- While the SPAC IPO and PIPE markets were challenging in 2021, the enormous amounts of capital already raised should drive merger activity in 2022.
- As more shareholders choose to redeem shares and potential PIPE investors scrutinize terms, dealmakers have been forced to reevaluate target prices and look for additional ways to fund de-SPACs.
- The SEC has made clear that it will continue to scrutinize SPAC disclosures and accounting practices, and the agency is slated to propose new rules for SPACs this year.
The 2021 SPAC market was a roller-coaster. Following a strong 2020, transactions accelerated in the first three months of 2021, with 298 SPAC IPOs priced and 97 de-SPAC transactions (mergers of target companies with SPACs) announced in that quarter alone. After that, activity slowed significantly in the second and third quarters of 2021. The fourth quarter of 2021 saw a rebound, though still below the level in the first quarter, with 163 SPAC IPOs priced and 61 de-SPAC transactions announced. Nonetheless, compared to 2020, the SPAC IPOs priced and de-SPAC transactions announced in 2021 more than doubled. SPACs priced a record-breaking 613 IPOs, representing a 147% increase over 2020’s 248, and announced an unprecedented 267 de-SPAC transactions, representing a 178% increase over 2020’s 96. As of December 31, 2021, SPACs collectively were holding in trust over $138 billion in IPO proceeds — “dry powder” — and over 500 were seeking an M&A target.
Through the first quarter of 2021, private operating companies looking to go public through a de-SPAC could expect to receive substantial cash from both the SPAC’s trust account and a concurrent private investment in the public equity (PIPE). In some cases, the sum raised in the PIPE exceeded the IPO proceeds. That began changing in the second quarter, as more investors opted to redeem their shares prior to the completion of the de-SPAC and the PIPE market tightened. In the fourth quarter, on average, SPACs returned over 60% of the amount they held in trust, up from 53% in the third quarter, 22% in the second quarter and just 10% in the first quarter. The average PIPE was smaller relative to the amount raised in the IPO compared to earlier last year. In addition, there were more terminations of de-SPAC deals in 2021 than in previous years, although the 2021 termination rate did not meaningfully increase compared to 2020 or 2019 given the greater number of announced deals in 2021.
Despite this widely reported slowdown in the SPAC market and the heightened regulatory scrutiny discussed below, we are cautiously optimistic that de-SPAC activity will remain strong in 2022, given the significant number of SPACs searching for targets and the staggering amounts of dry powder. We also expect increasing deal innovation in light of market pressures.
Stepped-Up Regulatory Scrutiny
Since the U.S. Securities and Exchange Commission (SEC) issued disclosure guidelines for SPAC IPOs and de-SPACs in December 2020, the agency has continued focusing on SPAC filings and transactions.
In an April 8, 2021, statement, Acting Director of the Division of Corporation Finance John Coates discussed potential liability risks for SPACs and questioned whether the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act of 1995 (PSLRA) applies to the projections of targets in de-SPAC transaction disclosures. While his remarks do not have the force of law, they reflect the SEC’s concerns about the use of projections in de-SPAC transactions.
The SEC has also targeted SPAC accounting practices. The Division of Corporation Finance and the Office of the Chief Accountant of the SEC jointly issued a statement on April 12, 2021, outlining the staff’s view that terms common to many SPAC warrants may require that the instruments be classified as balance sheet liabilities. Most SPACs had treated these as equity, so the pronouncement forced many to reassess their accounting. Ultimately, most SPACs restated their financial statements and related disclosures.
The accounting treatment of public shares subject to redemption also attracted SEC attention. Through comment letters and in discussions with auditors, the agency required that these be classified as temporary equity. Again, this differed from conventional practices, under which a portion of the public shares were accounted for as permanent equity. Consequently, most SPACs restated their financial statements and related disclosures.
The SEC’s rulemaking agenda calls for the commission to propose amended rules governing SPACs in April 2022. Practitioners will be watching closely. (See “SEC Expected To Introduce Host of New Rules in 2022, Enhance Enforcement.”)
In addition, the Financial Industry Regulatory Authority (FINRA) has set its sights on SPACs. In October 2021, FINRA launched an examination sweep covering member firms’ SPAC offerings and the services provided to the entities and their affiliates.
PIPE Market Challenges
As noted above, potential PIPE investors have been scrutinizing de-SPAC valuations more closely. This has resulted, in some cases, in a reduction of the target’s purchase price.
As PIPE capital has been harder to find and shareholder redemption rates have risen, SPACs have looked for alternative ways to show market support and/or raise additional cash. Some are bringing in their own buyers for all or significant portions of PIPEs. This can include a “pre-PIPE” process in which the SPAC essentially tests the PIPE market with some investors before launching the formal process, and/or a “PIPE upsize” process in which the PIPE is enlarged with existing investors after the de-SPAC transaction is announced.
Another alternative is support from a strategic investor that is not a traditional PIPE investor, via either a cash contribution or commercial arrangement.
To further incentivize potential investors, in some cases PIPE transactions have included convertible debt, convertible preferred equity or warrants in addition to or instead of common stock.
Any such incentives should be analyzed carefully, not only from commercial and contractual perspectives, but also for their impact on the market’s view of the target valuation.
As long as the market for PIPE funds remains competitive, we expect to see creative incentives and structures continue.
SPACs have also drawn attention from plaintiffs’ law firms. Before many de-SPAC transactions close, some shareholder-plaintiffs raise objections like those routinely seen in conventional public company mergers. Plaintiffs may, for example, assert disclosure-based claims under Section 14(a) of the Securities Exchange Act, or breach-of-fiduciary-duty claims under state law and seek additional disclosures. There have also been a growing number of federal securities lawsuits under Section 10(b) or 11 of the Securities Exchange Act after de-SPAC closings where the resulting company’s stock price has fallen. Framed as class actions, these cases highlight the need for SPACs to conduct and document robust due diligence on any target. In addition, see our January 6, 2022, memorandum for recent developments in Delaware, “Court of Chancery Issues SPAC-Related Decision of First Impression.”
The Search for Targets
As the surge in SPACs and total dry powder has heightened competition for targets, creative deal structures have emerged. For example, some SPACs have considered combining two private companies to create one public-company-ready business, or teaming up with other SPAC sponsors to conduct a single transaction between one target and multiple SPACs.
Many SPACs are now looking at targets outside the U.S., including in Asia and Europe. (See "SPACs Considering German Targets Face Unique Challenges.")
We also expect SPACs to seek mergers with divisions of public companies. For the parent, this may be an attractive alternative to a traditional sale, IPO, spinoff or split-off.
Given the number of SPACs in the market and their competition for targets, we expect to see more transactional innovations.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.