Financial institutions were until recently happy to foist these cash-shells on the market and collect a bounty of fees for helping them find targets — regrettably often not very good ones — to merge with and take public. Now they’ve developed cold feet because the US Securities and Exchange Commission wants the banks that underwrite blank-check firm listings to also vouch for the information that appears in the merger prospectuses. That would expose them to greater legal liability.
It’s bad to leave clients in the lurch like this but I don’t blame banks for wanting to distance themselves. The SEC seems determined to throw sand in SPACs’ gears. Even if some of its proposed reforms are watered down following public consultation, the appeal of going public this way is bound to be further diminished. New issuance has already slowed and former SPACs have frequently been hit with class-action lawsuits.
SEC Chair Gary Gensler’s beef with SPACs — one I share — is that they’re a form of regulatory arbitrage. He wants investors to enjoy the same protections regardless of how a company chooses to go public.
One difference with regular IPOs is that SPACs publish financial projections. These tend to be overly optimistic and are often used to justify fanciful valuations. Sometimes the financial targets are scrapped soon after the company has gone public. That stinks.
Another big difference is that when a SPAC selects a target, banks are hired to provide financial advice. These are often the same institutions that helped set up the blank-check IPO. Their job isn’t to confirm everything’s hunky dory in the merger prospectus — including those rosy projections. Gatekeeepers “should have to stand behind and be responsible for basic aspects of their work,” says Gensler, not unreasonably.
In theory, requiring banks to underwrite and do due diligence on the merger should help reinvigorate the depressed SPAC market by making investors will feel more comfortable. However, instead of leveling the playing field, Gensler’s critics worry that SPACs will be disadvantaged because banks won’t want to be held responsible for inherently uncertain financial projections. In a regular IPO, financial forecasts are shared privately with analysts and the banks aren’t liable, which seems unfair. One dissenting SEC commissioner warned that Gensler’s reforms were “designed to stop SPACs in their tracks.”
But if they are, would that be bad? Many of the perceived advantages of SPACs have already been exposed as exaggerated or false. A blank-check deal isn’t really a short-cut to joining the stock exchange anymore. The SEC now takes more months to review the required documentation. Crypto exchange Bullish’s merger with Far Peak Acquisition Corp. is expected to close around a year after the deal was first announced, for example.
Once you factor in the free shares SPAC sponsors receive and various other sources of dilution, SPACs are also very expensive. Though banks typically charge lower fees — around 5.5% compared with as much as 7% in an IPO — much of the money a SPAC raises is often handed back to shareholders who exercise their redemption right — a posh way of saying they ask for their money back. Lately these redemptions have often exceeded 90%, which has also undercut the idea that SPACs are a more predictable way of going public.
While SPACs still let targets agree to a valuation upfront — unlike in an IPO where the price is left to the vagaries of the book-building process — the amount of cash the target receives is unknowable until the deal closes. Increasingly, it’s a lot less than they’d expected, which is forcing SPACs to perform all kind of financial gymnastics to get deals over the finish line. So-called PIPE financing — institutional money that backstops a SPAC merger and validates the deal price — has dried up.
It’s bizarrely inefficient to raise a bunch of cash in an IPO, and then to hand almost all of it back again. Allowing shareholders to vote in favor of a deal yet still demand their money back means even bad deals get approved. And it remains the case that SPAC founders can make money even when other investors lose their shirts.
The SEC may be determined to regulate SPACs out of existence but it also has a duty to promote capital formation so it should take care not to throw the baby out with the bathwater. SPACs have a lot of faults but, until they came on the scene, public markets had been shrinking for years and retail investors were locked out of investing in startups. Meanwhile, businesses that listed the regular way have performed even worse lately.
I hope, then, that people continue exploring alternatives to IPOs, either by improving the flawed US SPAC model (like hedge fund manager Bill Ackman has tried to do with his SPARC) or by pursuing direct listings. Competition between listing methods is welcome providing it doesn’t undercut investor protection or provide benefits to insiders at the expense of the investing public. SPACs got caught doing the latter and are set to pay a steep price.
More From This Writer and Others at Bloomberg Opinion:
Thanks, Wall Street, But We Have Enough SPACs Now: Chris Bryant
The SEC Is Coming for SPACs: Matt Levine
Tech Stocks Are Entering an Age of Uncertainty: Parmy Olson
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.
More stories like this are available on bloomberg.com/opinion
