Valuing Founder Shares and other SPAC Investments

Special purpose acquisition companies (SPACs) have been around since the 1990s. Yet, 2020 saw more SPAC IPOs than in all previous years combined and was the first year where SPAC IPOs exceeded traditional IPOs. The first quarter of 2021 saw a continued expansion in the number of SPACs formed. In a statement on April 8, 2021, the U.S. Securities and Exchange Commission said: “over the past six months, the U.S. securities markets have seen an unprecedented surge in the use and popularity of Special Purpose Acquisition Companies.”

SPAC founders include a wide range of investors, from corporate entities to sports stars. Increasingly, alternative asset managers have formed SPACs as an investment vehicle on its own or as a vehicle to provide an exit route for underlying portfolio company investments. In other cases, the fund manager only provides an underlying portfolio company of a fund as the acquisition target for a SPAC.

Since April 12, 2021, and in response to SEC guidance, much of the SPAC ecosystem has been focused on SPAC warrant liability accounting and valuation (see companion article in this publication). However, it is important to remember that alternative investment managers must continue to rigorously and reliably estimate and report the fair value of all their investments on a timely and periodic basis, including investments in various SPAC securities and in underlying portfolio companies that my be targeted by a SPAC for acquisition.

Fair Value Reminder

Alternative investment funds are required by FASB ASC Topic 946 to measure and report all investments at “fair value” as defined by FASB ASC Topic 820. FASB ASC Topic 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” We know that the fair value of actively traded securities (sufficient volume and frequency to determine a price) is the publicly traded price. The fair value of private (non-actively traded) investments is estimated using informed judgment and various valuation techniques to determine what a market participant would pay for the investment at the measurement date.

Valuing SPAC-related Investments

There are several types of investments that an alternative investment fund may make with respect to SPACs. These include, but are not limited to the following, with a summary of the valuation approach highlighted for each:

• Publicly traded units: In a typical SPAC IPO, public investors receive a unit consisting of a share of Class A common stock plus a fraction of a warrant with a strike price of $11.50 per share. The unit issuance price is $10. The shares/warrants detach typically after 52 days and the Class A shares and warrants are traded on an exchanged. Fair value for actively traded units is the exchange price. 
• Publicly traded shares: Post detachment the fair value for actively traded shares is the exchange price.
• Publicly traded warrants: Post detachment the fair value for actively traded warrants is the exchange price.
• Founder shares: Typically classified as Class B shares. Prior to the SPAC filing for the IPO, the sponsor will pay a nominal amount (usually $25,000) for a number of founder shares which gives them up to 20% of the total shares outstanding after completion of the IPO. The 20% founder shares are often referred to as the “promote.” Often the fair value of Class B shares is determined by starting with the publicly traded share price and applying a probability of success factor or the price implied by publicly traded warrants and then adjusting for the time (discount for lack of marketability) until conversion and completion of a lockup period, if any.
• Private placement warrants: Private warrants may have similar terms as publicly traded warrants, or they may have terms which differ. Often the fair value of private warrants is estimated through an option pricing model such as Black Scholes, using appropriate inputs.
• Other securities: In addition to the aforementioned common shares and warrants, other new securities can include:
  • Equity-earnout shares
  • Private investment in public equity (PIPEs) 
  • Convertible notes
  • Forward purchase agreements
  • Working capital loans

Such investments are valued based on the terms of the agreement, the probability of a successful business combination and applicable market participant assumptions.

• Underlying portfolio company: The estimation of the fair value of portfolio company investments uses various valuation techniques and inputs based on the facts and circumstances and the assessment of the appropriate market participant buyer. In the context of a pending SPAC acquisition, the SPAC publicly traded share price may provide an additional data point as to how the public markets are valuing the underlying target company. Depending on the timing of the proposed acquisition and the state of regulatory review, it may be appropriate to place some weighting on the public share price of the SPAC when valuing the underlying private company which is the acquisition target of a SPAC.

Conclusion

Estimating fair value for illiquid or non-traded investments requires experienced, informed judgment. Investors in alternative investment funds need fund managers to provide reliable fair value estimates. Conceptually, investments in SPAC securities are no different than investments in traditional public or private debt and equity interests, yet the nuances of such investments must be carefully considered.