SPACs: is the party over?

While the world was quite thrilled about the expansion of SPACs in 2021, it seems now obvious that a shift has occurred over the course of the year.

A success in recent years based on three factors

As a reminder, a special purpose acquisition company (“SPAC”) refers to an empty company listed on a stock exchange that seeks to raise large sums of cash from the public, with the intent of using this capital to find and acquire a private target company (usually within two years).

Although SPACs have been around for decades, their popularity has increased dramatically in 2020 and 2021, as they accounted for 15% of all private equity exits in 2021¹. First, their recent success stems from the fact that they enable companies to access capital quickly on a large scale and affordably as compared to a traditional initial public offering (IPO).

Secondly, they give an opportunity to investors to invest in those private companies, which are often challenging to access.

However, the boom of the SPAC market was fueled thanks to the low interest rate environment which have forced investors to redirect to higher risk investments.

The statistics speak for themselves: the SPACs that went public in 2020 raised more money than all those launched between 2016 and 2019 combined while the amount of capital raised by SPAC IPOs in 2021 had already surpassed 2020's record levels. This increasing trend continued in 2021, as more than 40 percent of new public companies have been formed through mergers with SPACs.

Lastly, since 2022, the market has been challenged – we will dig deeper into this new perspective.

Why such a sudden change?

Over the past ten years, SPACs have captured the attention of investors, innovators, and regulators alike, and are today facing their greatest problems because of broader market circumstances, regulatory uncertainty, and rising redemptions.

The first half of 2022 witnessed significant turmoil in both financial markets and the broader economy, questioning the long-term decisions made by investors. Accelerated inflation led the Federal Reserve to raise interest rates, turning risk appetite into risk avoidance among investors. According to EY Global IPO Trends Q2 2022, the number of SPACs that went public plummeted by 80% compared to the previous year. So far this year, SPAC IPOs have attracted about $11.8 billion in gross proceeds — down 88% year-on-year.

In Europe, the pace of SPAC IPOs has also drastically decreased in the first half of 2022. EU SPACs raised US$1.8 billion in the first half of 2022, down from US$5.11 billion at the same point in the prior year. Similarly, the number of SPACs that went public in Europe also dropped by 25%².

In such turbulent times, sponsors of SPACs are operating in a tough market, numerous SPACs that already exist are still actively looking for targets, while the majority of these SPACs face potential expiration in the next year.

There have been high levels of redemptions from retail investors once deal targets have been announced. Redeeming SPAC shares skyrocketed in 2022, making mergers more challenging to complete and posing a liquidity issue for newly publicly listed companies. The number of announced SPAC mergers drastically decreased as a result of increased redemptions and financial market downturns.

Additionally, the turbulent stock market has made “despacking” activities even more unpredictable. Several publicly announced businesses were canceled only in June 2022, due to stock market conditions.

More transparency required from regulators and sponsors

After a series of rollercoaster years for this market, regulators, investors and sponsors are increasingly concerned about improving deal integrity.

In the United States, the Securities and Exchange Commission (SEC) has expanded its oversight, launched hundreds of investigations into SPACs, and proposed stricter regulations to safeguard investors because of several high-profile SPACs falling short of expectations. As a result, in 2022 the SEC issued new regulations for that placed limitations on the ability of Sponsors to sell shares of their companies as well as other measures meant to prevent fraud. The ability of the Sponsors to raise money from investors was hampered by these regulations. Due to concerns that new restrictions may reduce the deals' profitability, investment banks have started to distance themselves from SPACs. In the short term, the SEC regulation has created more uncertainty in a deal-making environment that is already challenging, but might provide improved transparence and deal integrity in the long run. By adjusting SPAC IPO structures in response to shifting investor preferences, sponsors and their advisers have strived to guarantee that SPACs remain appealing investment vehicles for investors.

A shortened investment is frequently seen in the EU SPAC IPOs. In 2021, typically SPACs would have two years to find a deal target upon its IPO. Today, deal source periods are shortened to 15 months in order to avoid investors' capital to sit unused and fail to earn interest for long periods. Extending investment periods has also become more difficult, since they are either excluded from the start or subject to shareholder approval.

EU SPACs have also introduced mechanisms that will ensure that the investors receive a premium on their initial investment if a SPAC does not find a deal target within its investment period. In a climate with low interest rates, investors would receive their original investment back if there was no deal or if they didn’t approve the target company and redeem their shares. Now, in order to entice investors, sponsors are offering further guarantees that, in the event that a deal falls through, they will return up to 2% more than the principle sum.

SPACs sponsors have also implemented higher thresholds for the granting of "promote" incentives, share rewards given to sponsors in a target company when a de-SPAC business combination is achieved.

These initiatives demonstrate how SPAC sponsors are currently adapting their offer in response to macroeconomic headwinds.

Why are SPACs still relevant in today's market?

Whenever the market returns to normal, the volumes of earlier years might never be seen again, but that does not mean the SPACs are “dead”.

In fact, SPACs can still make companies go public when markets are low. Despite these challenges, they continue to be a relevant investment option, offering an important alternative to the traditional initial public offering and providing opportunity to investors to diversify their portfolios. SPACs provide a way for investors to gain exposure to companies within a specific sector or niche with minimal risk compared to investing directly in startups themselves.

SPACs could also be an opportunity for distressed M&A and restructuring: when companies are coming out of a challenging period with significant amounts of debt and may need a party to take on their responsibilities to put them back into solid financial shape. Here, a SPAC could provide an attractive alternative.

Nevertheless, it may be that the worst of the SPAC market is already behind. In recent months, it has been witnessed that stakeholders and sponsors started to act more cautiously and adjusting quickly to new realities. As a result of enhanced disclosures, improved due diligence, and the selection of ready targets, the SPAC industry should be able to outlast the current economic challenges and legal headwinds to emerge stronger and more resilient.

The market will likely continue to evolve, with new entrants, evolving strategies and investor demand as well as regulatory clarity will likely drive future deal flows.