Doug Ellenoff of Ellenoff, Grossman and Schole Shares Insight into Booming SPAC Market.
Special purpose Acquisition Companies or SPACs had a blowout year in 2021. While the financing vehicle has been around for decades, in recent years SPACs have rocketed in popularity. SPACs are an option that allows a company to become a publicly-traded firm but without going through a costly traditional initial public offering (IPO). IPOs have declined in the past couple of decades due to the rising cost and regulatory burden along with an ocean of private capital that aims to jump to the head of the queue in holding shares in promising young firms.
Like just about everything, SPACs have their supporters and their detractors. The rise in utilization has piqued the interest of the Securities and Exchange Commission (SEC) as well as Congress.
Just last month, SEC Chairman Gary Gensler posted a video that was critical of SPACs. He claimed that SPACs do not necessarily align with an investor’s interests.
“As a result, investors should be aware that although most of the SPAC’s capital has been provided by IPO investors, the sponsors and potentially other initial investors will benefit more than investors from the SPAC’s completion of an initial business combination and may have an incentive to complete a transaction on terms that may be less favorable to you. “
When Gensler said you he meant a retail investor.
The House of Representatives, Committee on Financial Services held a hearing last year that targeted SPACs lining up a group of witnesses that hammered the concept while not including an industry representative to provide helpful perspective.
In 2021, SPACs raised a sturdy $145 billion – an increase of 91% over the year prior. These same SPACs helped to drive 2021 to a record year for IPOs (1,033) as there were 613 SPACs alongside 420 traditional IPOs. The year prior these numbers were less than half each.
For comparison’s sake:
|Total IPOs||SPACs||Traditional IPOs|
The success of SPACs has also created challenges beyond regulatory scrutiny. Typically a SPAC must find a target company within a set amount of time, meaning there is a lot of money chasing deals – some of which may not materialize.
Recently CI reached out to Doug Ellenoff, Managing Partner of Ellenoff, Grossman, and Schole (EGS). During 2021, EGS participated in 147 of the SPAC IPOs helping to raise $33 billion – making EGS the top law firm by deals and amount raised – a position the firm has held for the last 5 years.
We asked Ellenoff for his thoughts on the future of SPACs. Our discussion is shared below.
SPACs broke records in regards to money raised in 2021 easily topping the year prior. Is this an anomaly?
Doug Ellenoff: It’s not an anomaly IMHO even though it may never happen again if that makes any sense.
SPACs have been on a decade long increase in acceptance by market participants, and so while this year was exceptional until the rules and regulations for how private companies are able to Go Public are adequately addressed, SPACs are a very compelling option after a 30-year negative trend line in our public company universe.
Even with the continued drumbeat of regulatory hostility towards SPACs, they continue to be pursued by sponsors, investors, and companies wanting to access our public markets. There are fundamental reasons for the SPAC market to existing and it serves those needs. It’s not going away, although it will mature.
Currently, there is a lot of money chasing deals – typically with a deadline. Does this create a challenge? Are sponsors paying more to complete deals?
Doug Ellenoff: There is a looming concern that there is an imbalance between the number of funded SPACs and the number of private companies ready to assume the responsibilities of entering our public markets. That doesn’t mean that the existing funded SPACs won’t all find appropriate business combination candidates but it certainly makes it harder.
Beginning this summer and through the end of the year, it’s quite possible that the liquidation rates for SPACs may begin to see a percentage uptick after several years of very limited overall failure. Keep in mind though that there are thousands of private companies in the hands of not only private equity, venture capital, and divisions of other large companies that could be targets for these 500+ funded SPACs.
As I mentioned in my earlier response, the universe of public companies has decreased in my professional lifetime by nearly half to less than 5,000 listed public companies here in the U.S. Argue all you want about the root causes for this decrease, but private companies held by PE and VCs have increased by even a greater number.
So I believe we are simply seeing a bit of a pendulum swing. I’m not suggesting that all or most companies held as porticos for PE or VC are appropriate or receptive to a Go Public option, but many are and 500 wouldn’t surprise me, particularly if you add those privately-held family businesses or divisions of larger companies, both domestically and internationally.
The concern I actually have is simply that our mechanisms for processing these deals aren’t sufficient. It took 30 years to reduce our number of public companies and there aren’t enough fundamental investors, in particular, or transactional lawyers, bankers, accountants, etc. to facilitate it all as quickly as is being tasked at the moment. But is there the interest, you betcha.
The last year has clearly demonstrated that given the proper pathway, hundred of companies are willing to assume the responsibilities and duties of being publicly traded. And, that’s really good news. Our fund managers need more choices.
Valuations will always be controversial and one could easily argue that valuations were less defensible with fewer funded SPACs than the position we find ourselves in today. My actual view, given how the SPAC market actually works is that valuations are much more subject to intense negotiations today than a year ago, partly because investor demand for SPAC PIPE financing is much harder to come by.
So even if the SPAC agrees to a higher valuation, the investors funding the proposed business combination are much more likely to believe that they have more leverage and will challenge the originally proposed valuation, unless there are numerous funds interested in the deal.
The hot US SPAC market has caused other jurisdictions to pursue blank check firms. How is this competition impacting US markets?
Doug Ellenoff: We don’t even hear about it truthfully.
The experience of foreign exchanges and jurisdictions permitting their versions of SPACs goes back many years to the UK, Italy, the Netherlands, and more recently Canada. Newer entrants include Hong Kong.
I actually welcome these countries accepting the reality of SPACs and hope they succeed.
Our regulators should take note and seek to improve our alternative investment programs rather than undermine them.
Ironically, several such programs that we’ve been involved with for years, including crowdfunding and PIPEs, were similarly challenged in the past by regulators and are now simply part of our financing options.
I look forward to SPACs being just another financing option and Go Public strategy without all the misunderstanding and grandstanding. The US developed the SPAC market and has been instrumental in its evolution for 30 years and so I suspect that unless regulators and Congress succumb to outside political pressures that have their own agendas, they’ll realize what we contribute to our public markets and will work to enhance our continued success rather than frustrate it.
Criticism of SPACs frequently range from Sponsors making money regardless of the deal quality and retail getting in late. What are your thoughts on this?
Doug Ellenoff: The commercial observation is accurate that it’s possible for a SPAC sponsor to make money when public investors don’t. It’s equally true that the reverse may happen. It’s never the goal but a possibility.
Sponsors invest millions and millions of dollars to form and fund the SPAC and if they don’t get a deal done or it doesn’t work out, they lose all of their Capital WHILST the public gets a 100% return on their funds. That’s the business deal and has been for 30 years.
What we are actually discussing, that doesn’t get discussed in DC or the public square, is what is the appropriate rate of return for what Sponsors offer to the public.
As I’ve indicated before, we don’t have enough public companies. Underwriters are fewer than ever before and only willing to do bigger and bigger IPOs.
Think of a SPAC as being an outsourced advisor to select which private companies should go public by investors with significant track records. Sponsors are typically PE, VC and former C-Level executives that the public couldn’t co-invest with otherwise. Yes, on different terms admittedly.
In privates, if you don’t have substantial funds and aren’t willing to also pay a 20% promote, you aren’t eligible to participate. In privates, there are no rules that require fund managers to invest millions of dollars either. With SPACs, you have the opportunity to invest with the highest-profile fund managers and executives in the world.
What is failed to be raised in the discussions referred to in the question, is the limits of our securities laws. Our securities laws are premised on full and fair disclosure and NOT our regulators determining what is fair compensation to sponsors.
To date, institutional investors are comfortable with the construct of the SPAC sponsor promote and when they aren’t they certainly aren’t shy about renegotiating some of it down or away. For my money, I would much prefer the market to determine if the SPAC sponsor has done what was asked of it and are thereby entitled to the fully disclosed (yes fully and fairly disclosed compensation WHICH has been for the history of the SPAC program- regulators have supervised and observed the SPAC market for 30 years, 1000 IPOs and this has never been raised in any comment letter. Nor should it. This is a market issue and institutional investors should be vocal if they feel differently.
The SEC has voiced its concern regarding SPACs and SEC Chairman Gary Gensler has asked staff to recommend changes to these firms. What, if any, changes do you anticipate the SEC will seek to make? The SEC Investor Advisory Committee (IAC) submitted recommendations to the SEC in August suggesting greater disclosure providing a series of bullet points. Do you agree with their perspective?
Doug Ellenoff: “More disclosure” is always the talking point because that’s the SECs stock and trade. We heard the same from the outgoing commissioner a year ago and 650 more SPAC IPOs have been completed.
When those suggestions were made public, we had already addressed most if not all those concerns.
I don’t believe that more disclosure will benefit investors in any way and do believe that they have all that they need to make an informed decision. SPACs have been part of the public company, fully registered and reviewed securities community for 30 years, so I’m highly confident that the law firms, banks, accounting firms (the same ones that handle regular IPOs) know and do comply with the existing and relevant disclosure rules to provide both retail and institutional investors with the information that they require to make an informed investment decision.
Advocates of SPACs view these vehicles as reinvigorating a moribund IPO market while making earlier-stage ventures more accessible to retail investors. Do you support this perspective?
Doug Ellenoff: I do.
After many trips to DC and speaking before Congress and hearing the frustration of legislators a few years ago, who now challenge SPACs in the last year, that private companies were staying private too long and that public investors no longer have access to these exciting companies and ventures, I’m genuinely bemused by the expediency of their stated concerns and quick about-face.
Our securities laws are here to facilitate investment so long as investors have access to the risks and the complete story of the company that they are going to invest in. They have that right.
If public companies don’t comply with the laws or abuse the public trust then there are laws in place to handle those transgressions.
If we wanted a Federal merit review regime, Congress would have taken that approach in 1933.
I believe my earlier analysis of the decrease in public companies also is responsive to this question.
In 2021, a House Committee proposed several acts of legislation that could impact SPACs. Are you concerned about this at all?
Doug Ellenoff: Not by the effect of those proposals but by the misguided nature of the legislation.
No one seems to be observing the overall benefits of the SPAC market and are looking at a limited number of high profile cases to extrapolate their positions.
This isn’t responsible and the proposed legislation even goes so far to hurt the people it’s purporting to protect. The legislation is arguably investor protective but it also hurts those same people because this is complicated and knee jerk policy isn’t what’s going to be helpful.
Am I concerned, NO, the SPAC market as I believe I have laid out is responding to a macro dynamic caused by 30 years of policy that has decimated our public company universe. Trying to slow the SPAC market down by concocting multiple accounting issues that cause market havoc, only wastes the public money, undermines the confidence in our public markets generally (mostly by the hundreds of professionals entrusted to safeguard it) or by Congress weighing in on a marginal basis is merely a distraction and fundamentally misses the larger issues and ills that created the SPAC opportunity to begin with.
I’ve been involved in the SPAC industry since 2002/3 and can’t believe the explosion in recent interest, activity, benefit to the public markets generally, have always sought to improve it commercially with bankers, sponsors and investors and have worked cooperatively with regulators throughout this same period to achieve this same success and am proud of our achievements and legislation will only at best alter how we move forward to satisfy the clear need for alternative ways to go public.
Some observers believe 2021 was the high point for SPACs and the sector will cool in 2022. What is your opinion on this?
Doug Ellenoff: I agree that there will be fewer SPAC IPOs but believe that there will also be many more SPAC business combinations. 2023 will revert to a more normalized SPAC IPO and deSPAC market.