SPACs have certainly presented a well-lighted pathway for hundreds of companies to reach the public markets this past year or so. In testimony before a House subcommittee in May, SEC Chair Gary Gensler observed that we are “witnessing an unprecedented surge” in SPACs: so far in 2021, the SEC has received 700 S-1 SPAC filings, and 300 of these “blank-check IPOs” have been completed so far this year, compared to just 13 in all of 2016. Most recently, SPACs have been the target of extensive criticism, both from the SEC and outside commentators. However, in this DealBook column in the NYT, In Defense of SPACs, the Deal Professor suggests that the animus underlying much of this criticism is misguided; these “complex takeover vehicles serve an important purpose that’s worth protecting,” he contends. What is that purpose? As has long been lamented, the lane for smaller, earlier-stage companies to go public has substantially narrowed over a number of years. SPACs, he contends, have not just offered an alternative pathway to public company status—they have “single-handedly revived” the IPO market for these smaller, younger—and yes, sometimes riskier—companies to go public.
The critics have voiced a number of criticisms of SPAC transactions. For example, Gensler has contended that SPACs raise policy questions regarding appropriate disclosure, investor protection and whether retail investors are bearing the brunt of dilution and too much of the cost burden (see this PubCo post). Commentators have complained of excessively rosy projections and meaningless merger votes (see this PubCo post). SEC staff have contended that SPACs may not be entitled to the liability safe harbor of the PSLRA (see this PubCo post), issued guidance about problematic accounting for SPAC warrants (see this PubCo post) and questioned whether the private operating company targets of de-SPAC transactions are even fully prepared to be public companies (see this PubCo post).
But the Deal Professor has a different take. As he frames it, while there may be some issues that should be addressed, SPACs “have single-handedly revived the market for initial public offerings, taking small companies public by the dozens….And since these cash shells…often target emerging tech companies, that market has returned to its glory years. Why, then,” he asks, “are regulators trying to kill it?”
This recent regulatory scrutiny of SPACs, which has of late led to a steep decline in the number of SPAC IPOs, he says, has “been triggered by hand-wringing over whether they are too risky for retail investors.” As the Deal Professor reminds us, he warned about the “perils” of SPACs way back in 2008. In the current surge, he says, some SPAC companies have done well, while other have “flamed out.”
More broadly, however, the SPAC “has brought back the I.P.O. market for innovative, smaller companies. Despite the recent slowdown, there have been more than 330 SPAC I.P.O.s this year, raising just over $100 billion.” In the late 1990s, he observes, the heyday of the middle-market boutique investment banks, the four leading boutiques “cumulatively underwrote about 130 I.P.O.s a year at the time.” But, after the dot-com bubble burst and SOX “ushered in reforms to reduce broker conflicts, the small I.P.O. all but disappeared…. Since then, there has been a much slower pace of I.P.O.s, almost all bigger companies.” (See the author’s study of this subject.) Although the JOBS Act made it easier to go public, he notes, the drought in IPOs of smaller, earlier-stage companies continued, and “the goal of giving public investors earlier access to innovative start-ups has proved elusive.”
Now, the Deal Professor observes, the SPAC surge is “bringing many smaller companies to market.” While SPACs can “run into trouble…when they make an acquisition[, a] bigger problem is if shareholders who invest in SPACs after acquisitions are getting a particularly bad deal, which some research suggests. Are they?” he asks, in effect seeming to question whether declines are attributable less to the potential impact of the structural differences between the two IPO pathways and more to the “inherent risk” of the companies: “SPACs are bringing riskier companies to market. Stock Market 101 suggests that with more risk come more reward and more failures.” Whether investors should be exposed to these sorts of companies is certainly a judgment call, he argues, reminding us that, as discussed in the SideBar above, just a few years ago, the big worry was depriving retail investors of the opportunity to benefit from investments in IPOs of early-stage companies. “Now that the SPAC solves this problem,” he contends, “regulators are backpedaling.”
SPACs may continue to evolve to address some shortcomings, the Deal Professor says, but in the meantime, there are improvements that should be implemented: for example, “[m]ore disclosure should be required about the compensation that SPAC sponsors receive.” And the Deal Professor acknowledges, as many of the critics contend, “some SPACs are too aggressive or make companies public too soon or with faulty (or even fraudulent) business plans. But the same can happen with traditional I.P.O.s. That is not a reason to kill the only thing that has revived the market for I.P.O.s of small and emerging growth companies in 20 years.”