How to avoid SPAC disasters

What’s a pop­u­lar source of finance and one of the hottest ways for a busi­ness to go pub­lic, yet can also lead to a dis­as­trous M&A deal? The answer is a spe­cial-pur­pose acqui­si­tion com­pa­ny (SPAC).

A pri­vate busi­ness that achieves a stock-mar­ket list­ing by being acquired by a SPAC – a pub­licly trad­ed shell com­pa­ny designed specif­i­cal­ly for the task – can side­step sev­er­al of the stricter reg­u­la­to­ry checks that would apply if it were to go down the tra­di­tion­al IPO route.

Last year in the US, 248 SPACs obtained stock-mar­ket list­ings, rais­ing $83.4bn (£60.1bn) in total. In the first six months of this year alone, there were 361 SPAC flota­tions, which raised $111.2bn. 

The mar­ket was put on ice ear­li­er this year under mount­ing scruti­ny from the US Secu­ri­ties and Exchange Com­mis­sion (SEC), which remains con­cerned that SPAC invest­ments are caus­ing an equi­ty bub­ble. Despite this, activ­i­ty seems to be heat­ing up again. The three months to the end of June 2021 were a record-break­ing sec­ond quar­ter for SPAC flota­tions world­wide. Deals worth $1.5tn were announced – up 13% from Q1, which had also been a record quar­ter. 

The SPAC list­ing fren­zy is expect­ed to con­tin­ue over the sum­mer. But high lev­els of activ­i­ty height­en the like­li­hood that riski­er trans­ac­tions will occur. Indeed, there have been some dam­ag­ing SPAC deals recent­ly. Two cas­es, both in the US, stand out. 

Last Sep­tem­ber, Niko­la, a man­u­fac­tur­er of elec­tric lor­ries, was accused of deceiv­ing investors by exag­ger­at­ing the capa­bil­i­ties of its tech­nol­o­gy. The claims led to the founder’s res­ig­na­tion less than four months after a $3.3bn SPAC deal had enabled Niko­la to start trad­ing on the Nas­daq. 

At anoth­er auto­mo­tive start­up, Lord­stown Motors, accu­sa­tions of inflat­ed rev­enue pro­jec­tions in ear­ly 2021 led to the res­ig­na­tions of its CEO and CFO in June. Fed­er­al pros­e­cu­tors are inves­ti­gat­ing the com­pa­ny, whose $1.6bn SPAC deal went through at the end of Octo­ber 2020.

The share prices of both Niko­la and Lord­stown Motors have fall­en sharply, bruis­ing retail investors in par­tic­u­lar. It’s clear from these cas­es why the SEC wants to sub­ject SPACs to greater scruti­ny, accord­ing to Kath­leen Har­ris, man­ag­ing part­ner at the Lon­don office of US law firm Arnold & Porter. 

“There cer­tain­ly are ques­tions sur­round­ing whether retail investors under­stand the risks of invest­ing in SPACs,” she says. “Part of the attrac­tion of a SPAC to investors is that they aren’t hav­ing to pick a new com­pa­ny to invest in or do the due dili­gence. Instead, they’re leav­ing those jobs to the SPAC’s team.”

This isn’t to say that the SPAC teams behind deals that go wrong are fail­ing in their due dili­gence. But the nature of the SPAC struc­ture means that their team mem­bers (known as spon­sors) aren’t like­ly to lose out if that hap­pens. It’s often their small investors who are dis­pro­por­tion­ate­ly affect­ed.

“Spon­sors can still make a hefty prof­it even if a SPAC merges with a mediocre

com­pa­ny and its stock val­ue then drops by 50%,” says Max­im Man­tur­ov, head of invest­ment research at Free­dom Finance Europe.

This arrange­ment incen­tivis­es SPAC teams to pur­sue sev­er­al deals at once. Yet it’s vital that they don’t lose focus and/or select inap­pro­pri­ate acqui­si­tion tar­gets. 

Picking the right time to go public

SPAC tar­gets are usu­al­ly fast-growth com­pa­nies or star­tups that have yet to make a prof­it. The prospect of grant­i­ng equi­ty to a SPAC for a large lump sum and a stock-mar­ket list­ing might be tempt­ing for any founder, but choos­ing the right time to go pub­lic is crit­i­cal. Pay­oneer offers a case in point. The glob­al pay­ments provider start­ed trad­ing on the Nas­daq on 28 June after com­plet­ing a $3.3bn SPAC deal backed by vet­er­an bank­ing entre­pre­neur Bet­sy Cohen. 

Accord­ing to James Allum, vice-pres­i­dent and head of Payoneer’s busi­ness in Europe, the accel­er­a­tion of ecom­merce dur­ing the pan­dem­ic had cre­at­ed the “per­fect con­di­tions” for the firm to seek a list­ing. The com­pa­ny was on “an excep­tion­al tra­jec­to­ry, but need­ed addi­tion­al resources to grow at the required pace”, he says. A key advan­tage of the SPAC route is that it enables rel­a­tive­ly quick list­ing, because SPAC acqui­si­tions tend to out­pace IPOs.

“Recent high-pro­file fail­ures have giv­en SPACs an unde­served­ly neg­a­tive rep­u­ta­tion,” Allum argues. “Used prop­er­ly, they can play a vital role in fos­ter­ing inno­va­tion.” 

Regulation will ensure quality mergers

The num­ber of flota­tions via the SPAC route may con­tin­ue at a record rate, but a com­plex account­ing rule change intro­duced by the SEC in April has had a neg­a­tive effect on SPAC share prices. The reg­u­la­tor is also set to issue guid­ance on how acqui­si­tion tar­gets are val­ued and rev­enues are pro­ject­ed. 

SPACs are com­par­a­tive­ly rare in the UK, but there could be a change to the City’s list­ing rules that would result in a wave of flota­tions. The cur­rent rules mean that investors in each SPAC are locked into their hold­ings while it’s con­duct­ing an acqui­si­tion, which can take sev­er­al months, from iden­ti­fy­ing a tar­get to com­plet­ing the deal. But the Finan­cial Con­duct Author­i­ty is con­sid­er­ing whether to grant more flex­i­bil­i­ty for SPAC shares to be trad­ed with­out sus­pen­sion dur­ing this process – which is what the SEC allows. Har­ris expects that, if this hap­pens, SPACs will have to become more trans­par­ent and show that they have strong pro­tec­tions in place for investors to pre­vent dis­or­der­ly share trad­ing.

Reg­u­la­tors on both sides of the Atlantic will be hop­ing that investors become more aware of the risks of invest­ing in SPACs, accord­ing to Man­tur­ov. There is, of course, no guar­an­tee that any future SPAC trans­ac­tion won’t be a dud, but dis­as­ters should be less like­ly to occur, he pre­dicts.

“Increased atten­tion from reg­u­la­tors will help to sta­bilise the SPAC mar­ket, reduce risk and warn investors against trad­ing less suit­able trans­ac­tions,” Man­tur­ov says. “This, in turn, should pre­vent low-qual­i­ty SPAC deals.”