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Winna Brown

You’re listening to the EY NextWave Private Equity Podcast. I’m Winna Brown, and I’m your host.

In 2021, more than 40% of new public companies listed through mergers with SPACs. While SPACs have been around for decades, the boom of the last few years has dominated its narrative in the marketplace. Today, there are hundreds of SPACs seeking transactable targets that face potential liquidation in the next year or so if the deals aren’t made. Against this backdrop, SPAC sponsors are operating in an extremely choppy market environment for SPACs and other issues. And recent proposed SEC regulation has increased uncertainty in an already uneasy deal-making environment.

Today, I’m pleased to welcome back Karim Anani, EY Americas Financial Accounting, and Advisory Services Transactions Leader, and Mark Schwartz, Head of IPO and SPAC Capital Market Advisory. Together, we’ll explore how SPACs remain highly relevant in EY dialogue with operating partners and their backers, despite the market and regulatory headwinds.

In 2020 and 2021, SPACs (special-purpose acquisition companies), saw unprecedented growth and, in fact, SPACs represented about 15% of all private equity exits in ‘21. So perhaps you can give us a bit of a sense of what the current state of play is in the SPAC world.

Mark Schwartz

So, happy to. It certainly was a wild 2020 and early 2021. Now and pretty much since then, we’ve been in a period of much more, I’ll say, subdued and uneasiness in general. So just to back up for a second, record activity in ‘20 and ‘21: 850 SPAC IPOs, 350 plus announced SPAC mergers. The activity was so good that today we have 600 active SPACs with $160 billion of cash looking for targets and they need to deploy that money over the next four or five quarters. During that period, and we’ll get to some of the uneasiness in a second, but during that period, the product became so mainstream, that in 2021, SPACs were about 40% of the new public companies. But then beginning, call it the second quarter of 2021, some cracks emerged. There was the SEC Warren accounting issue, hundreds of restatements in connection with that, SPAC stock prices really started trading off, litigation ticked up and then we entered the current period where there are some new SEC proposed rules that are creating a whole lot of uncertainty.

Brown

Okay. Well, let’s just dive a little bit deeper. Mark, you mentioned the SEC, and the new SEC rules, Kareem, maybe you can give us some highlights around some of the most significant changes that are coming through from the SEC and how are they going to impact the attraction of the SPAC market going forward?

Karim Anani

Thanks for that Winna. And yes, the SEC has published some proposed rules and they focused around different components of the transaction. Some of it is on the deal-making side and ensuring that the investors in the SPAC, as well as pipe investors and other potential retail investors that may be looking to acquire shares pre- or post- de-SPAC — understand what the economics look like for the SPAC sponsors, what dilution looks like, what cost of capital may be, etc. That information is more or less disclosed in today’s filings but making it more prominent and easier to follow is something that is being looked at and should be helpful. In addition to that, some of the safe harbor protections that SPAC sponsors and operating companies have been utilizing are being revisited — the use of projections and how much scrutiny should be subjected to that from the bankers and should the de-SPACed side of the house be subject to something akin to an underwriter’s liability when they, when an IPO’s undertaken. So, trying to take some of the rules that they’re specific in the IPO world under underwriting and diligence, etc., and applying them to the M&A side of a de-SPACed transaction. Also, more scrutiny on the projections that are shared with potential investors, what’s disclosed in pipe decks, etc. How much diligence needs to be done there, as well as, having potentially independent third parties think about fairness opinions that are involved with these de-SPACed mergers. What does that do? I think it makes the product, it will take a little bit more effort in places to undertake a transaction, so more effort, more leg work, from all parties involved, that would also include auditors who maybe look to render comfort letters, attorneys who may have to render legal opinions around the transaction. This is something that has not been needed in the past. The additional disclosures, etc. But it should kind of just say, hey look, the level of the effort’s going up and what impact it has on deal-making. It in, by itself, it won’t have a specific impact. You have to look at the kind of market conditions, what the true cost of capital is, and how easy it is to undertake a transaction, as a de-SPACed transaction. But also, where the availability of capital is, etc. It’s easier to access capital in the private markets that may impact SPACs whether or not these rules are passed, for example. But the access to capital at the end of the day and the related cost of capital will play a major role on how the SPAC market kind of, you know, stabilizes, grows, decreases in size. We don’t believe that the product’s going away.

Brown

So the rules are going to be a little bit more onerous, potentially, and getting a SPAC listed will be a bit, perhaps take a little bit longer, and will involve some more costs and advisors along the way to make things a lot more transparent, if you will. But ultimately, the basic market principles around access to capital and, you know, how robust the markets are, those are really the underlying factors as to whether or not you’re going to go down a SPAC route or an alternate sourcing of capital for your needs.

Anani

That’s right. And yes, definitely agree that there might be some additional costs that come with a de-SPACed transaction as opposed to the length of time, once this gets incorporated and becomes a normal course of business, more or less. If it’s going to add time, it shouldn’t be much because these are just kind of more check-the-box items, a little bit more diligence that needs to be done here or there. But if it’s done at the normal course, I’m not so sure it will add an extended period of time on the de-SPACed side of the house.

Brown

Okay. Interesting. And then, so Mark, I mean we’ve been seeing a lot of news in the markets around the IPO markets slowing, the SPAC markets slowing, so how are companies actually approaching the public markets more broadly? I mean, we have direct listings, the IPOs, the SPACs, what are you seeing in terms of activity and in terms of market appetite?

Schwartz

So, it’s a good question. I think it’s a fascinating time because, obviously, SPACs are facing some of these challenges at the same time the IPO market is largely closed; it ran into some trouble towards the end of last year, beginning of this year, it is way down. Year-to-date I think IPO activity is down 90% or so. And frankly, if you take a look at the performance of the 2021 class of IPOs, a very large class of IPOs, and you take a look at their stock prices through today, they’re down 35% plus depending on the day. And the interesting part is that as companies are thinking about this private to public transition, the IPO market, in general, is affected by a whole bunch of extraneous factors, like volatility in the market, inflation fears, interest rates, recession fears, some of the geopolitical stuff and, in large part, the selloff in the growth stocks that began towards the end of last year. The difference between that and the SPAC side of the house, is that SPACs really need to transact regardless of what’s going on in the market or sponsors will lose a whole bunch of at-risk capital, in a lot of cases it’s millions of dollars, and sometimes tens of millions of dollars, per SPAC vehicle. That leads you to a place where companies that are thinking about going public are not facing the greatest of choices. Right now, a lot of them are thinking more about private capital raised, the discussion around strategic transactions, and M&A has ramped up. But when people are thinking about the public side, it’s largely a very challenged IPO market, as well as a very challenged SPAC market.

Brown

Okay, so what’s going to happen to all of these SPAC vehicles that are looking for a home, looking for a transaction? If the public markets are really tough, will it make, even just doing a SPAC, less attractive because, ultimately, once a SPAC is completed it actually is a public company? And if the markets aren’t that great, does it still make it attractive? Or will companies be seeking private capital? Which, you know, private equity has lots of dry capital out there. So, just kind of trying to understand what your sense is on where you think companies are going to look for that capital to continue their growth ambitions?

Schwartz

Before I start, Kareem, you should jump in, but listen, the SPAC path is, it’s fascinating because companies that need or want a public listing and all the benefits that come with a public listing, like liquidity and access to capital, even in today’s market, and even with the new regulations and some of the market, I’ll say, downdrafts; SPAC deals are still getting announced, they’re getting announced at reasonable, or what I would call, reasonable valuations in the market to attract longer-term investors. For the economics built into the SPAC structure are getting, perhaps more negotiated than they had even historically, but ultimately, if you have a company that should be public and is ready for the public markets, they need to look long and hard at the IPO path and the SPAC path.

Anani

Yeah, I’ll also add that pricing an IPO in very volatile markets, like we’re seeing today, is typically a non-starter. There are always exceptions to the rule, but typically, a non-starter. With the SPACs, and you know, Mark mentioned a number of SPAC vehicles out there, they’re all on a shop clock and have a finite life. What happens to them, they also get done, we think that certain SPACs will have to liquidate, maybe a larger percentage of liquidations towards the end of this calendar year and going into the next calendar year than we’ve typically seen before. I mean, the absolute dollar basis to liquidations will be higher, just because there’s a mountain of SPACs out there looking to do deals. And the 500-600 active SPACs are not going to see 500-600 announced in closed deals in the next 12 months. That being said, as Mark mentioned if you are looking to take a company out and you’ve got a very strong SPAC sponsor with the right amount of capital backing, yet certain SPACs have four purchase agreements that can guarantee minimum cash conditions. We’re seeing a lot more, you know, the pipe market is in flux, the financial and then the investors in pipes have diminished in size from where they were 12 or 18 months ago. But you’re seeing strategics come in and fill some of the void if the valuation of the company looking to SPAC is appropriate with upside and has a history of meeting and maybe beating expectations, deals will get done. The good news is, in a SPAC transaction, you have one party that you’re really negotiating with, kind of in an M&A setting, and then taking it forward for potential, kind of institutional investors to come in and look to close it. The volatility in the market has an impact, clearly, but nowhere near as pronounced an impact as if you were trying to go out and price an IPO. So, SPACs have that small, distinct advantage when it comes to that kind of angle in the market. But a company that can go public should be evaluating the IPO path, the SPAC path, and look at understanding the economics. And then, also if they’re looking to take, just raise capital and stay private. So, the options are good.

Brown

So, in light of what you’ve just said, do you think there’s any particular reason why a SPAC would be particularly attractive for private equity to use as an exit? I mean, to your point, there are multiple options. Are there specific nuances though, about a SPAC, that make it really interesting?

Anani

Well, I say the more complicated the story that you’re trying to weave, the better the SPAC investment vehicle is for a private equity firm. Let’s say, for example, you’ve got two or three disparate businesses, stand-alone businesses. They could be under, owned by the same investment fund, a private equity owner, or multiple private equity owners, but they believe the synergies of putting these companies together and taking them public in one go, you couldn’t do that in the IPO setting, you’d have to do a roll-up, it would take a period of time and kind of go in that manner. Well, guess what, you could kind of take two or three companies — you could do more, but it would be too complicated of a story — you could do two or three operating companies, put them together with a SPAC, bring in the financing, reshuffle the deck if there’s debt on those PE firms, portfolio companies balance sheets — that’s a great story for SPACs, in fact, some of the most successful SPAC deals have involved PE owners with kind of a combination of multiple assets. You can’t do that in an IPO setting. Number two, foreign companies —  we’re seeing a lot more foreign companies tap the US public companies. It’s a harder story for a foreign company unless they’re very well-known and have got a great name brand to list directly on the US exchange, but going through that PE via, going through that SPAC vehicle, is a real option. We’ve seen a lot of foreign companies kind of look to tap in for the higher value which is what they would receive. There are other instances where going public it’s just simply a non-starter. It could be, you know, you need the liquidity and there’s ownership stakes of foreigners, who are not regulated business and you’ve got to take that ownership out at the same time you list, we’ve seen that. In certain Fin-tech and financial kind of companies and you just need to reshuffle or restructure at the same time you go public. That SPAC vehicle gives you that opportunity to effectuate some legal manifestation and engineering to allow for something to move forward. The capability to adapt the SPAC merger terms and agreements, ownership structures, carrying, etc. are to the order of infinity. Theirs is no one SPAC deal out there. There have probably been 350 closed SPAC mergers over the course of the last three years, not a single one looks like another. There are always nuances and instances. So, the amount of financial engineering can effectuate between legal entities, etc., allows for the vehicle to be more versatile than anything out there when you’re looking to tap a public listing of some sort.

Schwartz

When we talk to private equity sponsors, the one feature of the SPAC that makes it highly attractive for companies in general, and for their owners in particular, is something also that, you know, not going to go away as a result of those SEC rules. With the ability to get certainty earlier in the transaction around whether or not you have a company that is going to, called, “make it down this path and enter the public markets,” because of the way the SPAC is negotiated, the SPAC deal gets negotiated in private, ahead of a public announcement, with a signed business combination agreement, ahead of effectively announcing to the world, for many owners, including private equity, for many owners, that’s an extremely attractive aspect of these transactions.

Brown

Okay, so you almost get to test your equity story and the viability of the company you’re looking to bring public, privately? And if it resonates and it has strong support, then, you know, it almost kind of gives you a sense of what, how your company is going to perform post-close, and once it’s public, is that what you’re kind of getting at?

Schwartz

That’s right. In some ways, owners and companies can be opportunistic, by testing the SPAC path, and see if there’s a deal that’s attractive to them to get done, as opposed to how, I think, a lot of private equity firms view the IPO market, especially in a window like this where it’s very challenged, which is, we can spend a whole a lot of money, all upfront, and kind of put the company through a very, very long pre-IPO preparation process, and never know if you’re ever going to file publicly, launch your roadshow or price of a transaction.

Brown

Okay. And I think the other point that I wanted to draw on that Kareem mentioned, well I guess both of you mentioned, what’s unique to SPACs is that you can, you actually do put projections out. And so, when you have a very complex deal, or you’re trying to bring together a number of different companies, it allows you to tell your story a lot better and it allows you to give a vision or in a picture of where the company’s going to go to, in a way that, in a normal IPO you could not do. And so, I think that is very much a tick, if you will, in the SPAC route.

Anani

Yeah, absolutely, Winna, I think that’s the right way to look at it. And if they’re all awaiting your options, it’s really important, sometimes, you know, somebody’s like, the market’s not doing good, can’t do an IPO; or I’ve heard some negative news on SPACs, we’ll just wait to IPO. But there’s no basis, there’s no homework that’s been done to arrive at that conclusion or I read an article on a webpage that said SPACs are dead, you know? You kind of hear that and you go, well, should I pursue it, or I should I not? A product’s been out there, the product’s been out there for more than 20 years and has been used successfully and if a deal is constructed well, all the economics makes sense, etc. So just do your homework, is our suggestion, really understand what your cost of capital is? What are the benefits? What are the pros? What are the cons? We spend a lot of time working on educating operating companies, as well as SPAC sponsors, look here’s the art of the possible, here’s what you need to look at, here’s what you need to consider, and here’s a compare and contrast, and then you can make a decision that either we move forward or not.

Schwartz

I like your point around the projections being kind of a differentiator. Obviously, we’re at a bit of a crossroads, and this goes back to what Kareem described at the beginning, which are the proposed rules and the potential impact that they could have amongst the more significant rules is taking away the safe harbor around projections, or potentially taking it away, as well as adding in this liability for financial advisors. Even during this interim period, prior to the adoption of new rules, we’re seeing the banks, in particular, act in a whole bunch of different ways. Some are sort of walking back from SPAC ideas, some are walking back from SPAC financial advisor assignments, but everyone is being more cautious around stepping up to diligence efforts, some of the banks are installing new committee processes in this. So totally agree that projections have been and will continue to be a differentiator for the product. How and in what way and in what shape and form they end up making it out going forward, I think is still an area that needs to be settled.

Brown

Okay. We’ll have to bring you guys back once the rules are sorted so that we can actually unpack what the ripple effect is across the SPAC market. So, shifting gears a little bit, let’s talk about the sponsors. How are sponsors reacting to the challenges in the markets? So, you know, rising interest rates, rising inflation; how is that impacting the way they’re thinking about SPACs, and perhaps, creating and thinking about creating new SPAC vehicles?

Anani

I’m saying it depends, you know, the SPAC sponsors who have turned out vehicle after vehicle after vehicle have slowed down, I think. The primary reason is there’s a lot of SPACs out there, right, so putting out another vehicle when everybody’s rushing to make a deal happen while they’re life span is shortening makes no sense so they’re being a little bit more cautious here. I also think that they’re studying the new rules and how that may impact them instead of just going ahead and raising two or three more SPACs, it’s like, okay, well let’s wait and see what happens and let’s take it a very deliberate point of view. We find the SPAC sponsors who are shale SPAC sponsors are very thoughtful, they think about different angles, a lot of them are private equity backed SPACs at the end of the day, and so, looking at the market, looking at what the market may bear all comes into play here. We haven’t seen anybody say, all right, we’re just going to stop, you know, the more prominent SPAC sponsors that put out serial vehicles are still only game at evaluating it and, you know, just taking their time to say, all right, what do we de facto back in? Most of them have activity close to the market right now, where they need to close mergers on, so no need to launch two more while you’ve got maybe one or two in the choppy markets that we see today.

Schwartz

And I agree with that, Kareem. In terms of what we’re seeing on a daily basis, we are seeing, I think partly because of the large number of SPACs and the time horizon that they have, we’re seeing companies receive more and more “hello-eyes,” sponsors are aggressive, sponsors are trying to move away from exclusive type arrangements because they need to get a deal done. Sponsors, in general, I think, are willing to negotiate, want to get to the right deal, want to get to a good deal. It’s been very long patterning that there are forfeitures in these deals, there are earn-outs in these deals. I think we’re starting to see some lockups get extended. We’re certainly seeing the use of a lot of structure capital in putting these deals together, and I think that’s going to continue. But in general, I think as an overriding theme, I think sponsors out there are more focused on finding companies that are transactable in the near term, and by transactable I mean they’re looking for companies that either have PCAOB audits or the way to PCAOB audits, they’re looking for companies that have financial projections that are rigorously prepared, documented, supported — companies that are really kind of on their public company journey.

Brown

Okay, so it sounds to me as though sponsors continue to be supportive of the SPAC market, it’s just a case now of, you know, markets have slowed down a bit, they have a lot of deals in play, there’s a lot of SPACs looking for homes. And so now, it’s just a case of really evaluating and, you know, making sure that you’re doing the right deals and picking the right vehicles in order to consummate the deals, as opposed to just this, you know, to your point, just trying to create more and more when things have already slowed down. Not sure if that’s quite right. Am I taking that the right way?

Schwartz

I would say the serial SPAC sponsors absolutely, also the size of the average SPAC rates has decreased over the course of the last four to six months. You know, if you’re a first-time SPAC sponsor and you’re entering into this market, how much experience you have in this SPAC market is anybody’s guess, because you’re a first-time SPAC sponsor. But when you look at the larger financial institutions sponsoring SPACs or shale-SPAC sponsors, being a little bit more cautious right now as one would expect.

Brown

Yep. Well, that’s just in line with where the market is right now. So, okay. So now the really tough question to both of you. I’d like you take a look into your crystal ball and think ahead to the next year, two years, where do you see the SPAC market evolving to? How do you think it’s going to mature over the next couple of years?

Anani

I’ll go first. I think the number of SPAC vehicles out there at any point in time will decrease dramatically. The amount of formations that we saw of SPAC vehicles in late 2020 and the first quarter, three to four months of 2021, will not be repeated as the sunset items because they’re getting deals done or because they’re liquidating over the course of the next 12 months will decrease the number of SPACs out there. Number two, the average SPAC-IPO race as I just mentioned has come down, we’re well over the $300 million mark, approaching $330–$340 million average SPAC size in 2020 and early 2021. I think you’ll see that number kind of fluctuate down to that $175–$225 million mark on average. The number of very large-sized SPACs that, raising over $500 million in one go, I think will decrease even more; there’ll be a few of them, at most, come out annually. The amount of innovation and engineering that goes into these SPAC deals has always been high and it’s been increasing the ingenuity that comes with has been increasing as, you know, different law firms, banks, etc., have really got familiar with the product over the course of the last 24 months, I don’t see that stopping. Trying to figure out the path forward and fitting the different pieces of the puzzle is something that we expect to see, we expect to see different types of deals being struck, the complexity of deals may be going up, and that’s what we will see in the next 12 months. Probably also more foreign companies looking to tap the domestic SPAC market as well.

Brown

Okay. Mark, your thoughts?

Schwartz

So, I agree with all of that, and Kareem and I spend a lot of time thinking about these things. I think in the near term, we need to see some clarity on the new SEC proposed rules. We need to know how the proposed rules differ from the final rules, we need to know if or when they’re adopted and what the transition state is, etc. As we continue to look for that clarity, we also need to work through this wall of capital that’s out there, that we talked about. Yes, I agree with what was said before, which is there will be more liquidations in an absolute amount and number than ever before. But deals will still get done. I hope to see them continue to come at reasonable valuations. They will continue to be heavily negotiated, with lots of structured capital here, like Kareem said, lots of bells and whistles, backed stocks, lines of credits, etc. Ultimately the SPAC market does need to find a more steady state. Like Kareem said, there’s not going to be 600 active SPACs, perhaps for a very long time, if ever. You know, I don’t know if the number is 50, 75 active SPACs, but they will be higher quality SPACs. They’ll be SPACs from sponsors that have field experience; they’ll be SPACs with sponsors that have access to a lot of capital alongside of them. And I also agree with what Kareem said around the complexity of transactions. The SPAC vehicle, I think, is tailor-made for highly complex situations, multiple entities, large acquisitions, call it, “shortly before they go public,” may be less of a path or runway to demonstrate some integration or some of the synergies in these acquisitions. So long-winded way of saying, I think the SPAC market has a lot to figure out over the next couple of quarters. My experience dealing with these things for a long time is that SPACs are very much like balloons, as you squeeze them, they kind of pop out in a different direction. They’re very adaptable. I think it’s a fascinating time for SPACs to be going through, but I think it’s probably going to be a transformational stage, especially with the IPO market as challenging as it is but looking forward to seeing what comes out on the other side.

Brown

Excellent. Well, thank you both for your perspectives. Really looking forward to seeing the directions that the SPAC market takes as it matures. Appreciate your insights.

Anani

Thanks for having us on.

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