'Blank check company' has eye on major media buy; SEC requires firm to cut deal with its $100 million or return the money to investors.

Some friends get together, realize they have complementary business skills, and decide to buy a company. So they go to Wall Street and investors give them $100 million.

It sounds like a fairy tale, but David Marshall, Kurt Brendlinger and Eric Pulier have lived it. They are the officers of Santa Monica Media Corp., a so-called "blank check company" that had its initial public offering in late March.

Marshall, the founder and current vice-chairman of the gambling site Youbet.com Inc. in Woodland Hills, serves as Santa Monica's chief executive officer. Pulier, whose day job is chairman of L.A.-based SOA Software Inc., serves as the new company's chief technology officer. Brendlinger, an asset manager, is chief financial officer.

Blank-check firms are legal structures in which investors provide money and managers use it to buy a company. In money circles, blank checks also go by the name of Special Purpose Acquisition Corporations, or SPACs for short. Under rules of the Securities & Exchange Commission, a SPAC must announce an acquisition within 18 months of its initial public offering and consummate the deal within 24 months. Otherwise, the company must return the IPO money plus interest to the investors.

Santa Monica plans to acquire an operating business in the communications, media, gaming or entertainment industries, according to its prospectus.

The managers intend to focus on opportunities where they can use their knowledge of the industries and apply new technologies, such as in developing online businesses and products. "We believe opportunities exist," the prospectus states, "not only in acquiring stand-alone companies but also in identifying and acquiring underperforming businesses currently owned by larger conglomerates."

The prospectus emphasizes that Marshall and friends don't have a specific target. "We're not looking for a hit-driven business like a movie studio," Marshall explained. "Our backgrounds are more technical, so we are looking for a technology that's proven, a distribution system that's proven, or an infrastructure in media and entertainment that we can take and grow."

He doesn't foresee Santa Monica Media becoming a conglomerate. "This vehicle is prone to acquire one company and grow it in that space. We're not looking to have a highly diversified company across media," he said.

Marshall believes a SPAC provides investors with little downside, but a potentially big upside.

David Ficksman, an attorney at Troy Gould in Los Angeles who worked on the Santa Monica IPO, said most--but not all--of the investor money goes into an interest-earning trust. Upon liquidation (in the event no deal happens), the non-trust money can cover company costs. He estimates that investors would get back about $7.87 of their original $8 per share investment in the event of a non-starter--a relatively small downside.

As for the upside, it all depends on the company Marshall and his colleagues buy. According to SEC rules, the company has to use a minimum of 80 percent of its IPO proceeds for the purchase, so that sets the floor at $80 million. But Marshall said the company could access debt, so he expects to spend $100 million to $400 million on the acquisition.

Eleazer Klein, an attorney with the New York firm Schulte Roth & Zabel LLP who specializes in SPACs, said hedge funds and equity funds are the biggest investors in SPACs. Most of the fund managers are pretty sophisticated in specific industries, because unlike regular investments, a SPAC has no business operations or financials to analyze. SPACs come from all sectors, but Klein has seen successes in the real estate, health care, insurance and retailing fields.

Santa Monica's shares currently trade in the $7.40 range--when they trade at all. However, SPACs usually show sporadic trading at this point, said Ficksman. He expects trading will pick up as soon as the company announces an acquisition target.

Curse of popularity

Santa Monica seemed to have caught the SPAC market at the right time, but whether that eventually pays off remains to be seen. During the last three years, a spike in SPACs has brought big-name underwriters such as Merrill Lynch, J.P. Morgan and Deutsche Bank into the market. Ficksman added that SPAC units now trade on the American Stock Exchange, making it "a more acceptable way to raise capital." In the case of Santa Monica Media, Citibank handled the IPO.

But "as the number of SPACs has expanded, so has the number looking for potential targets, just like private equity companies," said Ficksman. "There's a lot of money chasing deals."

The Santa Monica prospectus noted that since 2005, about 84 blank check companies have completed an IPO. Of those 84 companies, 21 have consummated a business combination and another 28 have announced a deal. Five SPACs couldn't find a deal and liquidated.

"Accordingly, there are approximately 30 blank check companies with approximately $3.2 billion in trust that are seeking to carry out a business plan similar to our business plan," the prospectus stated. "We may, therefore, be subject to competition from these and other companies seeking to consummate a business plan similar to ours, which, as a result, would increase demand for privately held companies."

The dangers of SPACs include the risk of not finding a target, or the related risk of not obtaining shareholder approval for that first acquisition, a legal requirement. Once the SPAC buys a business, it becomes a regular publicly traded company, with the associated quarterly reports and other regulatory obligations, Klein said. And like any other business, the value could stagnate or decline.

For entrepreneurs who may want to duplicate Santa Monica's trick of raising $100 million, Marshall gave this advice: "It looks easy when it's done, but it took us two years."

Ficksman warned that would-be SPAC managers "are going to have to put some skin in the game." For example, the threesome who put together Santa Monica Media have incurred more than $3 million in non-refundable costs in the event of no acquisition. However, "for folks that are well-recognized in their industry, it's an interesting way of raising capital."

According to Klein, loss of reputation looms as a major risk factor. Institutions invest in SPACs based on the track record and name recognition of the managers. If the deal goes sour, the managers' resumes will get tainted.

"If you have a good story, you can probably raise the money," Klein concluded. "But there's a reputation here. You shouldn't do this unless you believe you can really create value."