By | Louis Lehot | Business lawyer
Special-purpose acquisition companies (SPACs), organizations that raise funds in the public markets for the purpose of acquiring a private company and taking it public, had their heyday during the COVID-19 pandemic. In 2020, 248 companies went public through mergers with SPACs, exceeding the number of such deals in the past ten years combined, according to SPAC Data.
While the craze continued through the first quarter of 2021, issuance ground to a stunning halt in April. SPAC Research reports a nearly 90 percent drop in SPAC merger filings from March 2021 to April 2021. The overall market value of SPAC mergers has fallen as well; CNBC’s SPAC Post Deal Index, which is comprised of the largest SPACs within the last two years, has fallen more than 20 percent year-to-date. The plaintiffs’ bar has found SPACs, and have announced a plethora of stock-drop investigations and class-action lawsuits.
Now that it seems the SPAC bubble has burst, what’s next?
These are five things to keep in mind as we watch the market for what’s to come.
Market response is crucial
The SPAC slowdown is part of a market response to over issuance, soaring prices and a pending regulatory crackdown ahead of the bubble bursting.
In April 2021, the Securities and Exchange Commission (SEC) issued accounting guidance changing longstanding interpretation that SPAC warrants should no longer be classified as equity, and henceforth as liabilities. Warrants give investors a right to purchase a company’s shares in the future at a specified price; when these prices rise, investors can profit quickly by exercising these warrants.
To clear a pending transaction with the SEC, SPACs have had to go back and restate their financial results to properly account for warrants, slowing down the de-SPAC process.
Concurrently, the SEC announced that warrant redemptions negotiated as part of the de-SPAC process needed to comply with the tender offer rules, further slowing down the process.
Looking to the future, however, the SEC has prepared the market for what will be the most fundamental change that de-SPAC transactions get marketed to investors. Reuters reported that the SEC is preparing interpretive guidance to close the safe harbor for forward-looking projections in de-SPAC transactions under the Private Securities Litigation Reform Act. It is this safe harbor that made a de-SPAC transaction a much more attractive path to fundraising and public listing than a traditional initial public offerings for pre-revenue and early stage technology companies. Whereas PSLRA’s safe harbor is not available for initial public offerings, the SEC has allowed, and even required, that SPACs disclose forward-looking projections in marketing documents to stockholders considering de-SPAC transactions. Going forward, according to Reuters, the SEC will interpret de-SPAC transactions like IPOs and close off reliance on the safe harbor, effectively limiting the marketing of these transactions.
To the naked eye, this stark shift in trends, numbers and regulations could easily seem like cause for alarm. However, not only is this to be expected, it is actually indicative of healthy market growth. While it’s important to keep an eye on the market, it’s too soon to tell if this drop portends a long-term pullback, though there are several factors at play that could do so in the coming months.
Additionally, remember that there are other contributing factors that can impact the market above and beyond the SEC’s guidance. For example, the flurry of activity in Q1 may have been the last remnants of pent-up demand from 2020.
The announcement of proposals to significantly increase capital-gains and other taxes could also be encouraging the sudden pullback. As Congress marches down the road to compromise, the increases will not likely be as large as those initially proposed, the markets will price them in, and countervailing and mitigating measures will be introduced and implemented.
Prepare for a change of pace
The complexity associated with the new SEC accounting guidelines means that SPACs will need to be more meticulous with their accounting and sharing of forward-looking information. Since mindful disclosure takes time, expect that high-quality SPACs will find ways to minimize warrant issuance, restrict redemption terms and avoid detailed projections. Additionally, it is highly likely that the market will find some sustainable level of SPAC IPO activity, since the numbers suggest the market was not just oversaturated, but that companies are still figuring out how best to use this new investment vehicle.
Bear opportunity costs in mind
A recent report by PitchBook on the SPAC market notes that they have benefited from interest rates approaching historic lows. These record-breaking lows have created an environment where the opportunity cost of locking money in SPACs is also low. This means investors are much more likely to risk their money in SPACs due to the possibility of better returns.
Don’t worry about obsolescence
SPACs are still useful. A merger with a public SPAC will remain a reasonable alternative for a late stage private company ready to go public that wants to quickly capitalize on a market window. It is also a great option for a heavily capital intensive business going after a big disruptive opportunity that will require more than what venture capital or private equity can fund alone. Think rocket ships to outer space, air taxis, or green hydrogen pipelines criss-crossing the planet. As we look forward to find ways to finance the rollout of 5G wireless spectrum for consumers, or refinance highways, railways, airports and shipyards, SPACs may yet have a big roll to play.
SPACs offer flexibility in an industry that depends on it. In a market that has seen such explosive and impressive growth, investors may temporarily choose to turn away from SPACs for a time and focus on their existing investments. However, as long as SPACs can provide a viable path for companies to raise capital and go public, they have a seat at the table.
Financiers seem to agree that SPAC deals will continue to move forward, and that investors should be prepared to adjust in accordance with regulations and market pace. While it’s impossible to predict the future of SPACs off of a single data point, it’s important that investors and companies keep an eye on long-term trends. While this correction is a healthy move for the market, it’s too soon to tell if this signals a long-term shift.
While legal constraints, regulatory restrictions and investor protections should tighten up as we approach the summer of 2021, do not expect the SEC to permanently shut down a viable path for the capital markets to fuel global growth.
Louis Lehot is an emerging growth company, venture capital, and M&A lawyer at Foley & Lardner in Silicon Valley. Louis spends his time providing entrepreneurs, innovative companies, and investors with practical and commercial legal strategies and solutions at all stages of growth, from the garage to global