SPAC Attack: SEC Slowdown Hits Investment Vehicle
SPACs give ordinary investors a chance for big returns, but the SEC approval process is fraught with delays.
Initial public offerings (IPOs) are booming these days. But instead of operating companies offering their shares publicly—like Airbnb or DoorDash, both of which went public in 2020—the IPO market these days is being driven by a different kind of vehicle: the special purpose acquisition company (SPAC). While demand for SPACs appears to be cooling down, the Securities and Exchange Commission's (SEC) interest is heating up. As the SEC looks at SPACs, it must recognize the benefits of variety and innovation in IPO offerings to companies and investors.
To start, let's consider what SPACs are and what may be making them popular. A SPAC's purpose is to raise money in order to merge with an existing private company; it has no business of its own. The strength of the management team—often successful investors themselves—is the key selling feature. After the merger, also known as de-SPACing, the private company assumes the SPAC's place as a public company. SPACs typically have two years to complete a deal, or they must return the money to the investors.
The traditional IPO process takes about four to six months, not counting the time that a company spends preparing to start the process, and includes meetings with potential investors, known as a "roadshow," intended to create demand for the offering and to help set the offering's price. While the SPAC itself goes through a traditional IPO process, that process is simpler when there is no operating business to evaluate. And the private company that merges with the SPAC can avoid the costly and time-consuming process altogether by assuming the SPAC's public company status. Private companies also have considerably more flexibility in talking about, and talking up, their business through the merger process than through the IPO process, adding to the SPAC transaction's attractiveness.
SPACs are not new, but recently they've become a much larger part of the market. About 100 SPAC mergers have been completed since 2018, involving well-known companies like DraftKings and Virgin Galactic. More than 240 SPACs went public in 2020. SPACs raised $81 billion last year, compared to $100 billion raised by traditional U.S. firm IPOs. And SPACs have dominated the IPO market so far in 2021, raising more than $95 billion and accounting for 70% of all IPOs. In addition to SPACs backed by well-known financiers, a number of SPACs have debuted with celebrity connections, including Peyton Manning, Shaquille O'Neal, and Jay-Z.
Despite signs that the SPAC boom is cooling down, the SEC's interest is only growing. Following disclosure guidance and an investor bulletin in December 2020, the SEC issued three more statements on SPACs in March 2021: a statement from the Division of Corporation Finance, a statement from the acting chief accountant, and an investor alert. These statements address different parts of a SPAC's life cycle, from IPO to merger, and include a warning to investors that "it is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment." The SEC's Division of Enforcement has also begun an inquiry of underwriters involved in the SPAC process.
None of the SEC's recent statements or bulletins impose new regulatory obligations with respect to SPACs, nor can they. But the SEC's approval process for SPAC IPOs reportedly has slowed, even while fewer SPACs appear to be seeking approval. The reasons for the slowdown are not known—and there could be any number of reasons—but throwing up new hurdles to approval, where no new obligations have been imposed, runs afoul of the same limitations that should also prevent the SEC from regulating through its enforcement inquiry.
If the SEC chooses to change requirements that apply to SPACs, it should first recognize the benefits of variety and innovation in the IPO market. A diversity of offering types, and many paths to public company status, can better serve companies that have different capital structures and goals. While a SPAC merger may not be the right decision for every company, having the option adds depth to the public market. A SPAC provides a different path to public company status than a traditional IPO, but the result is the same: a public company subject to the SEC's public company disclosure regime.
This innovation benefits investors, too. As SEC Commissioner Hester Peirce recognizes, "We should welcome the addition of startup public companies that historically would have experienced their growth stage in the private markets, where retail investors are not permitted to participate." SPACs may offer ordinary investors the chance to see bigger returns that are usually reserved for wealthy accredited investors, but even if the returns are no more robust, encouraging more companies to join the public markets gives investors more choice.
While the SPAC boom has caught the SEC's attention, the SEC should not attempt to impose hurdles to their use. Of course, investors should understand the risks inherent in a potential investment, especially where that investment, like a SPAC, is more complicated than average. But if anything, the demand for SPACs should cause the SEC to examine why companies want to avoid the traditional IPO process. Rather than limiting options for companies and investors, the SEC may do better to make the IPO process more attractive for startups.