SPACs are coming to a company near you

By Alistair Kellie

Is the UK about to follow the US and enter the ‘SPAC age’ or are the growing number of column inches around special purpose acquisition companies out of kilter with the reality?   In case you’ve missed the mania around SPACs, there’s growing interest in these so-called ‘blank cheque companies’ with the City doing all that it can to encourage the government and regulators to change rules to make it easier for SPACs to list here.  But what are they and why all the interest in these investment vehicles?

SPACs were created in 1993 by David Nussbaum, an investment banker and David Miller, a lawyer, at a time when blank check companies were prohibited in the United States. Nussbaum stuck with the concept for years, even when only three or four SPACs were going public a year and has recently been quoted as saying, “It’s taken me 27 years to become an overnight sensation.”

Simplistically, they are in essence a form of reverse merger.  In a standard reverse merger, a successful private company merges with a listed empty shell to go public without the paperwork and rigours of a traditional IPO. The shell is usually a remnant of a previously operational public firm or is a public shell formed to combine with a private company. However, where SPACs are different is that the shell company is a proactive party, flush with cash from the IPO and hunting for private targets.

Since the 90’s, over 500 SPACs have been listed in the US, raising more than $100 billion. While the raises for each transaction used to be relatively small, typically at less than $100 million, they’ve become much more established today with an average raise of about $380 million. Indeed, the latest data from Refinitiv reveals that already this year $72 billion has been raised by 235 SPAC vehicles, which is already close to the total for the whole of 2020 of $78 billion by 244 SPACs.

But shell companies and reverse take-overs aren’t new, so why all the fuss?  Often criticised, reverse mergers have existed for decades, mostly on the margins of financial markets and there have seen several waves of them since the 1970s. They surged in the mid-2000s, outnumbering IPOs in some years, and peaked in 2010, before falling off a cliff in 2011 due to a combination of poor-quality players, bad publicity and regulatory concerns.

Some of the recent media interest here has been around the regulatory issues raised the last time SPACs were this active in 2007, just before the Global Financial Crisis.  But issuance surged in 2020 as we entered the Global Health Crisis and there are no signs of interest abating any time soon.  So, should we be worried?

US commentators are starting to raise the alarm about the growing, and heavy retail investor participation in SPACs, which now accounts for about 40 per cent of all trading in the vehicles, according to a report from the Bank of America.  There are concerns that significant retail participation is creating a new dynamic for SPACs trying to secure deals of have extensions approved due to the logistical challenges around getting investors to vote.

Votes to extend the time to close acquisitions typically require 65 per cent of shareholder agreement whilst approval of deal normally requires a simple majority.  This was normally not a challenge when the vast majority of shares were held by institutional investors or hedge funds which were well versed in the shareholder voting process and when US brokerages could just vote the shares.

There are also regulatory concerns surrounding SPACs.  Jay Clayton, Chairman of the Securities Exchange Commission has signalled that the US regulator has reservations about these vehicles and wants to ensure that SPAC shareholders “are getting the same rigorous disclosure that you get in connection with bringing an IPO to market.”

Under the rules governing them, SPACs must identify firms they can merge with within 24 months after they have raised their funds or they will be wound up and the IPO proceeds returned to investors. More than 300 SPACs need to pull that off this year or risk being liquidated. Ivana Naumovska, a professor at INSEAD warns, “…with only so many quality targets to go round, and SPAC founders’ strong incentive to close deals (even at the expense of shareholder value) SPACs may well end up in a negative spiral of poor quality/bad press/tighter regulation. And we know how that ended for reverse mergers.”

However, in the meantime the UK is set to make sweeping changes to London listing rules which are aimed at attracting technology initial public offerings and lifting a key barrier that has stopped SPACs from choosing the country. The government-backed Hill review, published last week, set out the need for the U.K. to act to ensure London doesn’t fall behind key European financial centres like Amsterdam and lose further ground to the U.S. and Asia.

The UK listing review, which was part of chancellor Rishi Sunak’s plans to reinvigorate the City in the wake of Brexit recommends removing a rule that has seen the UK fall behind other European financial centres as the boom in SPACs, has crossed the Atlantic.  With thousands of private equity based companies in existence today, many of which are or will be in need of exit opportunities, SPACs serve as a great mechanism for this, solving problems for both the companies and the investment firms.

However, current rules require SPACs to suspend trading once a target is acquired, meaning investors are locked in even if they do not approve of a potential purchase. Bankers, lawyers and stock exchange executives view the suspension rule as a key impediment to SPACs choosing to list in London and the Hill review calls for “liberalising” rules and recommends that the Financial Conduct Authority (‘FCA’) lifts the suspension requirement.  The FCA introduced the suspension rule in 2018 to set up barriers to a wave of smaller SPACs listing in the UK, but it has also put off larger blank cheque companies from choosing London.

Indeed, so far this year there have been no SPAC listings on the London Stock Exchange this year.  Although London has long been the capital of finance, it has been at risk of losing its crown since Brexit, something not lost on Ministers and senior City figures. 

In January, London Stock Exchange Chief Executive David Schwimmer said: “Britain should replicate New York’s “blank check” listings to boost London’s appeal as a global financial center after Brexit… SPACs have clearly taken off in the U.S. markets. There is increasing curiosity and potential interest in seeing more of them here.”  His comments were later echoed by the former London Stock Exchange Group’s chief executive Xavier Rolet, “The U.K. needs to promptly consider the SPAC revolution…The U.K. government should move quickly to embrace blank-check firms and cryptocurrencies to help the City of London flourish in the post-Brexit era.”

I was speaking earlier today to a leading business journalist who’s always well informed and is convinced that it’s only a matter of time before we see the first SPAC transaction in the UK.  So, watch this SPAC-E.