The Great SPAC Spiral of 2022
What happened to SPACs? Even when they were all the rage, scholars sounded the alarm on SPACs – special purpose acquisition companies created to purchase other private companies and take them public. While SPACs experienced wild success in 2020 – 2021, redemptions and regulations, fueled by fraudulent financial projections, have caused the SPAC market to crater.
According to Spac Track, there have only been 74 SPAC IPOs to date in 2022. This is compared to 160 SPAC mergers in the same period in 2021. A record number of SPAC deals have withered, with 143 SPAC IPOs withdrawn and 46 SPAC mergers terminated through the end of August 2022.
A SPAC Review
A SPAC has no commercial operations and is formed solely to raise capital to acquire a private company and take the private company public. Initially, the SPAC sells shares, usually at $10 a share, to raise the capital it will need to acquire a private company interested in going public. A SPAC has a set amount of time – usually 24 months – to identify and acquire a private company. If that does not happen, the SPAC must return the funds raised in its IPO to shareholders. By design, SPACs require less disclosures and financial reporting than traditional IPOs, which allows the transaction to proceed at an expedited pace.
The Role of Redemptions
SPAC investors pay $10 per share of the SPAC for the chance to reap large financial gain once the SPAC acquires its target. One benefit for shareholders is their ability to redeem their SPAC shares – at $10 each, plus some interest – in the event they do not want to become a shareholder of the newly acquired company. If shares of a SPAC trade below $10 before a deal closes, many hedge funds and other professional investors automatically choose to pull their money out to eliminate the possibility of taking a loss on the trade or lock in a risk-free return.
In 2021, redemption rates reached 67%, but by mid-2022, market sources put the average redemption rate over 81%. When shareholders redeem their shares, the stock price goes down and leaves companies with less cash on hand to build the business. If exceptionally high, the SPAC runs the risk of failing to meet the minimum amount of cash it needs to complete the initial business combination transaction. Though the merger went through, 94% of eligible investors redeemed their SPAC shares in 890 5th Avenue Partners upon the shareholder vote to approve its merger with media company BuzzFeed (BZFD). The result was a depletion of financial assets, which reclaimed much of the $250 million BuzzFeed hoped to get in the deal and left it with only $16 million from the merger.
Regulatory Scrutiny
The Securities and Exchange Commission has investigated or is investigating several SPAC mergers, including, among others, the mergers involving Lucid Group Inc. and Digital World Acquisition Corp. In response to the chaos surrounding SPACs, the SEC has proposed new rules to address behavior that disadvantages investors, to increase transparency, and to allow for increased liability if SPACs lead investors astray. One reason for choosing to go public via SPAC is to avoid the lengthy go-public process, including financial disclosures. The proposed rules increase disclosure requirements for both the public SPAC and private target operating company, making them both potentially liable for misrepresentations or omissions made by the SPAC by rendering unavailable the liability safe harbor in the Private Securities Litigation Reform Act of 1995 for forward-looking statements.
In addition, Nasdaq has sought comment on whether the listing standards for SPACs should prohibit the consummation of a business combination when a majority of a SPAC’s public shareholders exercise their redemption rights.
Inflation’s Influence
With the rise of inflation and the Federal Reserve’s response in raising interest rates, investors are looking for safer investment vehicles and have transitioned from growth to value stocks. Further interest rate hikes affect the value of SPACS and young growth stocks more than mature companies. As explained by Ben Alaimo, “This is because the value of a business is the value of its expected future cash flows, discounted back to today. As growth stocks have more of their value coming from the future, a higher discount rate means much lower valuations.”
Moving Forward
As with any investment, proceed cautiously. Do your research. Don’t let hype cloud your judgment. Once the dust settles, you don’t want to be left holding something of significantly less value than you invested.
The attorneys at Robbins LLP have experience litigating cases involving SPACs. If you suspect corporate wrongdoing is affecting the value of your investments, contact us for a free evaluation.
