Interview and introduction by Morgan Myrmo
Over the past year, special purpose acquisition companies (SPACs) have gained heightened investor interest. By May 18, 2021, SPAC IPOs have exceeded 2020 levels by nearly 30%, as SPAC-mergers have become a preferred method of entering public markets for an increasing number of high-growth, private companies.
While there have been multiple U.S. SPAC IPOs each year over the past decade, the growth in SPAC IPOs and funds raised in 2021 are on pace for annualized growth of over 300%. As of May 18, 2021, there have been 321 U.S. SPAC IPOs, which have raised $103,083,000.
The acceleration of SPAC growth has caught the attention of regulators. While SPACs got off to a great start in 2020, the market took a turn for the worse in after April 12, 2021, in response to new accounting guidance from the U.S. Securities and Exchange Commission (SEC) regarding how warrant options are accounted for. Such delays have lengthened SPAC merger timelines, as those with pending mergers have been forced to pause their timelines to respond.
To learn more about the current state of affairs in the SPAC world, from a regulatory standpoint, we joined Amy Lynch, former SEC and Financial Industry Regulatory Authority (FINRA) regulator, who currently works as a consultant with top investment firms as President of FrontLine Compliance.
Enjoy the Interview!
Interview Transcript:
Morgan Myrmo:
Aloha, this is Morgan Myrmo with iREIT on Alpha in coordination with Brad Thomas. Today we’re going to take a dive into SPACs.
I’m here with Amy Lynch. Amy Lynch is a former SEC and FINRA regulator, and now she’s a consultant with top investment firms as the president of FrontLine Compliance. Welcome Amy.
Amy Lynch:
Thank you, Morgan. Thank you for having me today.
Morgan Myrmo:
Absolutely, it’s a pleasure. Now, we’ve asked to speak with Amy today in regards to the growing popularity of SPACs and the changing landscape. As everyone is understanding these days, SPACs have been coming under pressure and a lot of it has to do with the changing landscape, and that’s what we’re going to talk to Amy about to see if we can get a pulse of what’s going on behind the scenes, and what she thinks is going to happen in the future. Amy from your understanding, can you tell us what a SPAC is and what your experience is in this field?
Amy Lynch:
So to start, I’ll tell you what a SPAC is technically. So a SPAC is a special purpose acquisition company that is formed specifically for the purpose of taking a private company public. So it’s a way to get a private company public without going through a direct listing with an exchange and going through the listing process, which can be quite onerous. So these began to be very popular as the markets began to heat up a few years ago, IPO’s are coming up for a lot of these small tech companies and the SPAC process became a sure fire way to get the smaller tech companies to the market publicly, in a reasonably quick and easy way.
So, there is a private shell company which is the SPAC, which then goes public in its own IPO. So, essentially there’s a shell company going public. It has no assets, it has no operating history but it trades publicly, typically at a steady rate of around $10 a share. And then once it finds an acquisition and it has a two year timeframe to do that, once it finds its acquiring target, it will reverse merge that company into the SPAC shell company, and then take that private company public and be listed on an exchange, and offered publicly to trade.
Morgan Myrmo:
Now with the growing popularity of SPACs, some things have caught the attention of the SEC, specifically warrants. Could you explain what warrants are versus what rights are? And what’s going on from what you see?
Amy Lynch:
So warrants are a special security type that are often attached to these SPAC deals, that allow for the purchase of additional shares at a specific price in the future. And it has been quite common to have these warrants attached to these SPAC transactions, to provide an incentive for the earlier investors in the SPAC to ensure, essentially, success in the future. So the issue that the SEC has recently had with these warrants, has to do with the accounting of the warrants and the way in which they have been described in the prospectuses, that have been filed with the Division of Corporate Finance and the Office of the Chief Accountant at the SEC. And both of those divisions are looking at the financial statements and the filings of these entities when they come to the SEC for registration. And one of the issues they have is, is how the warrant is being treated, is it being treated as an equity? Which in most cases it has been.
So that’s obviously a benefit to the company to have more equity via these warrants. Sometimes however, the SEC has said, depending on the accounting and how it’s being viewed, that these warrants are not actually equity but rather they’re a liability to the company, and therefore a detractor. And they’ve been telling certain firms that have not been accounting properly for those warrants, that they have to go back and refile their financial statements with the SEC. And they’ve also been holding current registrations for SPACs that have warrants attached to them, to make sure they have done the accounting correctly.
Morgan Myrmo:
So when a SPAC enters an agreement to merge with a prospective company that they’re taking public this way, if there’s an issue with equity versus liabilities for the accounting of warrants, it appears that it could slow down the process. Now the SECs job from our understanding, is to protect investors. So, why would the SEC want to slow down the process of investment vehicles to protect the investor by reclassifying, through filings the accounting of liabilities versus equity for the warrants?
Amy Lynch:
Well, it goes back to the financial statements of the entity itself. So from their perspective, remember, they’re looking at it purely from an accounting view. So the chief accountant’s office is saying, this is how the financial statements should be written if they’re not properly classified, and it’s going to affect the overall valuation of the SPAC. And then you’re going back to, okay, is the investor actually buying into this SPAC at the right price? So, that’s how they look at it from an investor protection standard.
Morgan Myrmo:
What is your firm’s view on this?
Amy Lynch:
Well, what we’re seeing, we have a few clients that do have SPACs and are in that market, and what we’re seeing is that because of this change in the accounting perspective by the SEC, firms are simply deciding to not attach warrants to their SPAC deals. And it’s an easy solution in many ways to not have the warrants come into play.
The real scrutiny these days, that I’m hearing from both the regulatory side as well as obviously what the media has been catching on to, is the issue of how these facts are disclosed to investors and how they’re being offered.
So a couple of issues that the SEC has with this SPAC offerings in recent history, and they’ve put out actually some investor alerts that are publicly available on the SEC website. But one thing they’re worried about is, how they’re being offered and sold. And they’ve seen a lot of celebrity endorsements of SPACs in recent history. So movie star celebrities, sports celebrities, people that have been coming out and endorsing specific SPAC deals.
And the SEC is then concerned about, does that make that a suitable investment? Because people do tend to follow what their movie icons and sports icons are saying, and they could be led to believe that this SPAC is going to be a good deal simply because a big name is attached to it. So they’ve been concerned about that. They actually put an investor alert out about that basically saying, don’t invest in SPAC because your movie star hero invests in one.
And they’re also concerned about conflicts of interest, and how these deals have been created to truly benefit the sponsors, and early phase investors. In other words, these early institutional investors that get into this SPAC in its initial days, as well as, obviously, the founders and sponsors of the deal, because they get special terms and conditions attached to their holdings in this SPAC, which basically guarantees these deals to be a win. So they’re not going to lose money. They are able to purchase shares of the stock for literally cents on the dollar. Whereas, when it goes public, it’s going to be at $10 a share, typically. So they’re already making money if they’re buying a share at 2 cents, and then it’s going to go IPO at $10 a share, they’ve already made a small fortune depending on how many shares they’ve been issued. So there’s no way for the founders to lose.
And that has been a hot topic in the industry and for the regulators, to make sure that in the prospectuses, that the average retail investor that can invest in that SPAC once it’s gone to IPO, understands that their investment is not going to be… It’s at the same terms as the initial early stage investors and they’re more at risk. So that $10 a share that they purchased, actually if the IPO shares fluctuate, because remember they have that two year grace period before they have to find that acquiring entity. So the SPAC is actually trading publicly for that two year timeframe. And the shares do fluctuate depending on the interest in the SPAC. So it can go from $10 to $12, $15, and they generally don’t fluctuate too much, but they do fluctuate. However, if you bought in at 10 and you decide later that you want to sell, Oh, it’s going at 15 now, I’m going to sell out and make my $5 share profit.
The truth is, they’re not going to get that $5 a share profit because the trust account, which acts as an escrow account for the IPO shares, is still valued at $10. And the trust account shares only fluctuate based on the value of the trust investment. So the IPO price is not actually the real price. They’re going to get the pro rata share of that trust account price when they redeem those shares. And that could only be $10 a share. And a lot of the retail investors don’t understand that.
Morgan Myrmo:
How prevalent is this in having early stage investors in the SPAC taking control of shares at cents on the dollar?
Amy Lynch:
Oh, almost always.
Morgan Myrmo:
Could you give us an example?
Amy Lynch:
So I actually did, they’re buying in their shares at cents on the dollar. So for their founder shares, being issued X number of founders shares have been issued and it will say this in the perspective, X number of founder shares have been issued at five cents a share to the founders and sponsors of the SPAC, and it’ll have other disclosure language attached to that.
Morgan Myrmo:
So for example, if Alex Rodriguez is getting a founder share and he’s promoting it where he’s getting it for cents on the dollar and then selling it, the SEC would be looking at that now. Is that what you’re saying? Or is this just retail, retail versus the celebrities and the big money?
Amy Lynch:
Well, it’s a little bit of both. I mean obviously if he is one of the founders and is getting that great deal, they’re going to look at the disclosures around that. So if he’s out there marketing it, they are concerned that the investor may not understand that their deal is not the same deal that Alex received, and they want to make sure there’s a proper disclosure’s around any associated marketing materials that explain the difference, so that the investor at least knows what they’re getting is not equal to the same deal that that celebrity received.
Morgan Myrmo:
Great. So if I’m a retail investor and I’m looking at, Hey, this is a cool celebrity or this is a cool guy that brought a big company public, that I trust is going to find something good and I want to invest with this person, how am I going to find out if this person has a vested interest easily? And then what the actual net asset value of the fund is?
Amy Lynch:
You can look at the financial statements. So the benefit of the SPAC going public is that it has to report like every other public company. So the financial statements, the quarterly reports, the annual reports of the SPAC entity itself are publicly available on the SECs website. So you’re going to look for the form 10-K, the annual statement. You’re going to look for the form 8-K, which are the updating statements and amendments to see what has happened with that entity and what the current value of the SPAC is.
Morgan Myrmo:
Great. And how are you navigating your institutional clients through what’s going on today?
Amy Lynch:
So my clients would be typically the large institutional money managers, which may be involved in these SPACs as sponsors or early stage investors. So we are recommending that they make sure that their offering materials contain all the adequate disclosures and are highlighted, and prominent in those disclosures so that it won’t get rejected by the SEC, if they’re going to file for a first-time SPAC or if they get examined by the SEC down the road, to see how they have been offering their SPACs to make sure that marketing materials and disclosures regarding any potential conflicts or related party transactions have been adequately disclosed to investors, so they understand what those conflicts are.
Morgan Myrmo:
Excellent. Well, this has really helped us understand what’s going on today. Is there any other issues or concerns that you’d like to highlight in this space?
Amy Lynch:
I mean, I think this is going to continue to be a hot topic area, and until the SEC really can wrap its arms around what they really want to see. Again, these are coming into popularity very quickly, and it was a flood into the division of corporate finance, as well as the chief accountant’s office. Really in the past two years, they’ve received a huge influx of applications for these transactions and so much so, they’ve had a hard time keeping up.
So literally, the accounting change came at a time when they needed to turn the spigot off so to speak, because they were getting overwhelmed. And this gives them an opportunity now to slow it down to a bit of a trickle as opposed to a flood, and get their arms around what they want to see, how they feel these transactions need to be shored up as far as their disclosures go to the investing public. And that really is the mandate of the SEC like you said earlier, is to protect the investor and they need to make sure that happens via proper disclosures.
Morgan Myrmo:
At Wide Moat, we track SPACs that may be interested in a real estate technology acquisition or SPACs whose management will compliment such a company and of the 43 SPACs that have not entered into an agreement, we have less than one month average time between filing for the SPAC and the IPO. For those that have filed without raising money, we have 34 SPACs. Everything has slowed down, as you’ve said. What we see here is over two months’ average time before the IPO with several SPACs in February and March that we would have expected to have already filed, excuse me, raise money, are still sitting there. Do you think this could be because the SEC is slowing the spigot and everyone’s trying to figure out what’s going on before they raise the money? Or do you think that the SPACs have reached a, maybe this is it, we have too many, let’s slow down on our own?
Amy Lynch:
I think it’s most likely the SEC. Remember the founders, the sponsors of the SPACs, have a huge incentive to get these deals to fruition. So I don’t think they would want to slow the process. I would suspect the process is being slowed on the other side by the SEC, because they, like I said, need to figure out what it is they’re wanting to really see. And by changing the accounting rules, that’s one way they need to go back and take a look at these deals and take a closer look at those financials to see that the updates that they requested has been made in the appropriate manner under the gap guidelines.
Morgan Myrmo:
Great. And one final question, where do you see this going in the future over the next five years? Do you think SPACs are here to stay? Or do you think IPO’s will come back and become more popular than they’ve been versus SPACs in the last 12 months?
Amy Lynch:
I think SPACs are here to stay but maybe the frenzy will die down. So, obviously this has a lot to do also with the market and the froth that we have seen in the market, especially the desire for test type IPO’s. So that will change by nature of the market’s changing. And now we’re coming out of a pandemic. There’s a lot of talk about inflation, we’ll have to see how that affects the market. And if the markets tend to lose some of their momentum simply because of economic changes, we may see an overall shift in the IPO market, which would also affect the SPACs.
Morgan Myrmo:
Well, thank you for your time Amy. We look forward to speaking with you again as the landscape evolves, and we appreciate your insights.
Amy Lynch:
Thank you very much for having me, Morgan. You have a great day.
Morgan Myrmo:
Absolutely, take care.
Happy Investing
Brad Thomas is Senior Research Analyst at iREIT and CEO of Wide Moat Research LLC. With over 30 years of real estate experience, he is also long-time Editor of Forbes Real Estate Investor, a monthly subscription-based newsletter that dives deep into the vast world of profitable properties, and since 2021, he has served as an adjunct professor at New York University.
Thomas has also been featured on or in Forbes magazine, Kiplinger's, U.S. News and World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. And he was the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020 and 2021 based on both page views and number of followers.
Thomas is the recently-published author of The Intelligent REIT Investor Guide (2021), co-author of The Intelligent REIT Investor (2016), and he wrote The Trump Factor: Unlocking The Secrets Behind The Trump Empire (2016) - all available on Amazon.
Thomas received a bachelor of science in business/economics from Presbyterian College and is married with five wonderful kids.
