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SPACs are transforming capital markets. From initial deals to merger success, their innovative structure unlocks growth and opportunities ¨C reshaping how companies go public and inspiring bold investment strategies

The special purpose acquisition company (SPAC) model is gaining traction in capital markets, with its core process centred on reaching a business combination agreement (BCA) with a target company. In its early stage, a BCA is mainly divided into two key phases: the letter of intent (LOI) phase; and the due diligence phase.

Preliminary agreement & LOI

Following a successful IPO, a SPAC must identify a suitable target company within 15 to 24 months, with the option to extend this period under special circumstances by paying an additional fee. During this phase, the management team leverages its extensive industry expertise and networks to identify target companies that align with the SPAC¡¯s investment strategy, demonstrate growth potential, and seek to go public through SPAC financing. Once a target is identified, negotiations commence promptly, culminating in the signing of an LOI.

The LOI serves as a pivotal preliminary document, outlining key matters such as the transaction structure, valuation range, equity exchange ratio and arrangements for the target company¡¯s management team. It lays the groundwork for subsequent due diligence while attracting investor attention and shaping market expectations.

Due diligence phase

Once the LOI has been signed, a due diligence team comprising financial, legal and industry experts is promptly assembled to conduct a comprehensive review of the target company.

The investigation covers several key areas: financial status; including revenue; costs; profits; assets and liabilities; actual performance and stability of operational results; legal compliance such as unresolved litigation and contract adherence; market competitiveness, including market share and competitive advantages; technological research and development capabilities; and intellectual property rights.

This meticulous examination provides a thorough understanding of the target company¡¯s actual condition and helps identify potential risks.

Negotiation phase of BCA

During this phase, both parties engage in negotiations to finalise the terms of the BCA. If issues are identified during due diligence ¨C such as financial discrepancies (e.g. revenue falling short of expectations) or legal risks (e.g. intellectual property disputes) ¨C the SPAC has the right to request adjustments to the transaction terms. These adjustments may include lowering the valuation, altering the equity exchange ratio, or even requiring the target company to rectify the identified issues.

The final BCA is a detailed and legally binding document that specifies all critical terms of the merger transaction. It includes precise company valuation, an accurate equity exchange ratio, arrangements for the target company¡¯s management team in the post-merger entity, performance commitments and compensation clauses (if applicable), conditions for transaction completion (e.g. shareholder approval, regulatory clearance by securities authorities), and the transaction timeline and termination clauses.

Merger implementation phase

Once the BCA has been signed, the SPAC project moves into the merger implementation phase. During this stage, a series of procedural steps must be completed, such as obtaining SPAC shareholder approval, meeting securities regulatory requirements, and completing the equity exchange. These steps ultimately facilitate the successful public listing of the target company.

One of the key responsibilities of lawyers during the signing of the BCA is to negotiate and design the corporate restructuring framework for the SPAC and the target company.

The author takes a recent project handled as an example to show a ¡°two-step¡± structure for the merger process, as outlined below.

Step 1: Establish subsidiaries

SPAC Cayman company leads. The merger structure typically begins with a SPAC company registered in the Cayman Islands, a preferred jurisdiction for such structures due to its unique legal and tax advantages, as well as its well-established corporate governance framework in the international business and financial sectors.

Creation of two subsidiaries. Under the SPAC Cayman company structure, two subsidiaries are established: merger sub 1; and merger sub 2 (the latter being a sub-subsidiary). These subsidiaries form the critical foundation for the two-step merger process. Merger sub 1 is often designed to handle specific assets, liabilities or business interests of the SPAC during the merger process. It may directly absorb the SPAC company in a reverse merger arrangement.

The sub-subsidiary focuses on the initial integration and preparation for merging with the target company. In this project, merger sub 2 was responsible for absorbing the target company. This initial step does not require comprehensive filing with the US Securities and Exchange Commission, saving a significant amount of time and avoiding certain procedural complexities.

Step 2: Merger

In the second step, the SPAC company and the target company are merged into merger sub 1. This merger involves a series of complex legal and financial procedures, including equity swaps and asset transfers, which differ significantly from domestic merger or absorption practices.

Drawing a parallel to domestic operations, this process can be likened to the sponsor company using the subsidiary¡¯s equity to exchange for the target company¡¯s assets. Consequently, the target company¡¯s shareholders become shareholders of merger sub 1, holding its equity proportionally.

Merger sub 1 assumes control over the sub-subsidiary, which has absorbed the target company. Following the absorption, the target company ceases to exist.

The sub-subsidiary, in turn, holds the intermediate holding company and the Hong Kong company, which ultimately owns the domestic company through a wholly foreign-owned enterprise. Merger sub 1 emerges as the listed entity in the capital markets, taking on the role of the listed company, with its shares available for trading on markets such as the US stock exchanges.