Bloomberg Law
May 20, 2021, 8:01 AM

What the SEC Is Not Saying About SPACs

Daniele D'Alvia
Daniele D'Alvia
SPACs Consultancy Ltd.
Milos Vulanovic
Milos Vulanovic
EDHEC Business School

The financial world has changed. According to SPAC Research, by the end of 2020, more than 248 SPACs (special purpose acquisition company) have been listed in the U.S. (on Nasdaq or the NYSE), raising a record $83.4 billion. SPACs have already surged last year’s record in the first quarter of 2021, raising $98.1 billion. SPACs are emerging as the new IPO (or IPO 2.0), with fewer formal requirements and at a lower cost.

Traditional IPOs are now under attack. For instance, look at Deliveroo’s IPO in March in the U.K. It closed down 26% on its first day of trading. The share price slump means tens of thousands of retail investors who backed Deliveroo are now sitting on heavy paper losses. Think also of China’s Ant Group’s pulled IPO in 2020.

And yes, when something sounds too good to be true, the number of disbelievers can only increase.

The boom started to cool off in April following warnings from the Securities and Exchange Commission. In December 2020, the SEC explained what a SPAC is, and followed up with new guidance on SPAC disclosures, and a specific warning concerning celebrities involved in SPACs. Subsequently, in March, the SEC opened an inquiry in understanding how underwriters manage risks involved in SPAC transactions, and dulcis in fundo, it raised accounting and reporting considerations for warrants issued by SPACs. The SEC suggested their inclusion as liabilities rather than equity or assets of the company.

SEC’s Decisions May Be Based on Misconceptions

The SEC’s decisions may be based on an apparent misconception on SPACs. The SEC’s concern about competition issues involving the business combination opportunities is unrealistic. A closer look to S-1 forms clearly shows that today, we do have sector focused or multi-sector focused SPACs. Competition might only emerge in the latter, although the number of potential targets are infinite, and competition (if it exists) extends far beyond American borders to Europe (see Arrival and Cazoo in the U.K.) up until Asia (see Grab in Singapore). The world is the SPAC’s oyster.

The warning on warrants does not have an implementation period. We think that this is not sound decision and represents an attempt to stop SPAC-frenzy. And it did, unfortunately. It is not grounded in economic fundamentals, as, in essence, before being completed, merger SPACs are convertible risk-free bonds and even the naivest investor holding SPAC securities until the merger date cannot lose a penny of its investment. Similarly, everyone in the SPAC game knows the nature of out-of-the-money warrants which are worthless until the equity price of post-merger company does not hit $11.50, if ever.

Looking forward, evaluating would-be SPAC partners is likely to become more important over time. SPACs de-risk IPOs, mitigate adverse selection, and offer more certainty for the target to go public with a consistent valuation process. SPACs’ standards have gone from profitable private companies, to earnings before interest, taxes, depreciation, and amortization-positive companies, and to pre-revenue companies. This can generate a concern as you are not taking an operating company, you are taking on a company that’s making a promise.

Hence, the fundamental question for SPACs’ sponsors is: shall companies listing via SPACs live up to investors’ sky-high expectations? Registration statements are key, as well as an accurate due diligence of the target.

On the SPACs’ promote (founder shares), sponsors often invest further cash into the SPAC at the de-SPACing phase and sometimes decide to align themselves with the target shareholders by giving up a portion of their promote. Furthermore, the private investment in public equity process takes the transaction risk early on the de-SPAC process. Consequently, the SPAC investors’ of today are not sustaining any particular cost. The promote is the skin in the game, although the sponsor’s compensation scheme shall be directly connected to the SPAC’s performance.

Ultimately, it would be important to question why the SEC or other market operators are not suggesting any improvement for traditional IPO in terms of price discovery mechanisms. The SEC’s warnings are not beneficial for SPACs or their investors alike. In financial markets, public information is a key. Misleading information can be fatal. Volatility is an intrinsic quality of market economies, and the role of any financial regulator shall be the first to preserve investors’ confidence as well as to guarantee transparency and disclosure of correct information.

It feels like a warning sign without an implementation date and legal force sits well beyond such objectives, and at the same time it might be able to cause, this time, a possible “bubble to burst.”

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Author Information

Daniele D’Alvia, Ph.D, is the CEO and founder of SPACs Consultancy Ltd. He is a teaching fellow in banking and finance law at Queen Mary University of London.

Milos Vulanovic is an associate professor of corporate finance at EDHEC Business School in France. He holds a Ph.D. in financial economics from the Graduate Center at the City University of New York.

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