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Paul Zimmerman
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SPACs: Their Current Status and the Future of Regulation

Just last month, the special-purpose acquisition company craze that hit its stride in 2020 began to show signs of slowing down. According to Dow Jones Market Data, as of early October, a market selloff erased approximately $75 billion in value of companies that went public using SPACs since mid-February.

But that correction may be just a hiccup, as these so-called “blank check companies” look to be storming back as 2021 marches to a close. In fact, the number of new deals now being rushed to market by year end is exploding—this despite the issuance of strict accounting guidance on SPAC warrants issued by the Securities and Exchange Commission last spring.

The numbers are quite compelling. Going into Q4, SPACS raised in the neighborhood of $140 billion in 2021. This sum eclipses the $125 billion initial public offerings are projected to raise by December 31, a figure calculated by a leading capital markets company.

Clearly then, SPACs continue to thrive, making this overview a timely resource.

SPACs in a Nutshell

The sole purpose of a SPAC is to raise money with the ultimate goal of merging or combining with a privately held business—a transaction that ordinarily leads to the acquired company going public. This happens first through an announcement of a merger agreement between the SPAC and its target company through a Current Report on Form 8-K, followed by a Registration statement on Form S-4 seeking shareholder approval of the business combination. The process, if properly executed, can be a quicker and less regulated way to take privately held companies public.

When a privately held company begins the IPO process, it faces a significant amount of document preparation and regulatory review and oversight by the SEC and the applicable stock markets, each seeking to ensure adequate disclosure to potential investors and that securities laws, among others, are not violated. Such scrutiny and initial regulatory vetting are not imposed upon SPACs, primarily because they do not sell any goods or services. Instead, SPACs are publicly traded shell companies that raise money through IPOs simply so that they can then combine with other companies ultimately targeted for acquisition.

This is not to say that SPACs are unregulated. SPACs are subject to SEC oversight, just to a lesser degree than the typical IPO. For instance, proceeds raised by a SPAC in an IPO must be held in trust and cannot be released to the SPAC until the acquisition of a targeted company, or de-SPAC transaction, closes.

Limitations on SPACs

SPACs must abide by certain rules along with a modicum of SEC governance. For instance, once a SPAC is (1) created, (2) a board of directors is announced, (3) the SPAC sponsor’s team of underwriters, lawyers and accountants is assembled, (4) capital is raised from investors, and (5) the SPAC goes public, the SPAC goes through a review and comment period with the SEC and obtains listing on the NYSE or Nasdaq. After going public, the SPAC targets a privately held company (or companies) for acquisition. Depending on the terms established by the SPAC, the target company generally must be acquired (including obtaining shareholder approval for completion of the acquisition) within 24 months. If an agreement is not reached with the identified target and shareholder approval is not achieved within that two-year time frame, the money raised by the SPAC must be liquidated and returned to the SPAC investors. Of note, leading up to the identification of a target, the SPAC’s sponsors cannot reveal the company (or companies) it intends to acquire or otherwise reveal its plans until a definitive agreement or letter of intent is reached with the target which can then be publicly disclosed in SEC filings.

Investor Considerations

SPACs are focused on fueling innovation and growth in identified sectors (read: technology, biotech, energy, media, consumer goods and the like), and it is a given that a well-executed SPAC combination can create real opportunity and value for all involved—sponsors, investors and targeted companies looking to go public. Toward that end, sponsors have positioned themselves as experts in identifying high-performing startups and other companies ripe for success. As such, those investing in a SPAC can hitch their wagons to best-in-class professionals with extensive deal and/or industry experience.

Of course, before participating in a SPAC, there are plenty of considerations investors should keep in mind. First and foremost, there are risks inherent when investing in a SPAC without having the slightest idea what other company, if any, it will acquire. Investors, therefore, must conduct their due diligence on a given SPAC’s sponsors, paying careful attention to their track record of backing profitable companies. Indeed, understanding the collective breadth of experience of a SPAC’s management team, and reading any published reports or statements that a SPAC publishes or files with the SEC, can go a long way when making investment decisions.

As otherwise stated, because SPACs have no real history in terms of selling goods or services (aside from the individual resumes of the SPAC’s sponsors and board of directors, any or all of whom will not necessarily remain with the company once the target acquisition is completed), it can be very difficult to predict how one might perform. This is why close examination of its management is critical. The good news is that investors uneasy about a proposed merger can pull out of a SPAC and redeem their shares in the company for cash invested plus interest.

Investors in a SPAC must also appreciate that if the SPAC fails to acquire a company within the allotted two-year timeframe, the company will be liquidated on a pro rata basis. Translation: investors will only receive the amount the SPAC’s IPO was listed at, and not the amount they paid for shares on the open market, which could lead to a loss.

While SPACs are a hot ticket item these days, they are not your typical investment vehicle and the potential for losses must be taken into account. To be sure, with less initial regulatory vetting than typical IPOs, there is the very real possibility of SPAC deals placing investor dollars at significant risk. That being said, before hopping on the SPAC bandwagon, investors should consult with their legal and financial advisors.

The Spector of Increased Regulation

As previously mentioned, the SEC addressed the classification and accounting for warrants utilized by SPACs several months ago. In so doing, the agency voiced its concerns that warrants issued by many SPACs should be properly accounted for under the liability method on the balance sheet. Consequently, the SEC has advised SPACs (or combined companies following de-SPAC transactions) to amend previously-filed audited and unaudited financial statements if and when necessary.

Many believe that the guidance issued last April is a preview of things to come; the SEC’s opening salvo into more regulation of the SPAC market. Which begs the question: now that it has weighed in on issues of accounting treatment, is heightened scrutiny by the SEC—be it on SPAC marketing, fees, disclosures or conflicts of interest—on the horizon? While no one knows for sure, additional heightened SPAC oversight certainly seems to be in the cards.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.