What Happened to SPACs? From Boom to Bust

Special Purpose Acquisition Companies, or SPACs, offer an alternative pathway for private companies to become publicly traded. They gained significant attention in capital markets, especially during periods of heightened market activity.

The Mechanics of SPACs

A Special Purpose Acquisition Company (SPAC) is a shell company that raises capital through an Initial Public Offering (IPO) to acquire a private company. They have no commercial operations or assets beyond the IPO cash. The proceeds from the SPAC’s IPO are placed into an interest-bearing trust account, used only for an acquisition or returned to investors if no deal is finalized. This makes the SPAC a “blank check company” since investors don’t know the target company at the IPO.

SPACs have a defined timeframe, typically 18 to 24 months, to find and merge with a target company. If a de-SPAC transaction (acquisition) is not completed within this period, the SPAC must liquidate, returning funds to investors. The de-SPAC transaction is the process where the SPAC acquires the private company, effectively taking it public. During this process, SPAC shareholders can redeem their shares for a pro-rata portion of the trust funds, even if they approve the merger.

The Surge in SPAC Popularity

SPACs experienced a significant surge in popularity, particularly between 2020 and early 2021, transforming into a mainstream investment vehicle. This period saw record SPAC IPOs and mergers, with SPACs making up over half of all U.S. IPOs in 2020 and 2021. Several market conditions converged to fuel this boom. Low interest rates and an abundance of capital created an environment where investors sought higher returns, making SPACs an attractive option.

For private companies, the SPAC route offered advantages over a traditional IPO. A SPAC merger often provided a faster path to public markets, typically 3 to 6 months compared to 12 to 18 months for a traditional IPO. This speed, along with greater certainty in valuation and deal structure, appealed to companies seeking to go public quickly. SPACs also allowed private companies to present forward-looking projections, generally restricted in traditional IPO prospectuses that focus on historical performance. High-profile sponsors, including experienced financiers and celebrities, also attracted investor interest, contributing to widespread adoption.

Factors Leading to the Market Correction

Following their peak in early 2021, the SPAC market experienced a significant cooling off, driven by a confluence of factors that shifted investor sentiment and increased scrutiny. A primary reason for this correction was the underperformance of many companies that went public through de-SPAC transactions. After their mergers, numerous de-SPACed companies saw their stock prices decline, eroding investor confidence and leading to increased skepticism about the long-term viability of this going-public method.

Regulatory bodies, especially the U.S. Securities and Exchange Commission (SEC), intensified scrutiny of SPACs, addressing investor protection and disclosure concerns. The SEC focused on due diligence deficiencies before acquisitions and whether sponsor payouts were adequately disclosed. Proposed rules sought to enhance disclosures regarding conflicts of interest, dilution, and business combination fairness, aiming to align SPAC disclosures with traditional IPOs. The SEC also removed the Private Securities Litigation Reform Act’s safe harbor for forward-looking statements in de-SPAC transactions, meaning optimistic projections faced greater liability.

A general market downturn and rising interest rates further contributed to the decline, making SPACs less appealing. This environment also led to higher redemption rates, as more SPAC shareholders redeemed shares rather than participating in the de-SPACed entity, reducing cash available to the acquired company.

The Current SPAC Landscape

The SPAC market has undergone a significant transformation since its peak, marked by a substantial reduction in activity and increased investor caution. The volume of new SPAC IPOs has declined dramatically, a stark contrast to the boom years. Many existing SPACs now face challenges in identifying suitable acquisition targets within their mandated 18-24 month deadlines. This often leads to SPACs liquidating and returning funds to investors, rather than completing a merger.

The market has shifted towards stringent due diligence and higher investor expectations. Investors now demand thorough vetting of target companies and clearer disclosures regarding potential risks and conflicts of interest. This increased scrutiny has made it more complex for SPACs to close deals, as target companies must meet rigorous standards for public readiness. Regulatory changes introduced by the SEC, aiming to extend traditional IPO investor protections to SPAC transactions, have also increased costs and complexities for market participants. These factors collectively shape a landscape where SPACs, while still present, operate with greater caution and heightened regulatory and market oversight.