By Lene Powell, J.D.
The hot IPO and SPAC market is likely to continue but SPACs may see some regulation around disclosures, panelists at a Practising Law Institute conference said. While some may call for SPAC investments to be restricted to accredited investors, educating retail investors and providing specific comparable disclosures could help protect investors while still giving them access to invest in SPAC IPOs. Some expect to see SEC rulemaking relating to SPACs next year, but the impetus for rulemaking might depend in part if the market stays strong or fizzles out.
The panel “Developments in the Capital Markets” took place on November 3 at PLI’s 53rd Annual Institute on Securities Regulation and was moderated by Jeffrey D. Karpf, partner at Clearly Gottlieb Steen & Hamilton LLP.
IPO boom persists. Last year’s feverish IPO activity has extended into this year, said Karpf. The number of IPOs filed this year has increased 115 percent last year, and the dollars raised this year to date is close to double last year’s amount.
This boom is likely to continue, said Kristen Grippi, senior managing director and head of equity capital markets at Evercore. The markets have been strong overall, and IPOs tend to lag the market. The average harvest for an IPO is two to three years after the process is started, and there were a lot of investments made in 2018 and 2019. So overall, the strong IPO market is likely to persist.
One exception, however, is in so-called “quick flip IPOs.” Here, buy-side investors have not been seeing private equity firms do much to revamp the companies they are taking back public, and returns have been less than stellar, said Grippi. Compared to 20 to 30 percent outperformance by IPOs on average, average performance for quick flips is up only about 12 percent after IPO. So, interest may be cooling in this area, said Grippi.
IPOs involving technology and healthcare companies, particularly life sciences/biotech, have continued to dominate the IPO market as they have over the last five years, making up about two-thirds of the overall capital markets calendar, said Grippi. There was also a resurgence in 2021 in the consumer sector, possibly due to demand from the stay-at-home trend. Issuance was up 50 percent. Industrials have also seen a small surge, particularly in sectors like building products, as part of a thematic play around infrastructure.
The follow-on market has been roughly comparable to what we would have expected 2019, maybe a little bit above from a discount perspective and a little bit wider, said Grippi. In biotech, follow-on offerings have come fast and furious, but have come at prices a little more dear. The average issuer is now looking at a discount in the teens to 20 percent, rather than in the five to 10 percent zone. In the technology sector, issuers moved away from a traditional “regular way” follow-on and moved instead to alternative ways to raise cash. At-the-market (ATM) offerings are in vogue in technology, with tech firms doing convertible bond issuances straight out of the gate, instead of after an IPO and a follow-on offering or two as previously.
SPACs. SPACs have seen a “really wild ride” over the last 18 months, said Sarah Solum, U.S. managing partner and head of U.S. Capital Markets at Freshfields Bruckhaus Deringer US LLP. SPACs were initially reinvigorated or popularized by a few prominent investors, but since then everyone wants to get on the bandwagon, including celebrities. Private company targets have been attracted by all the SPACs competing to give them money, as well as the benefit of locking in a valuation compared to an IPO, where the valuation is not locked in until the end of the roadshow. The appetite for SPACs did however see a decline due to market saturation as well as SEC scrutiny, said Solum.
Putting some numbers to the boom, Grippi said that in Q1 of 2021 there were over 30 SPAC IPOs a week. In her view, if there were 30 regular way IPOs a week, there are not enough good companies in the world for that to happen, and the same has to be true for SPACs. Then, however, SPAC IPOs ground to a screeching halt. Recently, SPAC IPOs have rebounded to a healthy level of between about three and seven SPAC IPOs a week. Many of these are for purpose-driven SPACs, in which the SPAC announces an aim of a specific sector or type of company for a target. For example, a SPAC will say it is looking for a specific type of software company, or a specific consumer.
Grippi expects to see repeat SPAC issuers like large banks continue to raise money, some of which have been at this for over a decade. There may be a trend of changing from being led by a specific individual who was a great private investor, to being led by a board of ex-operating executives. More banks may begin to emulate this strategy, because the specs that have real operators at the helm rather than just good investors at the helm have tended to perform better, said Grippi.
On the appeal of SPACs for companies, Grippi said that one advantage that SPACs have previously offered—rapid time to IPO—is diminishing due to the SEC slowing down the process for de-SPAC transactions. Before, a de-SPAC transaction could be as fast as three to four months, but that has now expanded. The going assumption should be it is at least a half a year, said Grippi.
Regarding the appeal of SPACs for investors, Grippi said that back in the first quarter of 2021, you would invest in “go anywhere” SPACs because the average one-day SPAC return from the IPO to one day post was about 7 percent. If you were in the game of just essentially day-trading, this is a not a terrible return. For some of the hedge funds, including the so-called “SPAC mafia”, they would go in for at least 5 percent. In contrast, for purpose-driven SPACs, the strategy is more buy and hold, and stay invested in the company when the shares convert. It is a smart strategy, you just have to have a lot of faith in the person you are investing with, said Grippi.
SEC scrutiny of SPACs. Solum said the SEC’s guidance about the accounting treatment of warrants caused hundreds of restatements and caused new SPACs to change the terms of their warrants to get equity accounting. In addition, the SEC has brought enforcement actions against SPACs, including the Momentus action.
The SEC has also really amped up the comments they give in connection with SPAC IPOs, especially in connection with the de-SPAC transactions, said Solum. SEC Chair Gary Gensler has raised questions about whether de-SPAC transactions are properly treated as merger business combinations, or if they should be more like IPOs, without the benefit of certain protections that apply in the merger context or for public companies like the Private Securities Litigation Reform Act (PSLRA).
In particular, the SEC is focused on the level of care and diligence that the sponsors put into their examination of the target before they agreed to buy them or invest in them, Solum said. The SEC scrutinizes the forecasts that are included and how bullish they are, whether the risk factors are adequate, and whether factual statements in proxy statements are accurate. Conflicts of interest are also very much a focus of regulators. Solum said she expects to see rulemaking next year in the area of SPAC.
Besides the SEC, House Democrats also are focused on protecting retail investors, said Solum. She noted there is a draft bill that would limit SPAC investments to accredited investors in certain cases.
Lona Nallengara, partner in Shearman & Sterling’s Capital Markets and Corporate Governance practices, agreed that the SEC has been subjecting SPACs to a lot of scrutiny. Staff has really done what they can do quickly. They cannot write a rule in a weekend, but they can put out guidance to tell the world what they think.
Regarding possible future rulemaking, Nallengara said the SEC could require companies to make the disclosure around compensation and incentives for sponsors and other insiders in a required format. That way, someone looking at an IPO prospectus or S-4 would be able to see that information in a comparable format. More broadly, the SEC may look at whether the de-SPAC transaction should be regulated as a capital-raising transaction. Former CorpFin Acting Director John Coates made statements about what the liability perspective should be in the de-SPAC transaction, and it the question could really use some serious thought and broad consultation.
How strong the call for rulemaking may depend on how strong the market is, said Nallengara. If the market stays strong, there will likely be a lot of call for rulemaking. But if it fizzles out, the priority for SPAC regulation will fall.
Digital assets and cryptocurrency. On the question of whether the SEC has authority to regulate the crypto market as a security, Nallengara said absolutely, yes, it is squarely within the scope of what the SEC does to determine whether something is a security or not. And if you define something as a security, then you are in the SEC’s house, and you have got to deal with all of their rules.
The challenge is that the rules are not necessarily for digital assets, said Nallengara. He noted that there are 20 or 30 pieces of legislation in Congress that are trying to give some moratorium or safe harbor or other exclusions from existing securities laws. Further, Coinbase put out a policy statement that urged a rethinking of how digital assets. Coinbase accepts the fact that digital asset should be regulated and there should be some disclosure around it, including relating to conflicts of interest disclosures. There is a range of requirements that should apply, of which some of can be graphed to existing disclosure requirements. But Coinbase does not want to shove a digital asset that is not fit for an S-1 disclosure, said Nallengara.
Retail investors. The last year has seen a massive increase in the retail investors interest in single stocks, said Grippi. In May 2020, on any given day, about 20 to 25 percent of all shares traded in retail hands. Previously, between about 2000 to 2015, the percentage of shares held by retail investing in some deals had gone all the way down to three to give percent. Now, with the advent of a lot more Twitter-style trading, the ease of execution on various retail focused platforms, and the gamification of trading, we are seeing more retail ownership in some types of companies than we have seen in the last 20 years.
On a question from the audience about whether the increased participation of retail is a good thing from a public policy perspective, Emily Roberts, partner at Davis Polk & Wardwell LLP, said that it is the ideal to be able to go out to retail investors with an initial public offering. But retail investors tend to be more disconnected than institutional investors from an understanding of the business model, the strategy, and the risks of a company. Institutional investors have a lot of structural advantages like professional training and being able to do one-on-ones during the IPO roadshow. Robert questioned whether the remedy is to restrict the public offering to discourage retail participation, or if is there some other way to ensure that companies are able to educate retail investors to the same degree that they are able to educate very sophisticated institutional investors.
Nallengara said it cannot be the answer to restrict IPOs to institutional investors. Certainly, there are always some bad actors in some of these transactions, he said, but the reaction is to wipe out the transaction and go after the bad actors, and to tighten up the rules that may have been permitting them to do it. Nallengara does not think all SPACs specs are corrupt, and retail investors should have access to IPOs. If you have the risk appetite and the willingness to learn about the company, then you should have an opportunity to invest in an IPO as a retail investor, said Nallengara.