Turmoil in the SPAC Market: What Private Tech Companies Should Consider Before Going Public Via a SPAC
In the spring of 2021, one of the hottest markets—the market for special purpose acquisition companies, or SPACs - has “screeched to a halt,” according to CNN. As the SPAC market grew red hot in the past six months, it seemed that everyone was getting into the game, with celebrities from Shaquille O’Neal to Former House Speaker Paul Ryan leading their own SPACs.
But shareholder lawsuits, huge value fluctuations, and warnings from the SEC have all thrown the brakes on the SPAC market, at least temporarily. So what do privately held companies that are considering going public need to know about the SPAC process and market?
The Benefits of SPACs: Efficiency, Potential Financial Upside, and Partnering with Industry Leaders
First, the upside of SPACs: they’re a much more efficient way for a private company to go public than a traditional IPO. By merging with a SPAC instead of launching an IPO, a private company can avoid the rigamarole of working with underwriters, hosting roadshows, preparing a prospectus, and other complexities of the public filing process. It can potentially be a fast track into an IPO with a seasoned partner who has experience navigating the process.
There are also big potential financial upsides. For example, stockholders of the private company will often roll over their stock in the private company and provide significant cash liquidity. SPACs also offer more certainty about a private company’s valuation than a traditional IPO, and some experts believe that a SPAC can add up to 20% to a company’s sale price compared to a typical private equity transaction. And, especially when the SPAC market was hot, multiple SPACs could create a bidding war to increase value and generate more favorable terms for a transaction than through the traditional capital markets. Lastly, partnering with an experienced management team and impressive industry insiders can help a private company accelerate its financial growth and create long-term value.
Warning Signs: Why the SPAC Market Has Stumbled
All these benefits led to a dramatic increase in SPAC transactions in late 2020 and early 2021. But the market cooled substantially in April, in part because of signs that the SEC will be scrutinizing the entities more closely in the future and due to high-profile problems in the market.
In particular, in early April, the SEC posted a comment noting concerns about potential abuses in the SPAC market, including “risks from fees, conflicts, and sponsor compensation,” among other things. The comment goes on to analyze at length whether the SPAC process is protected under a safe harbor in the Private Securities Litigation Reform Act (PSLRA) that a traditional IPO process. The comment strongly suggests that the safe harbor “should not be available for any unknown private company introducing itself to the public markets,” including those going public via SPAC.
On top of additional SEC scrutiny, Wall Street short sellers have targeted certain SPACs, including most notably SPACs targeting privately held electric vehicle companies, leading to wildly fluctuating valuations for SPACs targeting this space.
High-profile litigation may also be part of the cause for the SPAC slowdown. For example, a series of shareholder lawsuits were recently filed against data analytics firm MultiPlan Corp., a company that’s the result of an acquisition by the SPAC Churchill Capital Corp. III. The company lost almost 37% of its value shortly after going public. The lawsuits allege that the SPAC’s managers didn’t disclose serious problems with MultiPlan’s business - including the imminent loss of its largest customer, which made up over 1/3 of its sales. The lawsuits also allege conflicts of interest among the management team.
Steps to Prepare for a SPAC Transaction
Despite these warning signs, there are still hundreds of SPACs on the market looking to close deals, and this process can still have plenty of upsides. To get ready for a potential SPAC transaction, privately held companies should get their own financial house in order but also conduct careful due diligence into the SPAC and its management team and lead financial sponsor—especially now that it’s clear the SEC is paying close attention to this market.
For example, private companies should:
- Get your financial house in order. In order to consummate the deal, the private company must be ready to go public, including being ready to submit audited historical financial statements in compliance with public company standards. The target private company must also be prepared to implement internal controls and procedures for Sarbanes-Oxley reporting and establishing appropriate levels of oversight, such as an audit committee. The SPAC’s management team can certainly assist in this process, but the target company itself needs to ensure that its team is prepared to do business as a public company immediately following the merger.
- Assess the SPAC management team, financial sponsor, and major investors. Just like with any private equity or strategic investment from a third party, it is crucial for a target company to conduct its own diligence on the financial sponsor and the management team of the SPAC, as well as any major investors in the SPAC. What are the reputations and track records of the financial sponsor and the key players in the SPAC’s management team? Do they have a complete understanding of my industry and my specific business? Do the sponsors or major investors have conflicts of interest or other relationships in the industry of the private company (or otherwise)? In theory, the SPAC’s management team and financial should bring a lot of value to the private company, including an ability to streamline and synergize the target company, similar to what any private equity investor would offer to a private company. If these aspects are missing, this might not be the right deal.
- Consider leadership and interpersonal questions. How will the leadership and management styles of the private company and the SPAC management team work together? As with any deal, the team that will run the company after the transaction closes has to work together. Don’t sleep on these interpersonal and leadership style issues.
- Review the terms of any rollover equity. For any stockholders of the private company that will be retaining a management rollover stake after the de-SPAC transaction, it will be crucial to fully understand the terms of this equity stake, including when and at what price it could be expected to be sold. Understanding the economics of your rollover stake also requires reviewing the capital structure, business strategy, and financial wherewithal of the SPAC to achieve its strategy. Any rollover equity holder should conduct diligence on the SPAC similar to that of any outside investor deciding to invest a significant amount of capital into the SPAC itself.
These are all key questions that a private company should be asking before embarking on a SPAC transaction. The ideal partner for a target company in a SPAC transaction is a sponsor and management team that will serve in a complementary role to the target company’s existing leadership and help the target company reach its ultimate goals.
Despite the increased scrutiny of SPACs in the past couple of months, private companies considering a sale or other financing event will, and should, consider the option of a SPAC transaction. In order to properly analyze that option, boards and management teams need to fully understand the implications of going public through a SPAC. Additionally, while being vetted by a potential SPAC acquirer, boards and executive teams of target companies must conduct their own comprehensive reverse diligence to ensure that the financial sponsor and management team of the SPAC is the right fit.
Read the article on TechCrunch here.