With the number of SPACs searching for acquisition targets at record levels, Canadian companies are increasingly being approached for “de-SPAC” transactions.
A “SPAC”—a “special purpose acquisition company”—generally refers to a blank check publicly traded company with no operations but with a trust account of capital for the purpose of effecting a business combination with one or more unspecified businesses. While there are a number of SPACs that have raised money and are publicly traded in Canada under the TSX’s SPAC program, the vast majority of SPACs are publicly traded solely in the United States. Companies seeking to go public may enter into a business combination with a SPAC, receiving a significant cash infusion from the SPAC and taking on its public company status once the transaction is completed. This structure has been appealing to SPAC sponsors, SPAC investors and companies seeking to go public alike, for a variety of reasons, not the least of which include the SPAC’s perceived speed to market, lighter regulatory review, and increased control over valuation.
There are a number of important considerations for U.S.-listed SPACs and Canadian targets to take into account before embarking on de-SPAC transactions. Cross-border tax issues, financial statement requirements, and Canadian corporate and securities law issues need to be considered.
What you need to know
- Canadian shareholders of a Canadian target can avoid an immediate tax event of a de-SPAC transaction by employing alternative structures.
Depending on the structure used, the Canadian company may need to prepare its financial statements in accordance with U.S. GAAP.
- While the surviving entity need not list on a Canadian stock exchange, a prospectus filing with the applicable Canadian securities authority will be required in most situations.
- A shareholder meeting of the Canadian target and plan of arrangement process may be required to approve the transaction.
In a typical de-SPAC transaction, the SPAC will be the surviving entity. However, if Canadian shareholders exchange shares of a Canadian company for shares of a U.S. SPAC, a tax event occurs resulting in taxable gains to the Canadian shareholders of the target company with no cash to pay the taxes. There are a few ways to address this:
- Exchangeable share structure. One alternative is to use an exchangeable share structure in which the Canadian shareholders receive shares in a Canadian company, which are exchangeable into shares of the U.S. SPAC at the time a shareholder wishes to sell its stockholdings. Using an exchangeable share structure, the timing of a taxable event is deferred until there is a later liquidity event and cash to pay the taxes. The Canadian shareholders can also receive voting shares with no economics in the public company so that both the economics and voting rights of the Canadian shareholders mirror those of the U.S. shareholders.
- Redomiciling the SPAC. For those who prefer to avoid the dual share structure discussed above, the SPAC can be redomiciled into Canada. This transaction is best effected by using a SPAC that is publicly traded in the U.S. but is incorporated in an offshore jurisdiction. While a U.S. SPAC can be used, the transaction must be carefully structured to avoid triggering the “anti-inversion rules” in the U.S. Internal Revenue Code. The anti-inversion rules could cause the redomiciled Canadian parent to be treated as a U.S. corporation for U.S. federal tax purposes and/or result in unfavorable tax treatment of dividends and other adverse U.S. tax consequences. For companies which do not contemplate dividends, such as many biotech companies, this may be less of a consideration. Also, depending on the exact structure and whether a U.S. or offshore SPAC is involved, there could be some risk for U.S. shareholders that the de-SPAC transaction employing this structure would be taxable; however, notably, substantial transactions have employed this structure.
- Canadian target to be the surviving entity. Under this alternative, the Canadian target or more commonly a Canadian newly formed company rather than the U.S. SPAC, will be the surviving parent entity that will become the publicly traded vehicle in the U.S. following the de-SPAC transaction. This avoids the need for an exchangeable share structure or a re-domiciliation. The transaction can be structured to avoid current tax to U.S. shareholders of the SPAC and generally can be structured to avoid causing the Canadian parent entity to be treated as a U.S. corporation for U.S. federal tax purposes under the anti-inversion rules mentioned above. However, as noted above, companies that do not expect to pay dividends, including many biotech companies, may be less concerned about being treated as a U.S. corporation for U.S. tax purposes under the anti-inversion rules.
If the surviving company is the U.S. SPAC (and otherwise not a “foreign private issuer”), the Canadian target will need to prepare financial statements in accordance with U.S. GAAP. When a domestic U.S. SPAC files its registration statement and/or proxy statement to complete a business combination with a Canadian company, it is required to file U.S. GAAP financial statements for the Canadian company or otherwise reconcile the target company’s existing financial statements to U.S. GAAP (rather than International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS)). This process of recasting or reconciling the target company’s financial statements to U.S. GAAP can take several months to complete and require re-auditing by the company’s U.S. independent auditors.
However, if the de-SPAC business combination is structured such that the Canadian company is the successor entity that acquires the SPAC, the Canadian target would file a registration statement as a foreign private issuer, which would enable the company to file its existing IFRS financial statements (note that if the company’s existing financial statements are prepared under Canadian Accounting Standards for Private Enterprises (ASPE), it would still need to reconcile to either IFRS or U.S. GAAP). Also, if transactions involving non-U.S. incorporated U.S.-listed SPACs qualify as “foreign private issuers”, the target company financial statements may be prepared in accordance with IFRS.
In most circumstances where the target is incorporated in Canada or has any significant Canadian connections—even if there is no Canadian listing—the target will need to file a prospectus with Canadian securities regulators and become a reporting issuer in Canada in order to permit the pre-existing shareholders of the Canadian target to freely resell their shares on a U.S. stock exchange following the transaction. This will be required in situations where Canadians held more than 10% of the shares of the surviving entity at the time the pre-existing holders received their shares and any one of the following also apply: a) the surviving entity is organized in a Canadian jurisdiction, b) the head office of the surviving entity is in Canada, c) the majority of the members of the board of directors of the surviving entity are resident in Canada, or d) the majority of the executive officers of the surviving entity are resident in Canada. Given that the de-SPAC transaction will already involve the filing of a registration statement with the SEC, a concurrent filing with Canadian securities regulators may only marginally increase the cost and time associated with the de-SPAC transaction. However, de-SPAC transactions with Canadian targets are unlikely to be able to take advantage of the circumstances in which the SEC would accept only two, rather than three, years of financial statements.
Approval process under Canadian corporate law
Given the technical complexities of de-SPAC transactions, including under corporate, securities and tax laws, these transactions with Canadian targets will often be completed under a court-ordered “plan of arrangement” process available under most Canadian corporate statutes, which can be very advantageous in its flexibility. The plan of arrangement process is more likely to be suitable in circumstances where the Canadian target is being acquired by the SPAC (with the SPAC continuing as the surviving entity), and can be useful in implementing the exchangeable share structure. This is a typical Canadian way of effecting an acquisition and it can be beneficial in that the court approves the fairness of the transaction helping to protect the deal from challenges after the fact. In addition, it can allow for the implementation of transaction steps in an efficient manner and can also form the basis for exemptions under securities laws on both sides of the border in certain circumstances.
In sum, there are a number of complexities that a U.S. SPAC will face in completing a de-SPAC transaction with a Canadian company; however, as described above, when there is a SPAC, there is a way.
If you have any questions, feel free to contact Cheryl Reicin and Matthew Atkey.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2021 by Torys LLP.
All rights reserved.