Louis Lehot discusses the evolution of the SPAC market. He also highlights market factors and regulatory challenges. Sustainable adoption within an oversaturated market is only possible if SPACs continue to provide a measure of simplicity for companies going public. Likewise, it’s important to stay abreast of any new legislation or proposed rules from the SEC, including the effects of potentially rising interest rates or proposed tax hikes.
SPACS were the star of the show in 2020 and early 2021. They had quite a run in the last year through the end of Q1 2021 – growing from a sum IPO count of 59 in 2019 to 248 in 2020, to 311 in just the first quarter of 2021!
The total SPAC IPOs in the first quarter of this year blew past the total of 2020. However, the number of new IPOs dropped sharply in April. SPAC Insider listed 85 SPAC IPOs in January, 96 in February, 109 in March, but then only 13 in April. While the SPAC market was growing by 13 percent per month in the first quarter, April’s total showed a drop of 88 percent compared to March.
The drop in April was extreme, but the real question is: will the drop cause a long-term pullback? We can’t assume a trend from one single data point so that any guess will remain a guess, at least until there is more data available to analyze. When anticipating the trend, first, we must identify the most important market factors and regulatory challenges. One crucial point is that a correction is a healthy move for the market – double-digit growth month over month is not sustainable long-term. Hence, a pullback is not just expected but also indicative of a healthy market.
PitchBook released a new report on the SPAC market. It noted that current interest rates near historic lows have created an environment where the opportunity cost of locking money in SPACs is meager. Therefore, investors are more likely to risk their money in SPACs because the returns tend to be much better than investments that rely on interest rates. Additionally, several other contributing factors affect the market – for example, the increase in activity in Q1 may be from last year’s excess demand. Still, the potential of a steep rise in capital-gains taxes could be encouraging the pullback.
In addition, Congress is looking closely at whether existing legislation is sufficient enough. Congress is showing interest in increasing transparency and investor protection requirements that govern SPACs, which could add more pressure on regulators to increase missing out on these alternate funding vehicles that are disrupting capital markets. And regulators have shown concerns about whether SPAC mergers bypass investor protections in traditional IPOs. Some market participants say legislative attention could urge regulators to move quicker, regardless of whether bills get enacted. PitchBook reported that independent of pending Congressional action, the SEC is considering a rule change regarding SPACs.
The primary issue is that the warrants’ fair market value changes would now flow through as accounting earnings for the SPAC, which complicates the once-simple SPAC financial statements. So, this adjustment may no longer incentivize the inclusion of warrants in new SPAC IPOs, which are a vital benefit to the SPAC IPO investors. The biggest difference between a SPAC IPO and a traditional IPO is that a traditional one is selling based on three years of total revenues. Meanwhile, a SPAC is selling on three years of future gain. The playing field is not level, and pending Congressional or SEC action could completely change that reality.
Some also are curious whether a SPAC is a valuable way to advance technology innovation. After all, SPACs offer simplicity and efficiency in an industry that at the same time depends on both while also struggling with regulations challenging them. But in a market that has seen explosive growth, investors might want to focus on existing investments right now instead of searching for new ones.
Long-term, the market will find some sort of sustainable level of SPAC IPO activity. An increase of 13 percent per month only to drop by 88 percent the following month suggests that the market was oversaturated and that companies are still figuring out how best to use this investment vehicle. SPACs, while more than 30 years old, have recently gained widespread market acceptance. As long as SPACs can provide a measure of simplicity to companies going public, they are likely to stay popular.
Stay aware of any Congressional action, legislation, or proposed rulemaking from the SEC. It will also be interesting to observe any effects the rise in interest rates or tax changes will have on SPACs, as well as more warning signs of investor SPAC fatigue.
Louis Lehot is a partner within the Silicon Valley, San Francisco, and Los Angeles offices of Foley & Lardner LLP. Louis specializes in advising his clients at all stages of company growth from garage to global. Louis Lehot offers comprehensive business and legal advice for entrepreneurs, executive management teams, investors, financial sponsors and their advisors.
He specializes in helping emerging private companies secure venture capital financing, prepare for an IPO or de-SPAC, and navigate an exit or liquidity event. Louis Lehot’s experience includes successful public offerings of equity and debt securities, equity and debt private placements securities, mergers & acquisitions, dispositions, spinoffs, strategic investments, and joint ventures.
Louis is also a corporate governance and securities law compliance resources. Louis regularly represents the US and non-US registrants before the SEC, FINRA, NYSE, and NASDAQ. Leading peer-reviewed industry guide Chambers USA recognized Louis Lehot for offering the highest quality of advice with a passion and responsiveness to meet a diverse mandate of client needs.