5 Things To Watch In The SPAC Market After Last Year's Boom

By Tom Zanki
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Law360 (June 25, 2021, 5:32 PM EDT) -- The boom in special purpose acquisition companies that upended capital markets over the past year has come down to earth, but deal makers at the long-awaited SPAC Conference say they are confident these alternative funding vehicles will have staying power despite regulatory and market headwinds.  

More than 600 market participants gathered at the two-day SPAC Conference on Wednesday and Thursday at the Westchester Country Club in Rye, New York, attracting a mix of lawyers, investment bankers, accountants, business founders and other professionals.

The event marked the first SPAC Conference, hosted each year by DealFlow Financial Products Inc., since the coronavirus pandemic began, which ignited a whirlwind 15 months or so for the market.

Initial public offerings by SPACs surged to exceed traditional IPOs in the past year, providing many companies an alternative way of going public. SPACs, also known as blank-check companies, are shells that raise money in IPOs in order to acquire a private company. Upon completion of the merger, the acquisition target assumes the SPAC's stock market listing.

Some target companies may find the merger route to be a more certain path to public markets than a traditional IPO. Economic uncertainty triggered by the coronavirus pandemic further fueled interest in SPACs, which have been around for decades but skyrocketed in 2020.

Nearly 600 domestic blank-check IPOs have raised more than $200 billion since 2020, according to SPAC Research, accounting for the majority of the overall IPO market.

The torrid pace finally began to cool in March as fewer blank-check IPOs priced and shares in many SPACs fell. Plus, the U.S. Securities and Exchange Commission has begun scrutinizing whether these hybrid vehicles, which blend elements of IPOs with mergers, benefit investors.

The flurry of events gave conference participants plenty to talk about under the warm sunshine in Westchester. Most remained optimistic about the long-term viability of SPACs.

"This past year served an important purpose," Loeb & Loeb LLP partner Mitch Nussbaum said. "It sealed the deal that the SPAC has become vital and central to the capital markets and M&A universe."

Here are five takeaways from the conference.

Backlog Starts to Ease

Regulators jolted the SPAC market on April 12 when the SEC declared that warrants issued in blank-check IPOs may need to be classified as liabilities, rather than equities, as previously assumed. Warrants are a key feature in blank-check IPOs in that they allow investors to buy additional shares at a preset price, potentially bolstering their returns on investment.

The SEC statement, part of a review of SPAC accounting practices, slowed the pace of deals as it forced hundreds of blank-check companies with pending filings or mergers to review their documents to ensure financial statements were accurate and make restatements if needed.

After a bottleneck in April and May, transactions have begun moving again as SPAC teams and their lawyers and accountants sorted matters out, conference participants said.

"I think we've moved past most of it," said David Bukzin, vice chairman of the auditing firm Marcum LLP. "Not all of it, but it's moving in the right direction."

Projections Are a Sticking Point

The increasingly watchful SEC is also monitoring how SPACs and their targets sell themselves to investors. The securities watchdog in April said the vehicles should not assume they won't be held liable if they tout misleading forward-looking projections involving their acquisition targets.

Companies going public in traditional IPOs often avoid issuing projections, which can invite legal liability if rosy predictions flop. Companies going public through SPACs have taken more liberty in discussing projections, relying on a safe harbor in securities law applicable to mergers.

Many SPAC targets are young startups with little or no history of revenue, so offering projections may help persuade investors. Critics worry that overly optimistic projections can inflate valuations, plus they argue that current practice gives SPACs an edge over traditional IPOs.

It's not certain whether the SEC will clarify its policies regarding financial projections, though a key official has stated that new rulemaking is an option. Legislative action could also be afoot.

The U.S. House Committee on Financial Services released draft legislation last month that would explicitly eliminate the safe harbor on forward-looking statements for SPACs. And the SEC may also propose new rules regarding SPACs rules by April, according to a regulatory agenda released earlier this month. The agency didn't provide further details.

"Projections are where the big issue is," Nussbaum said. "We will see how the SEC addresses this, but I would bet that something happens here."

PIPEs Are Slowing

So-called PIPEs, or private investments in public equity, often provide additional funding to consummate SPAC acquisitions. These post-IPO financings, sold to institutional investors, can also help offset redemptions in the event that early investors sell their stakes before a merger.

But PIPE commitments have shrunk lately, falling to more than $4 billion in May after exceeding $15 billion in February, according to data provider SPAC Research. The drop has coincided with weaker share performances of many SPACs, which could be making PIPE investors pickier.

Mitch McCloskey, head of equity capital markets at I-Bankers Securities Inc., noted that investor fatigue could be settling in given the "sheer number of PIPEs being marketed to investors."

"There are too many SPACs chasing too few quality targets," McCloskey said.

The availability of PIPEs enables SPAC teams to take on larger acquisitions. But panelists noted that, before the recent boom, most SPACs historically were completed without PIPE financings. Novus Capital Chairman Robert Laikin said he expects that to happen again.

"I think you'll see a lot of deals announced without PIPEs because there is nobody to sell PIPEs to," said Laikin, whose Novus Capital has formed two SPACs, the first of which acquired indoor farming company AppHarvest Inc. last year with help from a $375 million PIPE.

Optimism Persists

Despite market turbulence and the likelihood of increased regulation, conference participants expressed confidence that SPACs will adapt and remain a valued part of capital markets.

Ellenoff Grossman & Schole LLP partner Doug Ellenoff said SPACs are proving to be an effective vehicle for bringing more companies to public markets, expanding the range of choices for investors and helping to reverse a decadeslong decline in public listings.

"SPACs have reignited a desire of private companies to accept the responsibilities of being public," Ellenoff said.

Notable companies that have gone public through SPACs include sports-betting business DraftKings Inc. and spaceflight company Virgin Galactic Holdings Inc., plus several electrical vehicle startups, some of which are going through rocky transitions as public companies.

Sidley Austin LLP partner Josh DuClos said SPACs and the funding they provide are well suited for early-stage startups, many of which until recently were delaying going public and opting to stay privately longer. SPACs are "enabling a lot more companies to go public sooner," he said.

Many more startups will likely go public in the coming years, given there are 423 blank-check companies that have completed IPOs and are hunting for a target, according to SPAC Research. On Thursday, digital media startup BuzzFeed Inc. said it was going public through a deal with special purpose acquisition company 890 Fifth Avenue Partners.

Deals, however, are not guaranteed. Most SPACs typically have two years or less following an IPO to complete an acquisition or return investors' money. Several conference participants said more failures are likely in the next year or two, given intense competition for SPAC targets.

Expect More Experimentation

As the field gets crowded, market participants expect SPAC founders to develop new structures in order to distinguish themselves.

For instance, several SPACs have said they plan to acquire several smaller companies with the intention of merging them into one entity rather than acquiring a single company, as is customary.

Cannabis-focused blank-check company Greenrose Acquisition Corp. in March said it would acquire four marijuana businesses in seven states, and other SPACs have formed this year with the intention of forming conglomerates in specific industries. These structures are called rollups.

"I think we are going to see some unique announcements coming out very soon," said Deloitte partner Will Braeutigam, who advises SPAC deals, regarding the possibility of more rollups.

The most noted example of a distinct SPAC strategy involves hedge fund giant Bill Ackman, whose blank-check company Pershing Square Tontine Holdings Ltd. raised a record $4 billion last year.

Rather than buy a single company, Pershing Square will buy a minority stake in music giant Universal Music Group BV while creating structures that would enable more acquisitions in the future, which would allow investors the option of funding at the time of announcement.

The jury is still out on whether Ackman's strategy will succeed or inspire followers, but market participants agreed that more creativity with SPACs is likely as the market returns to sober levels.

"I am pretty excited about all the cool stuff that we haven't dreamed up but are going to get to put together over the coming year," said David Cohen, a chief operating officer and general counsel at Reinvent Capital, a venture capital firm that has formed multiple SPACs.

--Editing by Philip Shea and Alanna Weissman.

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