As Alison Frankel at Reuters observed, of the 60+ lawsuits filed in New York state court in the first half of this year against SPAC directors for inadequate disclosures, most of them typically settled after the initial complaint was filed, without advancing their claims that the SPAC boards violated their duty of disclosure by withholding key information from their public filings relating to the SPAC transactions.  What is motivating the quick settlement?  The chance for those defending these claims to pay the lawyers a fee – known as a mootness fee after the accusation of insufficient disclosures becomes “mooted” by the SPAC supplementing its initial disclosures with new, curative information that overcomes the deficiency – and buy litigation peace in return.  Frankel noted that these lawsuits ostensibly sought to stop shareholders from voting on the SPAC’s proposed acquisition (consistent with the rationale that such shareholder vote would not be fully informed given the disclosure deficiencies), and yet those lawsuits did not include separate motion papers formally requesting the necessary injunction to halt that vote.

Frankel notes that this spike in SPAC disclosure suits smacks of the “deal tax” litigation that previously populated the Delaware Chancery Court after most public M&A deals were announced, with nearly 95% of all such deals facing disclosure-only lawsuits that typically settled after a therapeutic disclosure cured the alleged deficiency (Delaware had clamped down on such suits in Trulia and its progeny, sending that type of litigation to federal court after being repackaged as Section 14(a) disclosure violations.  While this piece appears to inject a strong dose of skepticism into the merits of this particular species of litigation, it should be noted that SPAC litigation has taken on many forms, in many courts, including claims going well beyond the Delaware disclosure-only strike suits of old.

Given the unprecedented surge in SPAC activity in the first half of 2021,  SEC Acting Director John Coates has expressed concerned about risks ranging from fees, conflicts and sponsor compensation, to the sheer amount of capital pouring into the SPAC market.  Naturally, with this surge has come “unprecedented scrutiny,” and the SEC has been focusing on clearer disclosures and transparency for shareholders.

Among the interesting data point Director Coates identified, only about 10% of SPACs have liquidated between 2009 and now, with most SPACs having proceeding to identify acquisition candidates.  To put that point in context, SPAC transactions are essentially two-step process, with the first step being as follows:

The basics of a typical SPAC are complex, but can be simplified as follows. A SPAC is a shell company with no operations. It proceeds in two stages. In the first stage, it registers the offer and sale of redeemable securities for cash through a conventional underwriting, sells them primarily to hedge funds and other institutions, and places the proceeds in a trust for a future acquisition of a private operating company. Initial investors also commonly obtain warrants to buy additional stock as at a fixed price, and sponsors of the SPAC obtain a “promote” – greater equity than their cash contribution or commitment would otherwise imply – and their promote is at risk. If the SPAC fails to find and acquire a target within a period of two years, the promote is forfeited and the SPAC liquidates. About ten percent of SPACs have liquidated between 2009 and now.

[citations omitted].  Next, once the SPAC spots its target, it effectuates a reverse merger by which a private company becomes public:

In their second stage, SPACs complete a business combination transaction, in which the SPAC, the target (i.e., the private company to be acquired), or a new shell “holdco” issues equity to target owners, and sometimes to other investors. SPAC shareholders typically have a vote on the so-called “de-SPAC” transaction, and many investors who purchased securities in the first stage SPAC either sell on the secondary market or have their shares redeemed before or shortly after the de-SPAC. After the de-SPAC, the entity carries on its operations as a public company. In this way, SPACs offer private companies an alternative pathway to “go public” and obtain a stock exchange listing, a broader shareholder base, status as a public company with Exchange Act registered securities, and a liquid market for its shares.

Director Coates is careful to note that the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act (PSLRA) does not necessarily insulate projections and other valuation material from liability; while the SPAC market may superficially appear to provide an “out” for sponsors and targets that is not available in conventional IPOs, Director Coates has warned: not so fast.  Indeed, the PSLAR’s safe harbor expressly excludes from safe harbor protection those statements made by a “blank check company” as well as IPOs, appearing to carve out SPACs from its protection.  As he puts it: “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst,” cautioning that any material misrepresentation in a registration statement that is part of a de-SPAC transaction is subject to Section 11 liability under the Securities Act, just as any material misstatement in a proxy statement is subjection to Section 14(a) liability.  And beyond just federal securities law claims, Delaware fiduciary duty law applies more strictly where a conflict of interest appears, as is often inherent in SPAC deals.

As Director Coates apply summed it up: no one gets a “free pass” from material misstatements in a de-SPAC transaction.

IPO News | Seeking Alpha

Welcome to our blog’s new SPAC Corner, as we kick-off an ongoing series of posts dedicated to this bourgeoning field of investor litigation.

A natural starting point for our focus on SPACs is to highlight the upcoming September 9 meeting of the SEC’s Investor Advisory Committee (IAC), at which the IAC will be discussing two recommendations to the SEC intended to increase SPAC disclosure and accountability.  As laid out here, in the IAC’s August 26, 2021 draft agenda, the IAC is proposing that the SEC (i) regulate SPACs more intensively with enhanced focus and stricter enforcement of existing disclosure rules under the Securities Exchange Act of 1934, (ii) provide an analysis of the players in the various SPAC stages, along with their compensation and incentives.

In laying out its case for greater transparency, the IAC provided the following background statement on SPACs, which provides a concise and neutral enough description of SPAC formation and mechanics that we thought it useful to reproduce a summary statement here:

In simple terms, a SPAC is a type of “blank-check” company that raises capital through an initial public offerings (“IPO”) with the intention to use the proceeds to acquire other companies at a later time.5 Unlike traditional IPOs, SPACs do not have commercial operations at the time of the IPO, which explains why they are referred to as “blankcheck” or “shell” companies. SPACs first appeared in the 1980s but have gained accelerating popularity in recent years, especially since 2020.

SPAC sponsors generally raise money in IPOs for future acquisitions of other private companies. Because finding acquisition targets can take time (typically two years), the cash raised (typically $10 per share) is held in a trust while the sponsors search for a target. After the SPAC completes a merger with the target company, the previously privately held target company becomes a publicly listed operating company. This last step of creating the listed successor company is referred to as a “de-SPAC” transaction. A SPAC is required to keep 90% of its IPO gross proceeds in an escrow account through the date of acquisition. The SPAC should complete acquisitions reaching an aggregate fair market value of at least 80% of the value of the escrow account within 36 months. If the acquisitions cannot be completed within that time, the SPAC must file for an extension or return funds to investors. At the time of de-SPAC transaction, the combined company also must meet stock exchange listing requirements for an operating company.

SPACs can be an attractive option for sponsors because they can raise money rapidly without having to deal with company preparation or company specific disclosure at the time of the IPO. Moreover, SPACs are attractive to targets because they represent a fast, certain route to liquidity without the delay, pricing risk, and market condition risk associated with the typical IPO process. However, the separation in time between the IPO disclosure and the company specific disclosure means that investors do not learn what they are investing in until after the fact and therefore, their invested funds are tied up for a period of time while the investors rely on the sponsors to find an appropriate target. Furthermore, the transactions by their very nature are complex and have some misalignments between the initial investors, sponsors, investors in the target and any intermediate financiers joining the de-SPAC transaction. At the time of the merger, often over two thirds of the SPAC’s shares are tendered for redemption and the sponsor or third parties purchase shares in a private investment in public equity (“PIPE”) transaction to replenish cash the SPAC paid to redeem its shares, diluting the original investors’ slice of the new company’s equity.  These complexities and misalignments are why researchers (such as NYU Professor Michael Ohlrogge and others) assert that SPACs can be frustrating and will likely continue to frustrate the shareholder value performance expectations of many of their retail investors.

The IAC went on to discuss the more recent slow-down and evolution in the SPAC market, which has experienced a reduction in the average volume of SPAC IPOs, increased participation of retail investors prior to the de-SPAC transaction, as well as increased pricing for D&O insurance, among other phenomena.  With this evolution has come a decreasing number of sufficient SPAC targets, which the IAC fears may spur sponsors to pursue substandard targets.

In addition, the IAC articulated a concern that many in the market have observed about the nature of shareholder votes, noting that a number of stockholders tend to vote to approve the de-SPAC transaction while redeeming their shares, suggesting that such shareholders do not believe in the underlying rationale behind the merger but vote to approve anyway.  Such votes have also raised concerns about the adequacy of the disclosures that SPACs have provided in advance of the shareholder vote.

We will continue to monitor the IAC meeting later this week and report on any resultant actions that the SEC may take in response to the IAC’s recommendations.

Will 2021 be the year the cannabis industry makes a comeback?

A data-rich thought piece by New Cannabis Ventures makes an interesting case for using a sum-of-the-parts analysis in valuing cannabis companies with diverse operating segments, as that helps filter out any boosted value that might be otherwise be included by a simple EBITDA analysis that inflates the overall valuation by including non-cannabis operating segments. The piece provides an excellent illustration of an instance in which a graphic identifying the “largest global cannabis companies by revenue” tells only part of the story. The snapshot describing Tilray / Aphria (post-merger) as the largest global cannabis company does not distinguish between cannabis and non-cannabis revenue – a critical distinction for many investors. As more cannabis companies expand not only their footprints, but the nature of their operations from strictly cannabis (marijuana) related, to other ancillary businesses such as pharmaceutical distribution, hemp-infused food and beverages and even merchandizing (think Jay-Z, Snoop Dogg, Tommy Chong and Bob Marley branded products just to name a few), revenue from these non-cannabis operations becomes a major consideration when it comes to business valuation. This is particularly significant for companies with U.S. operations, where the effective tax rate for cannabis vs. non-cannabis revenue may swing like a pendulum. New Cannabis Ventures’ suggestion that using sum-of-the-parts analysis as opposed to a simple EBITDA analysis for valuating cannabis companies that own disparate businesses makes a great deal of sense as the nascent industry matures and expands beyond the mere sale of cannabis products.

RKS thanks Jonathan Robbins, Chair of the Cannabis Practice at Akerman LLP, for this contribution.

 

Investing In Cannabis During A Crisis: What To Know About Stocks, Debt,  Equity, M&A | Cannabis Culture

Los Angeles Venture Association (LAVA) recently hosted a webinar discussing the recent uptick of merger and acquisition activity over the last six months, and the trends that will impact the future of the market.

Two reasons for the uptick in cannabis industry investments are confidence in the economy and elections which helped legalize cannabis.  Momentum in states like Texas have increased confidence for investors to enter in the cannabis industry.   With increased capital but lack of federal regulations, investors are embracing creative hybrid financing structures, such as convertible debt that might go away through federal legislation or judicial intervention.  While many investors are focusing on regional sales, large companies that can taking higher risks are now moving in and driving the market.

One issue raised that is relevant to cannabis company valuation is the quality of company “housekeeping” – what is the quality of records of the company, what are its outstanding legal issues, and what structuring issues are invoked by having multistate operations?  For the company, this likely means any valuation issue will require experienced M&A counsel.  For investors looking at cannabis businesses, understanding how housekeeping matters can affect valuation is critical.  In addition, when outstanding legal issues can affect valuation having legal counsel who can analyze the underlying issue and determine its valuation impact is critical.

Expert Retention and Discovery: Five Do's and Don'ts » Alameda County Bar Association

Attorneys for the investors in Tesla Inc. will argue that they have the right to use testimony from Elon Musk’s recent deposition in another case involving Musk’s control over Tesla and board conflicts in their action slated to go to trial later this month.  The investors urge that any contradictory testimony could be used to impeach Musk at trial.  But, Musk’s attorneys want to limit the investors’ access to issues involving the SolarCity deal – wherein Tesla purchased the rooftop solar company for $2.6 billion.

The core matter concerns accusations by Tesla investors that Musk led Tesla into a conflicted $2.6 billion purchase of SolarCity.  The investors have described SolarCity—which was struggling financially and of which Musk is the former CEO—as “a company run by Elon Musk’s cousins, intertwined with Tesla in a complex web of familial and business relationships, and in which [Musk] holds approximately $500 million of stock.”

Other Tesla directors previously agreed to settle the action, paying $60 million to escape the case, but Musk continues to fight.

Meanwhile, the Tesla CEO is also still involved in another lawsuit challenging Tesla’s board’s approval of his ten-year, $55 billion compensation package.  Musk’s deposition in that case is what attorneys in the SolarCity case are seeking.

The parties will argue this issue before Vice Chancellor Slights on July 6, 2021,   As Vice Chancellor Slights has previously granted investors’ motion to compel certain communications between Tesla attorneys and Musk while withholding communications with other parties, the argument should make for a unique battle.

For more on the SolarCity matter involving Tesla shareholder rights, see coverage by Law360 here [$$$].

Image result for entire fairness standard

This newest piece from Law.com [$$] analyzes the most recent appraisal decision from the Delaware Chancery Court, Regal Entertainment Group, in which the court awarded stockholders a 2.6% premium to merger price.  The valuation determination followed from the court’s pegging Regal’s fair value to merger price less synergies, while adding back the increase in value arising between the signing and closing of the merger agreement with Cineworld that resulted from the reduction in the corporate tax rate under the Tax Cuts and Jobs Act.

A full version of the court’s opinion here: Regal Decision

Marijuana Business Opportunity Cannabis Business Start Marijuana Business Cannabis Events

 

Global X, an ETF provider, provided this thorough but succinct survey highlighting the progress toward cannabis legalization in U.S. states.; this is part 1 of a 3-part series, so more to come.  As we’ve noted before, cannabis valuation issues are intertwined with regulatory and legalization issues, an interesting, but not necessarily unique aspect of the space.

This recent piece from Forbes provides an interesting look into how Michael Dell scored a huge windfall by opportunistically taking Dell private while the stock was undervalued.  Although the Delaware trial court had acknowledged a valuation much higher than the take-private price, the Supreme Court reversed mainly on policy grounds, on the rationale that public M&A transactions deserved heavy deference to deal price.  As the article shows, Dell internal documents showed it was worth more.

The Delaware trial court had indeed recognized that Dell’s value exceed the merger price, by about 28%.  Michael Dell, along with financial sponsor Silver Lake, had acquired Dell in 2013 for $13.75 per share in cash.  In its decision, the trial found the fair value of Dell’s shares as of the merger date to be $17.62, thus implying the deal undervalued Dell by nearly $7 billion.  The Supreme Court reversed that award and reinstated merger price as a proxy for fair value, rejecting the trial court’s analysis that, among other things, “investor myopia” and a focus on short-term profit had caused a “valuation gap” between the market price for Dell’s shares and its intrinsic value.  Based on the deal terms, Michael Dell’s personal stake of 15.6% of the company was worth about $3.6 billion; as the Forbes article shows, he has managed to parlay that stake into a current value of $39 billion, after deploying other financial devices in related M&A activity by Dell.  As Forbes indicates, Michael Dell made a play with a buyout rather than “spending years trying rebuild enthusiasm for the stock.”

The Delaware trial court understood that Dell stock had been experiencing a short-term lull and was prepared to compensate shareholders for losing out on any chance to participate in a longer-term rebound.  Although it had been criticized for identifying a valuation gap as large as $7 billion, it appears that the gap was in fact much larger even than that amount, and yet this enormous transfer of wealth from shareholders to insiders nevertheless took place after the Delaware Supreme Court shut the door on the shareholders’ effort to recoup just some of that value.

 

Cannalaw Conference Wrap-up:  What’s Next for Marijuana?

The conference closed with a look ahead to the future of the cannabis industry, patent issues, and emerging psychedelic market.  What will we see with regards to patent enforcement?  Only two cannabis related lawsuits have been filed to date, one that died.  However, there is speculation that as the industry grows and federal regulation is introduced, there will be a rise in patent lawsuits.  Aside from a few large patent holders, most patents are owned by inventors and small companies which could lead to patent troll activity.  When is the FDA going to regulate hemp products, including consumables?  The FDA has approved certain hemp products, such as hulled hemp, but they are looking into the safety and efficacy of other hemp products.  Steps are being taken, including establishing a CBD working group, but it will be some time before the FDA issues regulations.   What about psychedelics?  Several states have introduced legislation to decriminalize and legalize psychedelics, with Oregon being the first state to pass legislation.  If the industry uses cannabis as a blueprint and learns from their successes and missteps, we could see legalization move quicker than expected.

 

Quickfire Questions:  What’s next?

The panel offered insight and predictions into the future of the cannabis industry, patent issues, and emerging psychedelic market.  When is the FDA going to regulate hemp products, including consumables?  The FDA has approved certain hemp products, such as hulled hemp, but they are looking into the safety and efficacy of other hemp products.  Steps are being taken, including establishing a CBD working group, but it will be some time before the FDA issues regulations.  What will we see with regards to patent enforcement?  Only two cannabis related lawsuits have been filed to date, one that died.  However, there is speculation that as the industry grows and federal regulation is introduced, there will be a rise in patent lawsuits.  Aside from a few large patent holders, most patents are owned by inventors and small companies which could lead to patent troll activity.  What about psychedelics?  Several states have introduced legislation to decriminalize and legalize psychedelics, with Oregon being the first state to pass legislation.  If the industry uses cannabis as a blueprint and learns from their successes and missteps, we could see legalization move quicker than expected.