This topic has come up a lot recently. The SEC has shown a keen interest in addressing the SPAC fervor. For purposes of this blog post, I am going to assume the reader is familiar with SPACs. If not, many great articles are a quick search away. SPACs have been in the news a lot in recent years not because they are a new vehicle (they have existed for decades), but because the number of SPAC IPOs skyrocketed from hovering at 20 or fewer from 2008 through 2016 to 248 SPAC IPOs in 2020 and 613 in 2021 – raising over $160 billion that year. Though 2022 isn’t anywhere near 2021’s pace, we’ve still seen 58 through April (data per Statistica Research Department).
Much of that capital raised via SPAC IPOs remains to be deployed and though the pace of SPAC IPOs has slowed, the 58 just through April is still more than almost every full year from 2000 through 2018 (66 in 2007). The SEC, understandably with such a massive uptick, has focused meaningful attention on SPACs and proposed significant new rule changes in March 2022 with the proposed changes open to public comment through May 31.
The proposed rule changes do include language that could imply potential liability for the rules even for deals consummated prior to final adoption. This has the issuers and underwriters on edge as they look to complete their de-SPAC transactions. One guiding principal Chair Gensler has consistently evangelized is treating like cases alike. The question is then logically asked that if a de-SPAC transaction is an acquisition by a public company, then shouldn’t boards overseeing that transaction seek a fairness opinion? The answer isn’t clear.
Traditional IPOs don’t have fairness opinions as investors evaluate a company on its merits, place their orders, the underwriter builds their book of orders, hopes to be oversubscribed, underwrites the offering, then sells shares. Though the future is always uncertain, traditional IPO investors should have a good grasp on what they are buying via a road show and S-1. Investors in a SPAC IPO have some idea of the likely type of target and management team they are backing, but the ultimate de-SPAC target could materially differ from what they anticipated from a stage, business model, and valuation standpoint. As such, it could behoove a board of directors to order a fairness opinion to seek independent confirmation that the de-SPAC transaction is fair. Ordering a fairness opinion from a firm like ours could at least show another level of due care/diligence by the board – i.e., an “abundance of caution”.
A substantial curve ball to the idea of ordering a fairness opinion on a de-SPAC transaction is that the proposed rules also take direct aim at financial projections. They seek to enhance the disclosure of projections used in the deal. In many instances, the valuations in recent de-SPAC transactions are only supportable because of the longer-range projections – whereas public companies generally only provide two years of guidance at best. Companies will be hesitant to provide the market longer range projections, but shorter-term projections may not pencil out in a fairness opinion to merit the deal value. What to do? Do you provide the firm conducting the fairness opinion with longer range projections and thus make those projections a matter of public record or avoid the fairness opinion altogether and underwrite/approve the deal as a board based on standard 2-year projections? I tend to think if the deal only works based on financial performance in out years, then you may as well disclose that. If projections are attainable and best efforts are expended to meet those projections, then I would expect liability is relatively low for not knowing the future. If they aren’t attainable then the SPAC shouldn’t do the deal and if best efforts aren’t employed to meet attainable projections, then that management shouldn’t be running the company.
Now a brief thought on why so many de-SPAC deals have hinged on longer-range projections and if I think that’s a good or bad thing. The massive capital overhang from the ramp in SPACs and the shortage of IPO-ready companies has created a situation where many of these de-SPAC deals have targeted earlier-stage companies and as such, looked a lot more like public-backed venture capital investments. Venture investors tend to generate great returns, so that isn’t a bad thing in and of itself. In fact, many of us have lamented that Sarbanes-Oxley has deprived public markets of access to quality, high-growth, early-stage issuers. I think it’s great for public investors to have access to such investments. But public investors probably should understand the required growth a company would need to merit its de-SPAC value so the public can invest/trade the stock with clear eyes on the risk/reward profile of their investment.
Finally, a robust market like this could decrease or even eliminate the opportunity some companies have pursued of creating a large private market. The dream of a robust private market that companies like Goldman and Nasdaq have long sought to create have always lacked meaningful supply – private company issuers. There are some good reasons private companies like fewer shareholders and less disclosure. IF and it’s a big IF there were a substantial pipeline to public status for early and growth stage venture companies via the SPAC market, the supply of private issuers into an accredited investor and qualified institutional buyer-only private market could decrease even more.
The SPAC market will continue to be an interesting one to watch and Economics Partners has done a lot of work in and around this market.