Lesson 5 of 7
Trust, warrant and dilution
A blank-cheque company puts ten dollars a share in trust and hands its founders a fifth of the equity for 25,000 dollars. Count the shares from the prospectus.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A blank-cheque company sells units at ten dollars, holds at least ten dollars a unit in trust in government securities, and must complete a deal by a stated date or return the trust.
- Its founders buy a block of shares for a nominal amount, sized to be 20 percent of the shares after the offering.
- Because the founders paid almost nothing, the cash in trust behind each share is well below the ten dollars a public investor paid.
The structure is fully described in the prospectus, and the interesting part is arithmetic rather than judgement: count the shares, count the cash, and divide.
Who owns the shares, and who paid for them
Cash contributed
- Public investors: 21,000,000 shares · 10.00 dollars a unit$210.000m97%
- Sponsor and underwriter private units: 555,000 shares · 10.00 dollars a unit$5.550m2.6%
- Founders: 6,037,500 shares · 25,000 dollars in total$0.025m0.0%
Shares received
Total$215.575m
What the money does
The prospectus states that on closing, an amount equal to at least 10.00 dollars per unit sold in the offering, including the proceeds of the private units, is held in a trust account in the United States and invested only in government securities with a maturity of 180 days or less, or in a money market fund holding them.
If no business combination is completed within the stated window, which in this offering was 21 months from closing, the company redeems 100 percent of the public shares for their pro rata portion of the trust including interest earned. That redemption right is what the public investor actually buys on day one.
The dilution, counted
Three lines of arithmetic from the prospectus
-
Count the shares. 21,000,000 public shares, plus 555,000 private placement shares, plus 6,037,500 founders' shares, is 27,592,500.
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Count the cash. 210,000,000 dollars in the trust, which the offering and the private placement together funded.
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Divide. The trust holds 7.61 dollars for every share outstanding, against the 10.00 dollars a public investor paid for one.
Nothing improper has happened. The founders' block was described in the prospectus before anybody bought a unit, and the prospectus says it was sized so that the initial stockholders would own 20.0 percent of the issued and outstanding shares after the offering. The dilution is disclosed, priced into nothing, and often ignored.
The warrants on top
The founders' economics, stated once
The block that produces the dilution was bought before the offering, in this case for 25,000 dollars in total, or roughly four tenths of a cent a share against the ten dollars the public paid. The prospectus also discloses that part of the block is subject to forfeiture so that the initial stockholders continue to own 20.0 percent of the shares after the offering, whether or not the underwriters take up their over-allotment.
That is the mechanism to understand: the founders' stake is defined as a percentage of the finished company rather than as a number of shares bought for a price. It is fixed in proportion and the price is nominal, which is why the cash behind each share falls as soon as the arithmetic is done.
What a reader should take from it
Two habits transfer to every deal of this shape. Read the share count from the prospectus rather than from a data feed, because the founders' block, the private placement and the warrants are all disclosed and none of them is obvious. And separate the two distinct instruments hiding in one ticker: a redeemable claim on a trust of government securities before the deal, and an ordinary share of an operating company after it.
Those two things have almost nothing to do with each other, and the second one begins its life diluted by the arithmetic above.
Check yourself
What is held in the trust account?
- The sponsor's own capital only
- At least ten dollars per public unit, invested in short-dated government securities
- Shares of the target company
Show the answer
Answer: B.
The prospectus commits an amount equal to at least 10.00 dollars per unit, including the private placement proceeds, to a trust invested in government securities of 180 days or less.On the prospectus figures, how much trust cash stands behind each share outstanding?
- 10.00 dollars
- About 7.61 dollars
- 25,000 dollars
Show the answer
Answer: B.
210 million dollars of trust divided by 27,592,500 total shares is 7.61 dollars, because the founders' 6,037,500 shares cost 25,000 dollars in total.What happens if no business combination is completed in the stated window?
- The founders keep the trust
- The company redeems 100 percent of the public shares for their pro rata share of the trust
- The deadline extends automatically
Show the answer
Answer: B.
The redemption right is the public investor's protection, and it is the thing they hold before any deal is announced.Sources
- InterPrivate Acquisition Corp., prospectus filed under Rule 424(b)(4) on 2020-02-05: 21,000,000 units at 10.00 dollars, at least 10.00 dollars per unit held in trust in government securities of 180 days or less, 555,000 private units at 10.00 dollars, 6,037,500 founders' shares issued for 25,000 dollars in total and sized at 20.0 percent after the offering, warrants exercisable at 11.50 dollars, and the 21 month window with redemption of 100 percent of public shares.
What this leaves out
- Every blank-cheque company sets its own trust amount, founder block, warrant terms and deadline. These figures describe one 2020 offering.
- The 7.61 dollars per share is computed here from the prospectus figures and assumes no redemptions, no over-allotment and no warrant exercise.
- The structure changes again at the deal, where redemptions, new investment and the target's own shares all move the count.
- This is a closed historical offering used to show the arithmetic. Nothing here is advice about any security.