Impact of SPACs on Private Equity and Some Legal Issues They Raise

Special Purpose Acquisition Companies (SPACs) have a unique impact on investing and the private equity landscape in particular. In this post we’ll take a look at what those impacts are, and some of the legal issues SPACS raises for private equity (PE) firms and PE deals.

A Little Bit About SPACS: What they are and How they Work.

When private companies want to trade stock on the public market, the traditional approach is to conduct an Initial Public Offering (IPO). However, conducting an IPO is a time-consuming and expensive process. For start-ups or smaller companies conducting an IPO may simply not be feasible.

There are, however, other ways of taking a company public. One way is for a company to sell through a Special Purpose Acquisition Company (SPAC). SPACs are also commonly referred to as “blank check companies.” 

SPACs are publicly traded shell companies that are formed for one purpose only: to allow a privately held company to go public. They have a 2-year lifespan. Basically, a SPAC acquires privately held companies and brings them public. 

Because a SPAC is a shell company, it does not have an underlying ongoing business and the only assets it has are cash and certain limited investments. 

When a SPAC acquires or merges with (or “combines” with) a private company, it’s known as an “initial business combination.” The completion of the acquisition or merger transaction is referred to as a “de-SPAC transaction.” 

Like other publicly traded companies, once a SPAC is capitalized, it has to file a registration statement with the Securities and Trade Commission (SEC) and register the shares that will be sold in the IPO. Because the SPAC is a shell company that has no operating history, the focus of the registration statement is on the management team and the securities being sold. 

After conducting the IPO, the SPAC will then turn to finding a company to merge with or acquire and negotiating the de-SPAC transaction. Before the de-SPAC transaction closes, public stockholders have the right to return their shares. 

SPACs only have 2 years in which to complete an acquisition. SPAC funds are placed into an interest-bearing account that will be disbursed to accredited investors once the acquisition is completed. 

If the SPAC does not complete an acquisition within the 2-year timeframe, the funds are returned to the investors and the SPAC will be liquidated.

Once the de-SPAC transaction has been completed, the combined company becomes a publicly traded company and must comply with all securities laws. 

SPACS and Their Impact on Private Equity

SPACs have been around for decades, but, like other trends, for example, crowdfunding trends, they are seeing a resurgence in the past few years — especially in the private equity space. 

The private equity landscape has seen a considerable increase in the use of SPACs — especially in 2020 and 2021. The trend may be slowing for 2023, but the use of SPACs for private equity deals is still a viable one.  

Usually, a team of professional private equity investors sponsor or create a SPAC to find a private company to take public. The SPAC’s only purpose is to raise money through an IPO and then find a private company that wants to go public and acquire it. 

SPACs are attractive to private equity fund managers and investors with an accredited investor certificate because they are said to provide a faster and less costly means of taking a portfolio company public. In addition, they offer investors the advantage of being able to redeem their shares before the acquired company goes public. Another advantage is that the SEC requires fewer disclosures of a SPAC at the time of the IPO. 

SPACs are also attractive to accredited investors because the hold period is far less than in traditional private equity deals. A SPAC hold is 18 to 24 months, as opposed to a private equity fund, which can take up to 10 years before investors will see a return on their investment.

For all these reasons and more, SPACs have had a significant impact on the traditional private equity fund model.  

Despite their attractiveness, however, securities professionals warn that caution should be used if considering a SPAC. This is due to increased regulatory oversight, increased litigation, and because SPACs are not appropriate for all private equity investors or firms.

SPACS and Some Legal Issues They Raise

SPACs may make taking a private company public quicker and less costly than conducting an IPO, but they are not without their risks. SPACs and SPAC transactions decidedly raise a number of legal issues that verified investors and fund managers alike should be aware of.

For example, a major area of concern for, and increased regulation by, the SEC in this area is conflicts of interest. The SEC takes the failure to disclose SPAC-related conflicts of interest very seriously. 

On March 30, 2022, the SEC issued proposed new disclosure rules that will apply to SPACs and other shell companies. The proposed rules mandate specialized disclosure and procedure rules in de-SPAC transactions. In addition, at the point of an IPO, the new rules would require that SPACs make disclosures regarding the sponsor of the SPAC, any potential conflicts of interest, and dilution of shareholder interests. 

On top of that, the rise in popularity of SPACs — especially by celebrities — has caused the SEC to issue an alert warning to investors to undertake their own due diligence and not to become involved in a SPAC just because some celebrity has.

Adding to the regulatory pressures, this area has seen an increase in SPAC-related litigation. 

In addition, there has been an increase in the number of lawsuits involving SEC violations, especially regarding conflicts of interest or inadequate disclosures.

Most SPAC litigation concerns shareholder lawsuits. Failed mergers also generate lawsuits, as can situations leading to a breach of contract or breach of fiduciary duty claims. 

Many SPAC lawsuits center on M & A (merger and acquisition) issues. According to the American Bar Association, these types of cases tend to be brought by disgruntled shareholders after the merger is complete. 

SPACs have also led to securities class action lawsuits.

Unfortunately, litigation has permeated each part of the life cycle of a SPAC— from IPO to merger to the de-SPAC transaction. While litigation in this area is expected to increase, SPACs nevertheless still present a viable option for private equity investors.

Private equity is just one area of concern to both accredited investors and issuers. At VerifyInvestor.com we provide a fast, easy, and cost-effective method of compliance for companies seeking to verify their investors. At the same time, our platform shields companies from the potential risk of noncompliance and gives investors peace of mind that their information is confidential and protected.