it has to be addressed in the appraisal.

There was a recent CCA, I can’t quote you the number by heart, chief counsel advice from the IRS where a taxpayer was hammered because they had been shopping a business and they actually used an outdated seven month old appraisal that didn’t reflect the potential of a sale. So you have to be very mindful. And I think one of the take home points that comes from Nainesh’s comments is you need to hire your appraiser and do your estate planning as early on as possible. As you move down the continuum, which is just natural to want to do before you do anything, it gets less and less safe, less possible to argue for the kind of valuation at a lower end of the spectrum. Nainesh, back to you. Sorry.

Nainesh Shah (06:38):

Yeah. Totally. And it’s interesting that you brought that up because one of the SPAC that we valued, Marty, the sponsor of the SPAC said that why didn’t my investment banker told me about this before? So this should have been done parallel to the introduction of the SPAC and then planning for that SPAC. And so going back to the valuation, if you find the operating company is too late, because now you have to value it accordingly. But if you don’t find or you haven’t found the operating company, then the valuation depends on how much is the type B shares worth. And there is an optionality that you can think about and how much is the warrant worth.

The other thing that you are to think about is the time factor, the longer the time passes between that start point to the two years where the sponsors have to give the money back, the value decreases. And so that needs to go into the equation as well. But all of that needs to be kind of put into perspective and decide, let’s do the valuation. And then you need a qualified person who can understand the [inaudible 00:07:53] of the SPAC, understand the optionality that’s involved with that, and then value all components together. And-

Marty Shenkman (06:38):

Let me-

Nainesh Shah (06:38):

Sorry, go on.

Marty Shenkman (08:02):

Let me interject to another comment. Nainesh used the word qualified. I believe he used it in the English language sense that you need someone that knows what they’re doing, but he actually used a term that has important technical meaning. You need a qualified, it’s a defined term in the tax law, qualified appraiser that meets certain requirements to do a qualified appraisal if you’re going to use this for gift and estate planning purposes. We don’t have time to get into it, there’s other video clips on that, but I just wanted to make sure since he used a good term that you understood, there’s several different implications. Nainesh, why don’t you wrap up in the next couple of minutes and bring it home?

Nainesh Shah (08:39):

Absolutely. So I think the takeaway from our conversation here is SPAC is an entity that’s been around for a while. And a lot of SPACs are being sponsored and the sponsor has to think about valuing their ownership of the SPAC appropriately and quickly. And you need someone who can think about different component of the SPAC ownership and then value it. It’s a complex project, but it can be done. And you can think of all of this in terms of a financing company who’s investing in the operating company and how to value it.

Marty Shenkman (09:20):

Thank you, both Evan and Nainesh. Their contact is here. Please again, keep in mind that any information on Law Easy is presented for educational purposes only, and you should not take any action without consulting your own advisors. Thank you for joining us.

Nainesh Shah (09:36):

Thank you, Marty.

Evan Levine (09:37):

Thank you, Marty.

This video describes the valuation considerations for Special Purpose Acquisition Corporations. (SPACS).

Speakers: Nainesh Shah, CFA, CVA, Evan Levine, ChFC and Martin M. Shenkman, Esq.

Transcript

Marty Shenkman (00:09):

Welcome to Law Easy. My name’s Marty Shenkman and I’m joined by Nainesh Shah and Evan Levine, both with a company called Complete Advisors and we’re going to talk about really SPACs, SPAC valuation, and it’s really in part the valuation considerations for estate planning for sponsors. As SPACs as with all video clips and other information on Law Easy, please bear in mind that they’re for educational purposes only, don’t take any legal action or financial tax or other steps without consulting appropriate advisors. So how about we jump in?

Evan Levine (00:49):

Okay.

Nainesh Shah (00:49):

Great. Yeah, sure.

Marty Shenkman (00:53):

Go for it.

Evan Levine (00:54):

Good. Okay. Hi, Marty. Great to see you again. I guess I’ll start with the first bullet. What is a SPAC? A SPAC is a special purpose acquisition corporation. First created in 1993 by somebody named David Nussbaum. They peaked in popularity in 2020 and 2021, have since calmed down a little bit, but a special purpose acquisition corporation turns the traditional IPO process upside down. So traditionally you start a business, you grow the business, and then when you hit a certain point and you need to raise more capital you list and go public. The SPAC does it the other way. First they list and go public and then raise cash for the purpose of going out to purchase a business. Again, the special purpose is to make it acquisition. And I’m going to turn it over to Nainesh now to talk about why a sponsor of a SPAC who’s affluent in doing an estate planning might want to consider having that interest valued professionally before a business combination or an acquisition. Nainesh.

Nainesh Shah (02:02):

Great. Yeah. So the way SPACs are created is that is a sponsoring entity. The sponsoring entity behind that entity might be financial people or some operational people, but the sponsoring entity pulls money, about 20% of the total capitalization of the SPAC and invest in the SPAC to create the SPAC. Public invest with this investor because they believe in them, because they have done this in past, in some form. Now the sponsors, once they bring the company SPAC public, they have to decide what do they do with their investments. So there are two main aspects there to think about. One is what do they do with their own investments and how do they go out and find an operating entity within whatever field they have put it out in the public, in the documents, meaning it can be technology company, it can be biotech, It can be some futuristic AI related, but that has to be in the documents, so they have to go and combine with the companies.

So the SPACs have two different type of securities that it is built on. One is common shares and there are two types of common shares. One is type A, which is public common shares, and then type B, which is what sponsor is on and then the warrants. And the idea of combining the defined time the sponsor usually has is two years. So from the time the SPAC is introduced to the time they have to combine with some kind of outside entity is two years. If it is not done within those two years timeframe, then the sponsor has to give them the public’s money back and the sponsor loses their own investments.

So it’s really highly in their interest to make the combination happen. So let’s go back to the investments that they have and why they should create some kind of estate planning so that they can manage their taxes. If the SPAC doesn’t combine, they lose money. But if SPAC combines with a good operating entity, then there’s a significant upside. So let’s say a SPAC is worth a hundred million dollars and the sponsor has put in 20 million dollars of that. And if they find a great operating company, then market will recognize that and market will say, okay, the company’s about 2 billion dollars. Now, suddenly the 20% that sponsor has is worth about 400 million dollars. That’s a significant capital gain. So as soon as the SPAC is created, one needs to think about valuing the sponsors portion of it.

Marty Shenkman (05:13):

Nainesh, let me just interject a comment. One thing you have to be careful of, what human nature is, with anyone that has a business that they may sell or combined is, well, nothing’s happening yet. I’m going to wait and see if it’s going to happen. And the problem with that is the further you go towards the combination, the ultimate combination that’s going to enhance the value, as Nainesh said, the more difficult, if not impossible, it becomes to value the interest of the sponsor at a lower amount. Once you’ve started to move down that continuum, it has to be addressed in the appraisal.

There was a recent CCA, I can’t quote you the number by heart, chief counsel advice from the IRS where a taxpayer was hammered because they had been shopping a business and they actually used an outdated seven month old appraisal that didn’t reflect the potential of a sale. So you have to be very mindful. And I think one of the take home points that comes from Nainesh’s comments is you need to hire your appraiser and do your estate planning as early on as possible. As you move down the continuum, which is just natural to want to do before you do anything, it gets less and less safe, less possible to argue for the kind of valuation at a lower end of the spectrum. Nainesh, back to you. Sorry.

Nainesh Shah (06:38):

Yeah. Totally. And it’s interesting that you brought that up because one of the SPAC that we valued, Marty, the sponsor of the SPAC said that why didn’t my investment banker told me about this before? So this should have been done parallel to the introduction of the SPAC and then planning for that SPAC. And so going back to the valuation, if you find the operating company is too late, because now you have to value it accordingly. But if you don’t find or you haven’t found the operating company, then the valuation depends on how much is the type B shares worth. And there is an optionality that you can think about and how much is the warrant worth.

The other thing that you are to think about is the time factor, the longer the time passes between that start point to the two years where the sponsors have to give the money back, the value decreases. And so that needs to go into the equation as well. But all of that needs to be kind of put into perspective and decide, let’s do the valuation. And then you need a qualified person who can understand the [inaudible 00:07:53] of the SPAC, understand the optionality that’s involved with that, and then value all components together. And-

Marty Shenkman (06:38):

Let me-

Nainesh Shah (06:38):

Sorry, go on.

Marty Shenkman (08:02):

Let me interject to another comment. Nainesh used the word qualified. I believe he used it in the English language sense that you need someone that knows what they’re doing, but he actually used a term that has important technical meaning. You need a qualified, it’s a defined term in the tax law, qualified appraiser that meets certain requirements to do a qualified appraisal if you’re going to use this for gift and estate planning purposes. We don’t have time to get into it, there’s other video clips on that, but I just wanted to make sure since he used a good term that you understood, there’s several different implications. Nainesh, why don’t you wrap up in the next couple of minutes and bring it home?

Nainesh Shah (08:39):

Absolutely. So I think the takeaway from our conversation here is SPAC is an entity that’s been around for a while. And a lot of SPACs are being sponsored and the sponsor has to think about valuing their ownership of the SPAC appropriately and quickly. And you need someone who can think about different component of the SPAC ownership and then value it. It’s a complex project, but it can be done. And you can think of all of this in terms of a financing company who’s investing in the operating company and how to value it.

Marty Shenkman (09:20):

Thank you, both Evan and Nainesh. Their contact is here. Please again, keep in mind that any information on Law Easy is presented for educational purposes only, and you should not take any action without consulting your own advisors. Thank you for joining us.

Nainesh Shah (09:36):

Thank you, Marty.

Evan Levine (09:37):

Thank you, Marty.