SPACS and PIPEs and CVRs, Oh My!

For a year and a half, we’ve been following the continuous evolution of special-purpose acquisition companies, or SPACs. The SPAC market thrived in 2020 and 2021. Then SEC scrutiny and poor performance tore through like a twister, slowing merger transactions and limiting available funds.

As a result, we’ve seen more concessions to close deals, including warrants and rights for issuers as well as advantageous pricing for private investors getting into deals at a later stage. The latter, known as private investment in public equity or PIPE, is critical for making sure there’s enough money to complete the deal in the face of investors who may ask for their money back rather than maintain an investment in the post-merger SPAC.

In this blog post, we follow the yellow brick road from SPACs to PIPEs and on to contingent value rights, or CVRs. CVRs are an added benefit to PIPE investors and are becoming an increasingly common way to seal a SPAC merger deal.

The SPAC merger hurdle

The goal of a SPAC is to find and merge with a private company, passing on its publicly listed status to the company as an alternative to an IPO. A concern, however, is making sure the SPAC has enough money to do a deal. This may be for one of two reasons:

• The company to be purchased is worth more money than the SPAC was able to raise via IPO
• SPAC investors can redeem their shares, taking their initial investment back with interest rather than accepting the deal

Early SPACs often saw limited redemptions—in early 2020, for instance, they averaged 20%. More recently, redemption rates have commonly been more than half. In many cases they were more than 90% of the deal. For example, in December 2021, Buzzfeed saw redemptions of 94.4%, with investors leaving only $16 million of the $288 million raised in Buzzfeed shares. (We looked for “5 Reasons to Redeem Your Buzzfeed Shares,” but didn’t find them. Still, we assume “You Wouldn’t Believe #2.”)

The PIPE

A PIPE itself is nothing new. Often, large investors eschew a market transaction for a direct sale from the company. These shares, which are often restricted from selling into the public market, are sold by the company at a below-market price. The company pays a much lower issuance cost and gets its money quickly. At the same time, the investor saves some money and hassle versus a market purchase. The tradeoff is that they receive a share that cannot be readily sold on the market.

To bridge the funding gap, the SPAC will often detail a PIPE transaction around a merger announcement to ensure they have funds to get the deal done. This transaction can act as a backstop to replace what is otherwise redeemed capital.

CVR Securities

Typical SPAC-related PIPE offerings used to be on the same terms as the earlier IPO. While this may not sound like better pricing than the early investors got, the structure of the units—a share plus a fraction of a warrant—makes it valuable. Because a deal is closer to occurring, the value of the base share would be at or very near $10. So the warrant component of the unit is basically extra value for the PIPE investor.

Again, as SPAC performance has slowed, we’ve seen PIPE investors demand additional value above the unit. In other words, investors are looking more like a cowardly lion, in need of some courage. It’s not generally feasible to offer the shares at a lower price. But it can happen through additional warrants, preferred shares, or something we’re seeing more lately: the CVR.

A CVR is a conditional right to an underlying share or payment. One strategy is to issue CVRs specifically as shares vesting based on stock prices. We’ve seen CVRs that earn more shares based on hitting a regulatory milestone, other business milestone, or simply payouts determined from a company’s revenues. Some CVRs even pay investors if unexpected negative events occur.

Accounting Implications

In general, the accounting for CVRs would be expected to follow the model for earn-outs, which requires determining whether the payments are based on services or not.  If this is related to a PIPE, the likely outcome is that it wouldn’t fall under ASC 718 as it wouldn’t be compensation for services. Instead, we would expect these to fall under derivative guidance and likely be considered under ASC 815 rules.

If the instrument is accounted for as a derivative, the valuation would need to be marked to market as of each reporting period until the rights expire or are paid out.

Valuation Implications

Valuing a CVR follows the same methods used to value earnings, revenue, or share-based earnouts. The methods are based on the projected metrics for the company, adjusted downward to account for the underlying risk of hitting the targets. These typically require a custom Monte Carlo simulation and, given the structure of the CVRs can be especially complex, should be handled carefully.

On the other hand, a company may need to reflect the value of the underlying common stock based on an implied value from the PIPE. Because the PIPE has additional features, these features need to be removed, consistent with the SPAC warrants and other share rights as discussed here.

Not in Kansas Anymore

SPACs continue to be a witches’ brew of securities and unique valuation issues. As the market adapts to reduced capital and increased SEC oversight, we expect securities to adapt as well. Although CVRs are a horse of a different color, they reflect concepts we’ve seen in past transactions. We’ll continue to keep our eye on the market and post as more securities cross our radar.

If you would find it helpful to discuss these or any other related topics, please contact us.