Special purpose acquisition companies—commonly known as SPACs—are being left for dead by investors. In the US, two recent collapses in deal structure include Forbes Media and SeatGeek. They join more than fifteen other such shrivellings this year as so-called blank-check companies rapidly falter.
The root cause of this disarray, in our view, is not the looming prospect of tighter regulation, as commonly spotlighted by SPAC advocates. That argument is too easy. Rather, institutional investors have decided that parking their reserves in unproven, volatile acquisition companies may not be a good idea in a period of raucous market activity driven by higher interest rates. Hedge funds are prominent on this front; warrants associated with the offering will not work if the stock price goes down.
In the trade press, the term “blank-check company” originates from the idea that investors allocate to SPACs without knowing precisely how that cash will be used. Rather, they rely on the charisma or savvy of the SPAC sponsor to guide the effort. At the outset, investor funds are deposited into a trust account. The cash must be deployed within two years or returned to investors, unless shareholders agree to extend the aptly-named completion deadline.
SPACs are old news. They have been around since the early 1990s, albeit with a murky, tarnished track record. They catapulted into the center ring in 2020 as financial intermediaries were looking to cash in on an economy that was flush with pandemic cash. For their part, institutional investors relished what they were led to believe about fast returns and venture founders were lured by thin disclosure requirements. It has been, well, a perfect storm of greed and expediency.
The booby-trap in this process is that investors can redeem their positions in a SPAC prior to a business combination. BuzzFeed suffered this fate in late 2021 in its merger with a SPAC then known as 890 Fifth Avenue Partners. The unorthodox media company originally expected to be able to access more than $200 million in capital. Instead, it ended up with a bite-size chunk of near $16 million as some 94% of the investors in the SPAC choose to redeem their positions. The current crop of failed deals may have been scrubbed largely on this fear.
Venture businesses no longer have a clear trajectory in raising capital through the SPAC mechanism. Gaining access to large volumes of cash in a short time frame at limited cost is indeed alluring, if not intoxicating. Some bad apples, though, have ruined the bunch. As one example, Nikola, the electric truck maker, agreed to pay $125 million in government fines over misleading investors about its products, technical capacity, and business prospects. In other words, the firm distorted the external view of its entire commercial operation.
Both Congress and the SEC are centering attention on SPAC excesses, including self-dealing and misaligned incentives. The reality of mid-term Congressional elections suggest that the SEC will be the pacesetter on this front:
Legislation. Senator Elizabeth Warren (Massachusetts) is set to advocate for the everyday investor with the SPAC Accountability Act of 2022. The text of that bill has yet to be released, but clues on its content can be found in a just-released presentation from her office entitled: “The SPAC Hack: How SPACs Tilt the Playing Field and Enrich Wall Street Insiders.” There is truth amid this political posturing. In one illustration, she calls out a certain Wall Street firm for “egregious” SPAC-related fees.
Regulation. The SEC just concluded a public comment period on a set of guidelines that would strengthen disclosure requirements and broaden the definition of underwriter. While no final decisions are expected until year-end, the implications are vast. In effect, the SPAC mechanism will align closely with the IPO process, wiping out most of the cavalier features that have defined the SPAC industry. A key improvement would intensify communication standards on risks and compensation.
These trends imply that venture businesses may want to revert to direct listings and IPOs to raise public capital. For companies seeking cash, the process of using conventional market mechanisms is time consuming, if not costly. These traditional processes, though, are both earnest and measured, helping to assure greater integrity in the capital-raising process.
There are red flags in the marketplace that further question the sustainability of the SPAC business. Goldman Sachs has abandoned the product outright over possible liabilities. From our perspective, we were alarmed when other nations began to look at mimicking the SPAC structure as a fast-track approach to public listing, without consideration for the underlying quality of these securities. Academia has raised concerns. Findings in a prominent research paper entitled “A Sober Look at SPACs” conclude that shareholders punitively carry the embedded, outsized costs of SPACs. ■
Our Vantage Point: SPACs are an attempt to short-circuit the capital-raising process. In haste, missteps and swindle have undermined their ongoing viability as a capital source for growth companies.
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