What are the benefits of a lift out? 

One benefit is that you can buy what you really want. You don't have to buy other stuff that comes with the acquisition of a company. That makes the integration more manageable because you don't have to fire people you no longer need. 

The other difference is that companies lift out teams that perform well. There are some acquisitions where a big company acquires a little company that is not doing well and then invest in them and turn around their performance. The other difference is the price. If you have a small company that is being traded at $20 a share, you might have to pay $25 to buy it, right? We find that with lift outs there is not as much of an acquisition premium. In some cases the only premium you have to pay is to the leader of the team, so it's a less expensive proposition.There are some groups that look at lift outs as a substitution for acquisitions. On the one hand, you can hire stars from a bunch of companies and then you must convince them to work together. On the other hand, you can buy the company, and integrating the company and the human capital inside this industry is very complicated. Lift outs are in the middle as something that might work better than acquisitions of individuals or acquisitions of companies. 

What are some of the disadvantages of lift outs?

On July 31, computer-memory maker SanDisk (SNDK) announced that it would acquire smaller rival M-Systems (FLSH) of Israel for $1.35 billion in stock. From a strategic standpoint, it's a logical merger between two players in complementary businesses. Both companies make flash memory that stores digital images, music, and more. But SanDisk is known for removable cards, while M-Systems concentrates more on the memory that's embedded in wireless phones, MP3 players, and other devices [see BusinessWeek.com, 8/01/06, "Flash Free-for-All?"].

The deal stands out in another important respect, however. M-Systems is one of more than 60 companies that have been caught up in the ever-widening scandal over the backdating of options. In most cases, the companies awarded stock options to executives at advantageous prices, and they are now investigating whether the disclosure and accounting for those awards was proper.

Now, it looks like some of the companies involved in backdating may become takeover targets. M-Systems is the second company touched by the scandal in as many weeks that has agreed to be acquired. On July 25, computer giant Hewlett-Packard (HPQ) announced that it would buy software maker Mercury Interactive (MERQ) for $4.5 billion in cash [see BusinessWeek.com, 7/29/06, "Mercury's Star Rises"]. Before the deal, Mercury's shares had been in a prolonged slump, after the company had disclosed its own backdating issues and the departure of its chief executive.

The M&A survey, carried out by WKS Results, points to an escalating growth in both sectors which were best represented with 33 and 29 per cent of responses compared to 20 per cent for sectors including advertising and database marketing.

The industry expects strongest growth in the digital sector, with specialist agencies the primary focus for M&A activity, followed closely by database and direct marketing. Some 66 per cent of respondents expect to see a growth in interactive, compared to 45 per cent for database marketing and 34 per cent for direct marketing.

Respondents say open media, online advertising, mobile marketing and search marketing will propel the growth in the sector, with 49 per cent looking to secure additional skills or services as the lead motive for M&A activity. Open media, which includes blogging and podcasting, is expected to be the fastest growing field of Internet marketing, according to 34 per cent of the respondents.

Mandy Merron, partner at WKS, says: "A number of established businesses are working hard to develop digital expertise and this survey suggests they are right to do so, although there is still a strong market for growing profitable businesses with strong management from any discipline."

Overall, increased activity is expected in the M&A market in 2007, with buyers expecting to be more active than sellers. Levels of enthusiasm for takeovers are rising, with 59 per cent of sellers and 83 per cent of buyers believing they should act now.

From August 2003 through October 2006, about 130 SPACs have filed registrations with the Securities and Exchange Commission (SEC) and 72 SPACs have raised several billion dollars and have begun trading as public companies. Of those 72, about 15% have acquired a business and an additional 40% have announced proposed targets.

SPACs have typically raised between $50 million and $300 million to fund their acquisition strategies. The SPAC has a finite life of no more than 18 months (which can be extended) to identify and conclude an acquisition. Pending an acquisition, 95% or more of the IPO funds are held in a trust account with a money center bank. In addition, the acquisitions are subject to approval by the public shareholders of the funded SPAC.

Surging SPACs

SPACs have recently surged in popularity as an alternative due to their ability to raise capital through the public markets to fund takeovers of private companies. However, SPACs haven't gained widespread acceptance, due to their unique and often misunderstood structure. But it is this very structure that protects investors while motivating management, creating a healthy alignment of interests between them.

SPACs are subject to the same regulatory requirements as other public companies, such as filing public documents with the SEC.

Why CEOs Like SPACs

CEOs like SPACs because they enable them to capitalize on their prior accomplishments, which if recognized, will draw the interest of a SPAC underwriter. A fully funded SPAC permits management to conclude an acquisition without the help of a private equity firm.

In a typical SPAC deal, management is issued 20% of the post-IPO equity--excluding dilution from any over-allotment exercise. As a condition to the IPO, the SPAC sponsors are obligated to purchase privately placed securities in an amount up to 5% of the financing. The funds invested are "at risk" capital and subject to being lost if no acquisition is completed in the allotted time. The sponsors don't have to operate the acquired business--they may choose to keep existing management or recruit a new team altogether.

Why Investors Like SPACs

SPACs allow investors access to acquisition opportunities typically restricted to private equity funds.

The securities sold to investors are publicly-traded, so there is some liquidity, whereas an investor in private equity is tied up for years and doesn't have the option of liquidating their capital. Investors are also issued warrants of the SPAC at a set price below the offering price. Investors are able to hold on to those warrants even if they opt-out and vote against the business combination (if such a combination is completed).

If the SPAC doesn't conclude an acquisition accepted by the shareholders, then the money held in trust is distributed back to the public shareholders (or if less than 20% of the public shareholders vote against the proposed target, they can get their pro rata amount returned from trust).

Investors have no discretion over the type of investment the private equity fund will make, as fund managers are not required to seek investor approval before making a deal. Investors believe that management can add value by increasing private company values through a public equity.

Why Private Companies Like SPACs

Many owners of emerging growth companies would prefer to sell to a SPAC rather than go public on their own because the SPAC is already funded, and the path to additional capital more secured. Additionally, working with the SPAC sponsors, management may be able to reach business objectives more easily. The SPAC can purchase a private company for stock while maintaining the cash raised in the IPO for future acquisitions or to grow the target business. This is particularly relevant in today's market, where the IPO market for small-to-mid size companies is weak. Though similar to a reverse merger, the SPAC provides for a "clean" public vehicle with less risk.

Working together, the private management team may continue to operate the day-to-day affairs of the business while having access to the experience of the sponsors who will continue to act as board members. Alternatively, owners of such growth companies would prefer selling to a SPAC, either by cashing out or receiving publicly traded securities (as described below), and allowing the sponsors to operate the business going forward.