SPAC Mania: A Volatile Market and Undaunted Backers

In the last two years, Special Purpose Acquisition Companies (SPACs) have taken the financial world by storm, outdoing both IPOs and direct listings. SPACs have increased speed and the certainty of deal completion. However, SPACs are notorious for allowing companies to make projections about future performance—conduct that is strictly prohibited in traditional IPOs. In the face of increased regulatory and judicial scrutiny, and in a cooling market, it is unclear whether they will have a lasting place in the capital markets or will prove to be a passing fad.

While many companies have followed through on their mid-“de-SPAC” financial projections, many others haveunderperformed and left investors holding the bag.  of For instance, last year, Grab Holdings Ltd. began trading on Nasdaq after closing its SPAC merger at a $40 billion valuation with almost no redemptions. However, its shares fell following their listing debut, taking its market capitalization down to around $12 billion.

Though redemption rights originally acted as a risk reduction mechanism for investors by providing a “money-back guarantee,” the rocky performance of many post-de-SPAC companies had led to redemption rates as high as 97%. In the event of such radical redemption rates, the cash proceeds of de-SPAC transactions for the company are drastically reduced. As investors continue to redeem their funds at an increasing rate, SPACs are struggling to fulfill their minimum cash requirements that are crucial to close the transaction.

This phenomenon has led many SPAC companies into short-term agreements with alternative asset managers and private equity groups in order to replace cash being pulled out by investors. The redemption option creates uncertainty as to the amount of cash available after the business combination takes place, and SPACs are attempting to mitigate this risk by issuing securities to institutional accredited investors in a PIPE transaction that is contingent upon closing of the initial business combination. Under the provisions of such agreements, asset managers and private equity groups agree to buy shares from investors who are willing to withdraw their funds and the company gathers enough funds to meet its minimum cash requirements.

However, even with the security of a PIPE transaction, going public via a SPAC poses risk for private companies. For instance, in December 2021, Virgin Orbit closed a deal with NextGen Acquisition Corp II where Virgin Orbit had expected to raise $483 million in total gross proceeds, including a $100 million Private Investment in Public Equity (PIPE) transaction led by Boeing, AE Industrial Partners, and others. However, due to an 82.3% redemption rate ahead of the transaction, the SPAC’s trust account lost $315 million. As a result, the company only raised half of what it had originally anticipated.

According to SPAC Research / SPAC Alpha, last year, while the average monthly SPAC redemption rate ranged from 7%-43% from January to July, the market witnessed a 60% redemption rate from July to November as the range jumped to 43% to 67%. As the SPAC frenzy appears to have cooled down and more companies are starting to perform poorly in the stock market, SPAC executives are getting desperate to close their deals.

Many critics argue that the agreements illustrate how desperate SPAC executives are to close their deals and how alternative funds have targeted the investments to generate returns, with dealmakers viewing the terms granted as very favorable to the funds. Amidst all the regulatory scrutiny and poor performances, while entering into agreements with forward funds may ensure that deals get closed, such transactions may add to the financial crunch being faced by the public companies and may not solve long-term problems.

The Delaware Court of Chancery has also been looking more critically at SPACs in recent months. In In re Multiplan Corp. Stockholders Litigation, while the key issue revolved around fiduciary duties in the context of SPACs, the court also highlighted the significance of robust disclosure of material information so that all risk factors can be carefully considered. The court held that certain key officials of the SPAC, including its directors and CEO, violated their fiduciary duty of loyalty to the SPAC’s stockholders by failing to disclose material information regarding its target.

However, despite changing market conditions and an increased regulatory scrutiny, SPACs are here to stay, and the SPAC deals in the future will be of higher quality. Despite all the risks present, SPACs may attempt to protect themselves from high redemption rates in many ways. For instance, “bulldog provisions” limiting the percentage of total outstanding shares a single shareholder can redeem have begun to appear in SPAC agreements.  SPACs may be down right now, but these setbacks likely do not mean it is the end for the instrument. SPACs have revolutionized the capital market, and while they may need to change for it, it will need to change for them too.