Introduction
SPACs, better known as Special Purpose Acquisition Companies, are mainstream financial products of Wall Street, as Grab’s transaction shows. At the same time, SPACs are the “poor man’s private equity funds,” according to Lora Dimitrova, and the promised “bubble to burst,” according to Ivana Naumovska.
On May 24th, 2021, the U.S. House Committee on Financial Services received draft legislation amending the Securities Act of 1933 and the Securities Exchange Act of 1934 to specifically exclude all SPACs from the safe harbour exemption for forward-looking statements. The draft legislation defines the SPAC as a “development stage company.” However, the definition gives rise to possible confusion with search funds, and de-naturalises the SPAC’s blank check company functions. Similar to Bitcoin, SPACs act against common wisdom. Thus, although the SPAC concept faces challenges to be accepted or fully understood, it also undeniably represents a unique American financial innovation.
SPACs and the Safe Harbour Exemption
A SPAC is a blank check company set up with a special purpose: to conduct an acquisition. The SPAC reverses the normal IPO procedure. Instead of the operating company seeking investors, investors seek an operating company. Once the SPAC completes the envisaged business combination or reverse takeover, funds are released. This phase is also defined in the specific SPAC jargon as “de-SPAC.” A critical distinction between a de-SPAC transaction and a traditional IPO is the ability to include forward-looking financial projections in a proxy or registration statement rather than historical financial results. Financial projections made in relation to a de-SPAC fall within the definition of forward-looking statements provided under the Code of Laws of the United States of America 15 Section 78u-5. Forward-looking statements are based on the future economic performance of a company, such as revenues and income, plans for future operations, etc. Specifically, the Private Securities Litigation Reform Act of 1995 (PSLRA) has modified the qualification of those statements in terms of misleading information under Section 11 of the Securities Act of 1933 and Section 10 (b) of the Securities Exchange Act of 1934. The PSLRA is creating a safe harbour rule for selected types of issuers such as the target company of a SPAC (i.e. the newly de-SPACed public company or alternatively the company that is taking over the SPAC).
As opposed to operating companies, SPACs are investment vehicles and blank check companies. To this end, Professor Steven Davidoff Solomon has recently restated that the main objective of a SPAC is to list a target company. Undoubtedly, the de-SPAC phase relates to M&A transactions where operational risks can be properly curtailed by adopting appropriate contractual tools such as earn-out arrangements. However, SPACs often involve the acquisition of pre-revenue companies, where such contractual tools are less effective, and it is more difficult to assess the company’s enterprise value. The buyer (the SPAC) might want to protect itself against overpaying for a new company that does not grow in the original seller’s direction. To put it simply, if a target is not ready to go public, or if the corporate valuation is inflated, this final responsibility rests with the target company itself rather than the SPAC.
Analysis
The real concern on SPACs and forward-looking statements relates to pre-revenue companies. In this case, SPACs are buying into a speculative company that has yet to earn real revenue. Hence, the promise of a pre-revenue company (i.e. future sales) might lead to misleading statements (i.e. forward-looking statements).
A SPAC reform (if ever) should be aware of market practices and efficiency, and fairly discern between less risky SPACs (those targeting positive EBITDA companies), and more risky ones (SPACs whose targets are pre-revenue companies). Furthermore, the safe harbour rule should still be available to every SPAC due to a fundamental legal principle of common law systems (at least): caveat emptor. Additionally, the valuation of the equity is always tricky and subjective in any type of acquisition. Nonetheless, contractual mechanisms and private negotiations can mitigate those risks.
Ultimately, we believe that SPACs are here to stay. As opposed to the 2007-2010 financial crisis, SPACs’ main evolutionary trends are disciplined by the regulator (so far, mainly the SEC) and listing requirements (the Rule 102.6 under NYSE and the Rule IM-5101-2 under the NASDAQ).[1] SPACs are dominated by the mantra of self-regulation, and from today onwards, they have the ability to become a way of listing, in addition to direct listings and traditional IPOs.
Daniele D’Alvia is an Associate Research Fellow at IALS and Milos Vulanovic is a Professor of Finance at EDHEC Business School.
[1] Daniele D’Alvia, Milos Vulanovic, “The Promise and Limits of a SPAC Revolution” (September 2020) Bloomberg Law – Professional Prospective.
