Article by Brian McMahon, Regulatory Change Analyst at Vox Financial Partners
The acronym that is on everyone’s mind (maybe not everyone) lately is SPAC. A special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company. Also known as “blank check companies,” SPACs have been around for decades. In recent years, they’ve become more popular, attracting big-name underwriters and investors.
In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don’t identify that target to avoid extensive disclosures during the IPO process. They usually have 24 months to complete an acquisition. If investors in a US-listed SPAC dislike a purchase target, they can redeem their shares from the trust account established after the IPO but keep the warrants, allowing them to get back in at an agreed price if the acquisition goes better than they expected.
The rapid proliferation of SPACs mirrors a pattern seen a decade ago with another controversial M&A practice: reverse mergers. SPACs are a form of reverse merger. In a standard reverse merger, a successful private company merges with a listed empty shell to go public without the paperwork and rigors of a traditional IPO. The shell is usually a remnant of a previously operational public firm or a public virgin shell formed to combine with a private company. Where SPACs are different is simply that the shell company is a proactive party, flush with cash from the IPO and hunting for private targets. The reverse merger bubble surged in the mid-2000s, outnumbering IPOs in some years, and peaked in 2010, before bursting in 2011.
Investors poured $100bn into SPACs globally last year. The trend has continued into 2021, with 188 vehicles raising $58bn in the US alone.
While SPACs have grown in popularity with investors over the past few years, this has also led to an increased focus from regulators. There are rules that they must already adhere to, such as SPACs cannot know of the company they’re going to acquire ahead of time, and the acquired company must be worth at least 80% of the cash raised in the SPAC IPO. The SEC Chairman Jay Clayton has also been vocal on disclosure concerns surrounding the incentives and compensation to the SPAC sponsors.
Compared to a traditional IPO, a SPAC IPO can be significantly quicker. Due to its lack of fundamental operation, both financial statements and the prospectus filed during a SPAC IPO are considerably shorter. They can be prepared in a matter of weeks (compared to months for a traditional IPO).
No historical financial results are disclosed or assets to be described, and business risk factors are minimal. As a result, the SEC comments are usually few and typically do not require burdensome changes. The entire SPAC IPO process can be accomplished in as few as fifteen weeks from its starting point. SPACs have attracted more companies in futuristic industries such as space tourism and electric vehicles. These companies that have yet to make a profit could market their future financial attractiveness in a SPAC listing — something that’s not allowed in an IPO.
On the other hand, the acquisition/merger transaction (De-SPAC) involves many of the same requirements as would apply to an IPO of the target business, including audited financial statements and other disclosure items that may not otherwise be applicable if a public operating company acquired the target business. Also, the De-SPAC needs to be approved by a majority of the SPAC’s shareholders. Those shareholders can opt to redeem their shares, which could leave the surviving company post-merger with significantly less money in the trust account than was raised in the IPO.
On the other side of the pond, there are renewed calls for UK regulators to loosen the regulations surrounding SPACs. London hasn’t seen as much of a ‘SPAC boom’ as the US. This is mainly due to a rule that says shares in the company must be suspended after it picks a target, leaving investors with their cash locked up, even if they want to sell.
A UK listings review recommended the financial authority remove this rule “and replace it with appropriate rules and guidance to increase investor confidence in these companies further.” However, the review did appear to share similar concerns as the SEC about the fact that SPACs are skewed towards big pay-outs to “sponsors”.
More than 300 SPACs in the US have to complete their merger this year or risk being liquidated. But with only so many quality targets to go round and SPAC founders’ strong incentive to close deals — even at the expense of shareholder value — SPACs may well end up in a negative spiral of poor quality, bad press, and tighter regulation. And we know how that ended for reverse mergers.
It will be interesting to see how the regulatory landscape changes for SPACs in the coming weeks and months, particularly in the US and UK, and if there is alignment in the rules that govern them. With the growing interest and volume of SPAC transactions continuing at pace, regulatory reform is more a matter of when than if. As the discussion unfolds, we will come back with an update.
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