Pressure to De-SPAC Raises Due Diligence ConcernsNovember 18, 2021
As we get closer to the end of 2021, we are beginning to see the pros and cons of utilizing SPACs as an avenue to launch successful publicly traded companies and generate returns for investors.
The benefits of creating a SPAC include:
- Raising liquidity relatively quickly by a solid management team or SPAC founders,
- Nominal initial equity, and
- Up to two years to complete a transaction.
When the SPAC formation is approved by the SEC, the capital raised is kept in a trust while the SPAC founders continue to hunt for a suitable Target. Ideally, the letter of intent negotiation, Quality of Earnings analyses and other diligence processes should have begun at this stage in the SPAC timeline, in order to avoid regulatory and deal pitfalls. Once the SPAC closes the transaction with the Target, the initial business combination is often referred to as a de-SPACing transaction.
Before 2020, going public through a Special Purpose Acquisition Company (SPAC) was virtually unheard of, and those companies that did use a SPAC to go public were seen as having exploited a “loophole” of sorts to get listed. Descended from the notorious “blank check corporations” of the 1980’s, SPACs struggled to gain a foothold in the market until recently.
Investment banking analysts deemed 2020 “The Year of the SPACs” when the number of filings nearly quadrupled year over year to 251. However, the year did not live up to the name. As of October 2021, SPACs had raised capital in 498 IPOs.
While the number of SPAC filings has increased exponentially since 2019, however, many SPACs are having a difficult time de-SPACing, or completing a merger with a private company, in the time period they are granted.
When formed, SPACs specify a time period in which they will identify and complete a merger with a private company. Typically, this time period is around two years, however some SPACs have opted for time periods as short as 18 months. While 251 SPAC companies filed in 2020, less than 45% of them have completed deals. As the allotted time periods tick away, pressure to complete a deal in time could lead to due diligence concerns for SPACs that are rushing to merge before investors funds are returned.
The Importance of Proper Due Diligence
At the end of a de-SPACing transaction, your company will become public and therefore subject to the rules and regulations of the Security and Exchange Committee (SEC). While the process of identifying a company with whom a SPAC can merge may take up to two years, as noted above, the actual completion of the merger can take as little as two weeks. This means that your company needs to be compliant or able to be able to become compliant with these rules and regulations within that time frame.
SPACs Come Under Regulatory Scrutiny
As SPACs have risen in popularity, they have also come under increased scrutiny by regulatory agencies. The time pressure to complete a deal before the SPAC is essentially dissolved makes them inherently more risky than the more traditional IPO route, and some companies have learned this the hard way.
For example, the SEC has recently charged Stable Road Acquisition Corp., a SPAC, and Momentus Inc. with misleading claims and inadequate due diligence in their proposed SPAC transaction, representing the first time that the SEC has sanctioned a SPAC and its target company before a shareholder vote on a merger. SEC Chair Gary Gensler commented “this case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors.”
The Right Due Diligence Team
As SPACs’ two-year time period winds down and they become anxious to complete a deal, having the right due diligence team is absolutely crucial to a successful transaction. Anchin’s Transaction Advisory Services (TAS) group has years of experience helping companies conform to the rules and regulations of the SEC and assisting companies with mergers, acquisitions, initial public offering and more transactions.
If you have any questions about SPACs, de-SPACing or due diligence, contact Lami Ajibesin, Managing Director and Leader of TAS.