Over the past 14 months, there have been many changes in the world of special purpose acquisition companies (SPACs), which continue to present a desirable mechanism for accessing the capital markets. As the market continues to be shaped by mounting complexities such as increased deal competition and regulatory scrutiny, SPAC sponsors and target companies must find new ways to harness competitive advantages and secure capital.

Understanding the current state of SPACs

Deal complexity, disclosures, and other regulatory matters: The market has seen two rounds of financial reporting material misstatements that required restatement of previously issued financial statements related to accounting for warrants and the accounting for redeemable shares. While neither of these generally altered the economics of the deal or the deal terms, the disruptions are part of a trend calling for management and advisors to carefully consider all aspects of the SPAC lifecycle. This includes examining the initial SPAC structure and subsequent transactions leading up to and through a SPAC merger (or “de-SPAC”). The SPAC lifecycle continues to face more oversight as the Security and Exchange Commission’s proposed rules seek to better “align the required financial statements of private operating companies in transactions involving shell companies with those required in registration statements for (a traditional) initial public offering.” In addition, stricter disclosure requirements aim to help investors receive more transparent information regarding all aspects of the transactions, including all benefits to be received by the sponsor and selection process details such as how other targets were evaluated and why a party was not ultimately selected.

Dynamic dealmaking trends: Initial public offerings (IPOs) involving SPACs have decreased drastically thus far in 2022 due to tighter regulations, increased competition among the many SPACs seeking targets, and stricter limits on the availability of private investment in public equity, or “PIPE” (traditionally a popular component of SPAC transactions). By comparison, 2021 tallied 200 SPAC mergers and nearly doubled the prior year’s record proceeds from SPACs. Projections in 2022 are on pace for just over $20 billion of SPAC IPO proceeds—the lowest in four years. While demand for the SPAC IPO has waned, there are currently over 700 active SPACs seeking to acquire target operating companies. And although more SPACs are expected to liquidate without identifying a target, there are currently 116 live deals and over $188 billion in active capital available to be deployed, revealing that SPACs continue to be a popular alternative to a traditional IPO.

Differentiating amid the SPAC competition—four ways companies can stand out:

• Enhancing due diligence for SPAC sponsors and target companies alike. When navigating the stages of a SPAC deal, SPAC sponsors can benefit from increased rigor surrounding the buy-side due diligence process. Likewise, targets should prepare for a SPAC merger with a formal sell-side due diligence process. The process of adequate diligence allows for the target company to be properly evaluated by the sponsor across finance, operations, and any other key elements of the business as part of the selection process. Diligence provides an accurate picture of the health of an organization and its readiness to become a public company. Further, proper diligence by the target company provides more competition and allows the target company to maximize deal economics and shareholder value.
• Expanding the focus on the company’s environmental, social, and governance (ESG) framework. Investment for ESG has skyrocketed over the past year, and demand is expected to continue to grow moving forward. Marketing-making opportunities will arise from environmentally and socially responsible efforts, especially as investors and lenders continue to view ESG elements as necessary for reasons beyond regulatory compliance. As ESG literacy expands, investors will be able to make informed decisions that consider the long-term value offered by organizations—SPACs included—focused on driving positive environmental and social impacts (for example, reducing carbon footprint or improving workforce diversity and inclusion). In addition, companies’ ESG assertions will influence lender and investor relationships, especially as regulators continue to standardize reporting methods and call for disclosures to become more transparent. Anticipating this trend will enable companies to optimize positioning and improve their access to capital through strong ESG programs.
• Signaling the importance of anchor investors through sponsor concessions. SPAC sponsors can make concessions to lead investors called anchor These anchor investors typically ensure a certain amount of capital will remain with the SPAC and allow for more certainty when redemptions are announced through the execution of non-redemption agreements in exchange for incremental shares or private warrants
• Obtaining incremental funding through the SPAC sponsor. Funding can be provided through a backstop, a sponsor PIPE agreement, or a combination of both. Targets have started to request financing to be determined as part of the merger agreement with the SPAC to secure financing during the early stages of the merger process. This reduces deal risk and provides a more secure transaction with fewer variables.