Image: Zegna

The newly-rebranded Zegna Group is making its stock market debut on Monday. The Italian luxury goods group will become a New York Stock Exchange-traded company (ticker: ZGN) by merging with Investindustrial Acquisition Corp., a special purpose acquisition corporation (“SPAC”), in furtherance of a deal that will give it an estimated $3.2 billion valuation. The new cash sets the stage for further expansion of the almost 112-year-old Zegna’s key brands, its marquee Zegna label and suiting company Thom Browne, which it acquired in 2018, with CEO Gildo Zegna telling Italian media that while the group “would consider acquisitions should the opportunity arise,” it currently has “so much scope to grow organically” that it is in no rush to buy.

Zegna is the latest Italian company to bolster itself in a fiercely competitive and increasingly-less-independent fashion industry; formerly independently-owned Versace sold to Michael Kors-owner Capri in 2018, Missoni sold off a 41.2 percent stake to Italian investment fund FSI Mid-Market Growth Equity Fund in 2018, the outstanding 33 percent in Pucci was acquired by LVMH, L Catterton Europe revealed this year that it would acquire a majority stake in Etro, Tod’s let go of a bigger stake to LVMH this spring, and Armani has reportedly been eyeing a deal with a big group; although, no such Armani, Exor transaction has come into play

The other trend here is, of course, the rise of the SPAC, which as surged in popularity in recent years as an alternative to the traditional initial public offering (“IPO”), which is a notoriously costly and time-consuming transaction. “From a target company perspective, merging with a SPAC is viewed as a quicker, more efficient and cost-effective route to going public than a more traditional IPO and deal values can be higher,” according to Paul Hastings LLP’s Roger Barron and David Prowse. Meanwhile, from an investor’s point of view, “SPACs offer the opportunity to invest in a private-equity style transaction with the liquidity and regulatory comfort offered by the capital markets.” 

By removing some of the “negotiations with banks and investors,” and the “filing of complex documents with federal regulators,” Proskauer Rose LLP’s Corey Rogoff and Julia Alonzo claim that SPACs typically operate on “a much quicker timeline, and involve fewer parties.” They note that “in this environment, it is not surprising that investors have looked to other means to shepherd more ‘unicorns’ into the market.” And investors are, in fact, looking to other means: more than half of the companies that publicly listed in 2020 did so by way of a SPAC – or a “blank check” company that “has no commercial operations,” per CNBC. These types of firms “make no products and do not sell anything,” as their primary purpose is to take private companies public by way of a merger. 

Such momentum, as indicated by the Zegna SPAC among others, is expected to carry through 2022, thereby, raising questions about the nature of SPACs, and what the legal risks associated with the growingly-popular “alternative IPO” approach are.  

Zegna & the Lifecycle of a SPAC

“A publicly traded company created for the sole purpose of acquiring or merging with an existing operating company,” a SPAC often provides its target company with “an alternate route to a traditional IPO,” according to a note from Skadden Arps Slate Meagher & Flom LLP, which states that while SPACs can – and have – listed on various stock exchanges around the world, “most SPACs list in the U.S., with 298 American-listed SPACs holding approximately $92 billion in cash in trusts looking for potential business combination partners as of January 31, 2021.” 

SPACs – or better yet, the ultimate merger between the SPAC and its target company – is different from a traditional IPO on a number of fronts. For one thing, a SPAC – which does actually take part in a traditional IPO at the outset in order to raise funds – raises capital from public investors for the “purpose of identifying a target [company],” per Skadden. “Although at the time of a SPAC’s IPO, the acquisition target is not known,” and thus, “investors rely on the skills of sponsors” – such as Bernard Arnault, who launched his second SPAC earlier this month with former UniCredit head Jean Pierre Mustier or former Gap Inc. CEO Art Peck, who launched a $200 million SPAC early this year – “to identify the right target and create value for their investment through the business combination.” 

Through that business combination, the target company (once it is identified, and depending on the specific stock exchange rules, voted on by SPAC shareholders) merges with the SPAC. The life cycle of a SPAC ultimately “culminates in a de-SPAC transaction, at which point the SPAC transforms from a cash box vehicle run by the sponsors into a U.S. public company led by existing management of the target with the continued participation by the sponsors,” per Skadden, which states that “once a SPAC has identified a business combination partner, it can – and often does – raise additional capital through a private investment in public equity (‘PIPE’) process.”

At that point, the sponsors would then start the process again if they wanted to merge with another private company, as SPACs are essentially one-off transaction entities, hence, the IV in CCIV. The name of the Lucid Motors-focused SPAC – which closed this summer and has since come under Securities Exchange Commission scrutiny – is Churchill Capital IV, as the Lucid de-SPAC transaction was Churchill Capital’s fourth SPAC-specific deal. 

The Legal Issues

“With their limited downside and huge upside potential for companies and investors alike, SPACs are increasingly becoming a mainstream source of acquisition capital,” Carpenter Wellington PLLC asserted in a recent note, thereby, “bringing innovation to the capital markets, and attracting a diverse array of market participants.” These burgeoning new deals are not without potential legal complications, though. In fact, Rogoff and Alonzo assert that “SPACs bear many of the same risks that plague newly public companies.” Among them are potential challenges that result from “failing to act in the best interests of shareholders due to conflicts of interest” between directors and officers of the target company, and PIPE financers or the SPAC’s sponsor; and failing to disclose “material information.” 

In terms of potential conflicts, the U.S. Securities and Exchange Commission (“SEC”) stated in a December 2020 Guidance that “the economic interests of the entity or management team that forms the SPAC (i.e., the ‘sponsors’) and the directors, officers and affiliates of a SPAC often differ from the economic interests of public shareholders, which may lead to conflicts of interests as they evaluate and decide whether to recommend business combination transactions to shareholders.” With that in mind, the SEC asserted that “clear disclosures regarding these potential conflicts of interest and the nature of the sponsors’, directors’, officers’ and affiliates’ economic interests in the SPAC is particularly important because these parties are generally responsible for negotiating the SPAC’s business combination transaction.” 

When preparing disclosures, the government agency encourages a SPAC to “carefully consider its obligations under the federal securities laws as they relate to conflicts of interest, potentially differing economic interests of the SPAC sponsors, directors, officers and affiliates and the interests of other shareholders and other compensation-related matters” in order to avoid potential Securities Exchange Act of 1934 liability. 

In an IPO scenario, the SEC says relevant questions that SPAC sponsors should ask when considering disclosures, include (but certainly are not limited to): “Have you clearly described the sponsors’, directors’ and officers’ potential conflicts of interest?  Have you described whether any conflicts relating to other business activities include fiduciary or contractual obligations to other entities; how these activities may affect the sponsors’, directors’ and officers’ ability to evaluate and present a potential business combination opportunity to the SPAC and its shareholders; and how any potential conflicts will be addressed? Is it possible that you will pursue a business combination with a target in which your sponsors, directors, officers or their affiliates have an interest?  If so, have you disclosed how you will consider potential conflicts of interest?” 

Later on, when a SPAC prepares to present a business combination transaction to shareholders, it should ask (and address), “Have you provided detailed information about how you evaluated and decided to propose the identified transaction?  Have you explained how and why you selected the target company? Who initiated contact? Why did you select this target over other alternative candidates?  Have you explained the material terms of the transaction? How did you determine the nature and amount of consideration the SPAC will pay to acquire the private operating company? Have you clearly described the negotiations regarding the nature and amount of consideration?” 

Moreover, “What material factors did the board of directors consider in its determination to approve the identified transaction?  How did the board of directors evaluate the interests of sponsors, directors, officers and affiliates?” 

Based on SEC Guidance to date, the government agency “appears to be focused on disclosures, and specifically on potential conflicts of interest,” per Rogoff and Alonzo, making those particularly relevant considerations for sponsors, and SPAC targets. At the same time, given that the popularity of SPACs as a common mechanism for companies (particularly high-growth companies) to access the public markets, is still relatively newfound, they have “not yet faced a breadth of legal challenges” that will likely involve SPAC sponsors, as well as the directors and officers of the acquisition target, and the public entity that is born from the de-SPAC transaction. 

As such, while special purpose acquisition corporations, including the new Zegna SPAC, may prove to be a budding fashion trend in some sense, they are not without a slew of budding legal issues that will continue to develop throughout the year to come.