Are Special Purpose Acquisition Companies Dying Off? A Few Points to Consider.

by / ⠀Funding / June 1, 2021
SPACs had a fantastic run last year through March '21. The drop in April was stark but the question is whether it portends a bigger pullback.
SPACs have had a fantastic run in the last year through the end of Q1 2021, rising from a total IPO count of 59 in 2019 to 248 in 2020 and a whopping 311 in just the first quarter of 2021. The number of SPAC IPOs in the first quarter of this year exceeded the total of all of 2020. However, the number of new IPOs fell off a cliff in April. SPACInsider lists 85 SPAC IPOs in January, 96 in February, 109 in March, but only 13 in April. The SPAC market had been growing by 13% per month in the first quarter. Somewhat alarmingly, April’s total showed a drop of 88% compared to that in March. The drop in April was stark, but the real question is whether the drop portends a long-term pullback. We can’t extrapolate a trend from a single data point, so any guess will simply remain that, a guess. That will be true at least until we have a few more months of data. Anticipating the trend will require first identifying some important market factors and regulatory hurdles.

Market Correction…or Something More Ominous?

One important point is that a correction is a healthy move for the market. Double-digit growth month over month is almost certainly not sustainable long-term. We should expect pullbacks. They are indicative of a healthy market. PitchBook recently released a new report on the SPAC market. It noted that prevailing interest rates hit near historic lows. This created an environment in which the opportunity cost of locking money in SPACs is very low. Accordingly, investors are much more likely to risk their money in SPACs. The returns can be so much better than investments that rely on interest rates. As interest rates start to move up in response to fears of stimulus-induced inflationary pressures, the appetite for yield potentially satiates in traditional bond market products. Certainly, other contributing factors also affect the market. For example, the flurry of activity in Q1 may represent the last vestiges of pent-up demand from last year. However, the possibility of a sharp increase in capital-gains taxes could be encouraging the sudden pullback.
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Legislative Influences on the Horizon

Congress is also looking intently at whether existing legislation is sufficient. According to a recent report, Congress is showing interest in toughening transparency and investor protection requirements that govern SPACs, potentially adding pressure on regulators to increase oversight of these alternate funding vehicles that are disrupting capital markets. Members of Congress, the Securities and Exchange Commission (SEC), and other rulemaking bodies have publicly expressed concerns. They wonder whether existing paradigms that enable a private company to bypass traditional IPO rules via the de-SPAC process are leaving retail investors high and dry. Whenever legislators start talking about new statutes and rules, it ought to garner attention. Regulators can be expected to heighten enforcement of the tools already available. PitchBook also noted that, independent of pending Congressional action, the SEC is rumored to be considering a multi-prong rule tightening. This would affect how SPACs accomplish mergers with private companies and take them public.

The PSLRA of 1995 May Get Some New Guardrails

First, the SEC is reportedly considering the issuance of interpretive guidance or rulemaking under the Private Securities Litigation Reform Act of 1995 (or PSLRA) to disqualify SPACs from the safe harbor currently relied upon to market their projections of future earnings and profits. The PSLRA was never intended to be availed by SPACs to market their deals to retail investors. While the PSLRA explicitly excluded statements made in connection with initial public offerings from the safe harbor, SPACs have relied on the safe harbor to market de-SPAC transactions, postulating that de-SPAC mergers are not technically “initial public offerings” under the Act. Reining in growth projections made by SPACs will be achieved through regulatory curtailment of their availment of the PSRLA’s safe harbor by including de-SPAC mergers within an expanded definition of “initial public offerings.” This probably levels the playing field between de-SPAC transactions and traditional IPOs more than any other regulatory action.
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Warrant Accounting, Income Statements, and Disclosures

Second, starting in April 2021, during the de-SPAC review process, the SEC began pushing SPACs to change warrant accounting and mark them to market through the income statement. The new accounting policy change will discourage the inclusion of warrants in SPAC IPOs. These provide a key benefit for SPAC IPO investors, who sell the warrants shortly after initial listing to short investors. Lastly, movement is afoot on Capitol Hill to require detailed disclosure of the amounts that SPAC sponsors stand to gain from SPAC listings and de-SPAC mergers through their various equity instruments, units, and warrants.

The Usefulness of SPACs for Investors

Some wonder whether a SPAC is a useful vehicle to advance technology innovation. SPACs offer simplicity and efficiency in an industry that simultaneously depends on both while also struggling with regulations at odds with them. But in a market that has seen such explosive growth, investors may choose to focus on their existing investments for now, rather than pursuing new ones. Long-term, the market will find some sustainable level of SPAC IPO activity. Increasing by 13% per month — only to drop by 88% the next month — suggests that the market was not just oversaturated. It was an indicator that companies are still figuring out how best to use this investment vehicle. While 30+ years old, they only recently gained widespread market acceptance. As long as SPACs can provide some measure of simplicity to companies going public, they will likely remain popular.

Best Advice: Stay Tuned for Further Developments

Keep a sharp eye out for any Congressional action, legislation or proposed rulemaking from the SEC. We’ll see what effects any rise in interest rates or tax changes will have on SPACs. We’ll also want to be looking for any waning in investor SPAC fatigue.

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About The Author

Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley, San Francisco and Los Angeles offices, where he is a member of the Private Equity & Venture Capital, M&A and Transactions Practices and the Technology, Health Care, and Energy Industry Teams.

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