In the last few years, SPACs have been used broadly in the United States as an alternative vehicle for listing on stock exchanges without having to endure the expenses, delays and uncertainties of a traditional IPO. SPACs surged in popularity during the post-pandemic period marked by capital market volatility (which made seeking a listing through a traditional IPO perilous), low interest rates and a search for high-risk, high-reward investments. It should be considered whether SPACs remain a viable option to access public markets.
What is a SPAC?
A SPAC is an empty shell or blank-check company which has no current or past operations or assets, other than cash. Its sole purpose is to raise capital from public investors by undergoing a SPAC IPO. The capital is then deployed to acquire, or merge with, one or more existing private companies, which is known as the qualifying acquisition or the de-SPAC transaction.
The rules and principles of Canadian SPACs are generally modelled on those governing American SPACs. However, SPACs must comply with specific rules in accordance with the stock exchange it seeks a listing on. For instance, in the case of a listing on the Toronto Stock Exchange, rules are set out in Part X of the TSX Company Manual; in the case of a listing on the Canadian Stock Exchange, rules are set out in Appendix 2C to the CSE Policy 2.
Benefits of SPACs
Benefits for target business
For the target of the qualifying acquisition, a SPAC represents an expedited path for accessing capital markets and becoming a public company. By opting for this approach, private companies are spared the intricacies and expenses of having to execute an IPO of their own. They are also subject to lower fees and fewer regulatory requirements, and provided with greater flexibility in accessing capital rapidly and affordably, thus reducing market risks. Participating in a de-SPAC transaction also offers target companies greater control and certainty over the process, notably with regards to valuation and timing. Some SPAC IPOs may take as little as three months to complete.
Benefits for investors
As for the investors, SPACs represent a unique co-investment opportunity in companies usually sought by private equity firms. Investors get to benefit from the greater transparency and certainty regarding valuation. As a publicly traded company, SPACs provide investors with access to liquidity. They also may benefit from the purchase of warrants, a type of security which offers the ability to purchase additional shares at a later date and at a predetermined price. Thus, they can benefit from the potential of a sizable return-on-investment (“ROI”) over a short period of time. Most importantly, SPACs provide safeguards allowing investors to retrieve their investment upon the non-completion of a qualifying acquisition or the exercise of their redemption rights upon voting against a qualifying acquisition.
Benefits for sponsors
As for sponsors (the management team having formed the SPAC), SPACs allow them to benefit from a broader pool of investors, thus making it easier to raise capital. Upon completion of the qualifying acquisition, they are also given the opportunity to contribute to the target business. Additionally, sponsors may profit from their exercise of warrants as well as founder shares that they may have acquired for nominal consideration after the completion of the IPO. Thus, like investors, they may benefit from sizable return on investment potential over a shorter period.
Risks associated with SPACs
While SPACs offer certain advantages, they also contain inherent risks. The target company must be prepared for a public issuance and to operate as a public company in a condensed timeframe, and often with limited resources. Further, if redemption rates are high, the SPAC may not have the minimum amount of capital required to complete the qualifying acquisition, which can jeopardize the transaction. If the qualifying acquisition is not completed within the permitted timeframe, the SPAC faces liquidation and delisting, causing the sponsors to lose their entire investment. For this reason, sponsors can face a merge-or-lose dilemma which may result in a potential conflict of interest between the sponsors and the shareholders. Sponsors may be incentivized to expedite due diligence, embellish financial projections and overpay in order to complete the qualifying acquisition, so as to benefit from their founders’ shares and warrants and avoid losing their investment. The success of a SPAC may also depend on the quality of its sponsors and their savviness in their field.
The following points summarizes certain advantages and risks pertaining to SPACs at a glance:
Advantages:
Target business
- Expedited path to public listing;
- Spared the expenses and time of having to undergo an IPO;
- Lower fees and fewer regulatory requirements;
- Greater control over valuation and timing;
- Profit from the experience of sponsors.
Investors
- Public co-investment opportunity;
- Access to liquidity;
- Benefit from warrants;
- Sizable ROI potential;
- Safeguards protecting investments.
Sponsors
- Broad pool of investors;
- Easier to raise capital;
- Opportunity to contribute to target business;
- Benefit from warrants and founders’ shares;
- Sizable ROI potential.
Risks:
- Short readiness period for target business;
- High redemption rates jeopardize transactions;
- Liquidation, delisting and loss of sponsors’ investment upon non-completion of a qualifying acquisition;
- Sponsors’ potential conflict of interest;
- Success can depend on sponsors.
What led to the downfall of SPACs?
The U.S. market reveals a total of 59 SPAC IPOs completed in 2019, with USD14 billion invested, 248 SPAC IPOs in 2020 with USD83 billion invested and a staggering 613 SPAC IPOs in 2021 with USD162 billion invested. The SPAC bubble subsequently burst in 2022 with only 85 SPAC IPOs completed and USD13 billion invested. As of March 21, 2023, only 9 SPAC IPOs were completed and USD1 billion invested. As for de-SPAC transactions, there were 35 in 2019, 94 in 2020, 227 in 2021, 160 in 2022 and only 45 in 2023. SPAC liquidations have also increased, rising to 121 in 2022 and 61 in 2023. From these statistics, it is clear that the use of SPACs has decreased. Further, companies resulting from de-SPAC transactions have underperformed in the stock markets resulting in a decline in average share prices, subpar returns for investors as well as bankruptcies and reverse stock splits to avoid delisting.
What explains this trend?
The conditions of the current market are among the most notable causes. For example, the rising inflation and interest rates as well as the economic slowdown and the threat of recession are leading investors to look for less risky sources of investment. The threat of increased regulation in the U.S., which may reduce deal profitability, is also causing banks to distance themselves from these deals. Another problem is the dilution in the SPAC structure, with shares trading at premiums compared to their net cash value. There has also been rising redemption rates among shareholders, leaving the post-merger company with less capital as well as liquidity issues. In addition, SPACs have had difficulty finding suitable targets. Consequently, many have been unable to complete their qualifying acquisition within the permitted timeline, leading to increased liquidations. As a result, many sponsors have lost their investment. Finally, there have been increased lawsuits and investigations regarding the conduct of sponsors, causing banks to further step away from SPACs for liability reasons.
In Canada, SPACs have not seen the same popularity as in the U.S. Given that investors do not know the target of the qualifying acquisition upon investing, and that cash is the SPAC’s only asset, investors must rely on the sponsor’s ability to find a viable target and to ultimately obtain a worthwhile return on investment. SPAC investors would therefore require a certain appetite for risk, which, in Canada, is often less widespread than in the U.S.
Conclusion
Despite the risks and the downward trend of their use, SPACs remain an important alternative for accessing public markets when conventional IPOs are unavailable. SPACs could also represent an interesting opportunity for distressed M&A and restructuring for companies with significant debt. However, the use of SPACs seem increasingly less popular, and have even caused many investors to carve out SPACs from their definitions of « Qualified IPOs » in deal documents.
For further information regarding SPACs, please feel free to contact a member of our Capital Markets & Securities team, or the authors of this article.
Additional references can be found here:
- TD, “What are SPACs?”, Online.
- Miller Thomson LLP, “Recent amendments to certain Canadian Securities Exchange policies: Part 2”, Online, June 27, 2023
- Practical Law, “Special Purpose Acquisition Corporations (SPACs) in Canada: Overview”, Online, August 2022
