January 29, 2023
Special Purpose Acquisition Companies, or SPACs, saw a major boost in popularity during 2020 and 2021, spurred by low interest rates and stimulus funds being pumped into the economy. Sponsors create SPACs, which are essentially shell companies, and list them on exchanges to raise money with the intent of acquiring a private operating company. The operating company then merges with the shell company and begins trading on the exchange in what’s called a de-SPAC transaction. SPACs enable private companies to get listed without going through a traditional IPO. SPACs have up to two years to find a suitable acquisition target. If no suitable target is found within the timeframe, there are two options: 1) liquidate and return the money to the investors or 2) extend the deadline.
During the SPAC boom, hundreds of SPACs were listed, including many that probably shouldn’t have been. However, the boom started slowing down in April 2021 after the SEC announced that the accounting for warrants issued by a SPAC should be classified as a liability. This treatment requires the warrants to be remeasured to fair value, with changes in fair value recorded in earnings. In addition, the classification of redeemable shares issued by the SPAC should be classified as mezzanine equity and not permanent equity. Certain stock exchanges require a minimum equity balance, which would be affected by the classification change.
SPAC IPOs essentially fizzled out by the middle of 2022. According to SPAC Research, there were only 86 SPAC IPOs in 2022, compared to 613 in 2021. In addition, there was a record number of withdrawn IPOs in 2022. This was primarily due to additional regulatory scrutiny, disappointing performance by de-SPAC companies, inflation, rising interest rates, and general macroeconomic uncertainty.
In March 2022, the SEC came out with a number of proposed guidelines around disclosures, marketing, and third-party oversight of SPACs to protect investors. The objective was to align the rules and regulations around SPACs with traditional IPOs. Historically, the sponsors had an incentive to push through an acquisition even if it was of low quality or not the right fit, which hurt the retail investors. While not yet final as of the date of this post, many SPACs are treating the guidance as final, which has caused SPACs to be less appealing. One of the provisions makes the investment banks potentially liable for misstatements in a de-SPAC transaction. The large banks have since started to pull away from SPACs. In addition, the proposal would require significant disclosures around the projections used to raise money, which would also no longer be protected by the safe harbor of the Private Securities Litigation Reform Act of 1995. Originally, one of the benefits of going through a SPAC versus an IPO was that projections could be shared with investors, no matter how realistic they were.
Also causing the slowdown of SPAC IPOs and deals was the dismal performance of de-SPAC companies. Their performance in 2022 has been among the worst in the stock market. The stock price of Lucid Motors, one of the largest de-SPAC companies, declined over 80% in 2022. DraftKings, another large de-SPAC company, declined over 50% in 2022. The AXS De-Spac ETF, the first exchange-traded fund for de-SPAC companies, fell by almost 75% in 2022. Other de-SPAC companies have also done poorly or even gone bankrupt.
In 2022, the SPACs that went IPO in 2020 and 2021 have started to reach their deadlines to find an acquisition target. Unfortunately, many could not find a suitable acquisition target in time, causing a wave of liquidations. According to SPAC Research, approximately 140 SPACs worth approximately $48 billion were liquidated in 2022. Even some notable sponsors pulled their SPACs in 2022, including Chamath Palihaptitiya (formerly dubbed the SPAC king) and Bill Ackman, who raised the most money ever ($4B) in a SPAC.
The liquidations ramped up significantly towards the end of the year. There were at least 80 SPAC liquidations in December 2022 alone, many of them liquidated early based on speculation that an additional 1% excise tax on stock buybacks as part of the Inflation Reduction Act would apply to a SPAC liquidation. However, in late December, the treasury department clarified that SPAC liquidations are exempted from the tax.
Lucky for investors, SPACs protect their investments and enable them to get their money back. In addition to the liquidations, 2022 saw a record number of investors exercising their redemption rights to cash out their pro rata share of the IPO proceeds. These redemptions take away from the cash available to close a de-SPAC transaction and threaten the liquidity of the post de-SPAC operating company.
After riding high in 2020 and 2021, the sponsors lost the most as a result of the liquidations. Sponsors typically contribute a percentage of the listing proceeds upfront to cover underwriting and operating costs. However, upon liquidation, they don’t get to recoup any of that back. It is estimated that the sponsors lost approximately $600 million in December alone and approximately $1.1 billion in 2022. In addition, the typical 20% sponsor’s “promote,” which allows the sponsor to receive 20% of the post-IPO shares, becomes worthless if the acquisition does not get done.
What does 2023 look like for SPACs? According to SPAC Research, there remained approximately 385 SPACs searching for a merger target and 150 SPACs in the process of closing official acquisitions at the beginning of the year. A large portion of the SPACs searching for a target have deadlines that occur sometime in Q1 2023. A small number may file for extensions, while most will choose to liquidate for the reasons above. At least in the first quarter of 2023, many more liquidations will come. There has been one SPAC IPO in the first month of 2023. After the next wave of liquidations and the market resets, SPACs may recover, although never to the levels before. With the proper oversight though, SPACs are still a real and viable alternative for promising private companies.
