M&A Outlook 2022: SPACs | What to expect in the year ahead?

Special purpose acquisition companies (SPACs) as an asset class saw their strongest year by volume ever in 2021 with over 600 completed initial public offerings (IPOs) in the United States. That performance came on the heels of a strong year for SPAC IPOs in 2020, which saw about 250 SPAC IPOs completed.  However, almost half of the SPAC IPOs were in the first quarter of 2021, with a steep decline in the second and third quarters followed by a partial recovery of SPAC IPOs in the fourth quarter.  The factors contributing to the evolution of the SPAC IPO market during the year included:

• Increased scrutiny by the US Securities and Exchange Commission (SEC) of SPACs at both the IPO and the de-SPAC stage (that is, at the time of the consummation of the business combination that converts the "blank-check company" SPAC into a listed-operating company);
• The poor share price performance of a number of the SPACs following their de-SPAC business combinations;
• An increase in private litigation relating to SPACs, in consequence of the poor performance of certain SPACs; and
• Investor fatigue given the volume of SPAC transactions and concerns about the quality of some of the SPAC propositions on offer.

Not surprisingly, de-SPAC activity also increased during 2021, with about four times the number of de-SPAC transactions closing in 2021 than closed in 2020 (approximately 200 versus approximately 50).  However, the mismatch between the number of SPAC IPOs in recent years and the number of de-SPAC transactions means there are reportedly more than 500 SPACs still looking for targets, creating a competitive market for attractive acquisition targets.  This competitive dynamic is intensified by the fact that, by NYSE and Nasdaq rules, SPAC sponsors are typically allowed only two years to complete an initial business combination or they are required to return the capital invested by the SPAC’s public investors and forego the “promote” they typically receive if they complete a de-SPAC transaction.

While this backdrop makes it difficult to predict what will happen in 2022 in terms of the number of SPAC IPOs (other than that is seems likely there will be fewer SPAC IPOs than there were in 2021), the de-SPAC transaction as a path to the public markets will very likely remain a viable alternative to a traditional IPO or a direct listing and as a source of additional equity will remain a viable alternative to other forms of private or public capital.  While the shareholders of potential targets of SPACs will continue to focus on the relative valuations that can be achieved through each of these alternatives when evaluating a potential de-SPAC transaction, the competitive posture of the de-SPAC market suggests the number of de-SPAC transactions is likely to increase in 2020.  However, the increased competition for targets by SPACs is likely to mean that certain other trends relating to de-SPAC transactions will continue to evolve and SPAC market participants should be mindful of them.

• Target shareholders should not underestimate the cost of and human resources required to engage in a de-SPAC transaction and to become a public company.  A realistic assessment, with the support of financial, accounting and legal advisers, of whether the target business is prepared to complete such a transaction and meet the on-going requirements of being a public company is a key to a successful transaction.  This is particularly true for early-stage businesses and for businesses not traditionally taken to the public markets at such an early stage in their evolution.

• Both historically and going-forward, the strength of the SPAC's sponsor has been and will continue to be key to a successful de-SPAC transaction.  What does the sponsor bring to the target's business: reputation in the sector, experience and industry knowledge, business connections and opportunities?  Particularly if the target shareholders are primarily looking for additional capital, does the sponsor have a track-record of successfully completing de-SPAC transactions?

• De-SPAC transactions involving a private investment in public equity (PIPE) are likely to continue to be viewed favourably by public investors and therefore arguably have a greater likelihood of success.  The institutional investors who invest in the PIPE are seen as imposing discipline on the SPAC’s sponsor and the target both in terms of valuation and due diligence on the target and the transaction.  The PIPE, combined with a minimum cash condition for the closing of the de-SPAC transaction, will ensure the target business will have the cash it expects to develop its business in the manner contemplated when the business combination was initially agreed.

• The SEC has repeatedly expressed its concern about a number of aspects of SPACs at different stages in their the lifecycle.  Some politicians have also raised concerns about SPACs.  Consequently, further regulation or guidance relating to SPACs seems likely.  Concerns expressed include:  (a) conflicts of interest between the sponsors and the public investors and full and fair disclosure regarding those conflicts, (b) the accounting treatment of the warrants typically issued by SPACs, (c) the liability regime applicable to projections and other forward-looking statements typically used in connection with a de-SPAC transaction (as compared to a traditional IPO, where such information is typically not disclosed) and (d) the level of disclosure by the SPAC more generally both at the time of its IPO and at the time of its de-SPAC transaction given the complexity of their structures.  While these concerns will not prevent de-SPAC transactions from being negotiated and completed during 2022, they are likely to mean (i) greater scrutiny of the level and quality of the SPAC's disclosure at the time of the de-SPAC transaction in order support good decision making by investors; (ii) longer regulatory review periods of proxy statements and joint proxy and registration statements as SPACs seek to satisfactorily address comments raised by the SEC's staff, which inherently creates greater execution risk; and (iii) an increased level of uncertainty until the SEC is satisfied that, through rule-making or additional guidance, it has satisfactorily addressed its concerns about SPACs.

• The increased level of litigation around de-SPAC transactions is unlikely to abate and indeed is more likely to increase.  Such cases so far have typically focused on the accuracy and completeness of the disclosure made by the SPAC about itself and its target; however, such litigation may also involve other claims such as shareholder derivative lawsuits alleging breaches of fiduciary duties by the SPAC's directors in approving the de-SPAC transaction.  Of course, a traditional IPO may also attract legal claims based on the adequacy and completeness of the issuer's disclosures; however, market practice limiting the use forward-looking statements in IPO offering materials are likely to make such litigation less of a risk.  Again, while such litigation is unlikely to prevent de-SPAC transactions from being negotiated and completed, the risk is likely to affect the dynamics of the due diligence exercise and negotiations as the parties seek to protect themselves against such claims being brought.

While the level of interest in SPAC IPOs as an asset class in 2022 is somewhat uncertain, an increase in de-SPAC transactions seems likely.  SPACs offer retail investors without access to the private equity market investment opportunities or to allocations of shares in attractive IPOs a product with features that replicate to a certain extent such access and allocations.  A SPAC offers the retail investor access to the skills and reputation of the sponsors and also allows the retail investor the ability to ultimately decide whether or not to participate in a specific investment opportunity, through the ability to exercise redemption rights at the time of the de-SPAC transaction.  At the same time, many targets are likely to find the de-SPAC route to the public markets, which among other features moves the valuation of the business from the end of the process to the beginning, more attractive than the traditional IPO or direct listing, even if likely upcoming regulatory actions eliminate some of the perceived advantages of a de-SPAC transaction.