Goldman Sachs to Wind Down SPAC Involvement After SEC Creates New Rules

It appears that the SPAC investment vehicle is grinding to a halt. Goldman Sachs provided a strong signal to that effect this Monday by officially winding down SPAC entanglements.

“We are reducing our involvement in the SPAC business in response to the changed regulatory environment,”

Maeve DuVally, Goldman Sachs spokesperson

In other words, there is more liability on the horizon due to new SPAC rules introduced by the Securities and Exchange Commission (SEC) at the end of March. In 2021, Goldman Sachs was the second-largest SPAC investor, with the underwriting of $15.4 billion across 66 SPAC launches. Citigroup was at the head of the SPAC game with $21.7 billion raised capital.

The Rise and Fall of SPACs in Corporate America

Overall, SPACs massively exploded over the last two years, going from a highpoint of 59 in 2019 to 248 in 2020, toppling all records at 613 in 2021.

The SPAC boom was bound to happen due to its benefits. Just like a regular IPO (initial public offering), SPAC (special-purpose acquisition company) is a way for a company to receive funding by returning value on investment However, in a SPAC IPO launch, the private company going public merges with a shell company to attract investors.

That technicality speeds up the whole IPO process by a factor of 3x, in addition to up-front value discovery. For instance, a regular IPO launch would depend on market conditions at listing time, while a SPAC would enable the price to be negotiated beforehand with the shell company. For this reason, there is also less cost involved in public marketing, helped by the more expedient IPO launch.

However, reliance on venture capital (VC) can also backfire. Case in point, eToro used SPAC to secure $10.4 billion last November, only for the valuation to be cut by 15% a month later. Eventually, eToro postponed its SPAC merger due to investor concerns about an overvalued market.

Furthermore, SPACs are somewhat controversial because there is no underwriting for the target company, i.e., there is no comfort letter. This means there is a lack of accounting for assets and regulatory requirements because the pre-merger shell company is, after all, a blank-check entity.

In turn, exaggerated SPAC valuations tend to underperform when the merger is complete and the company goes public, according to School of Management research:

“Firms going public via a SPAC acquisition exploit safe harbor provisions and provide misleading projections to elicit investments, especially from retail investors,”

Michael Dambra, associate professor
Department of Accounting and Law

Although SPAC cons can be a boon for some parties, the new SEC rules are set to curtail them, making this particular IPO vehicle less appealing.

Proposed SEC Rules Tightened the SPAC Noose

On March 30th, 2022, the SEC proposed a suite of new SPAC rules in a 372-page document. Here are some of the more important highlights:

• The target blank-check company would have to be registered when filing for SEC Form S-4, derived from the Securities Exchange Act of 1933. This includes all the information about the transaction, involved risk, merger/acquisition ratios and material contract info.
  
• The Securities Exchange Act of 1933 would itself be amended to restrict what kind of financial statements shell companies can provide to facilitate the merger.
  
• Tightened scrutiny on conflicts of interest. This includes commonly held fees at 5% from SPAC’s proceeds.
  
• The definition of “blank-check company” itself would be amended to increase legal liability.

The last two points are the most likely culprits for Goldman Sachs’ SPAC withdrawal. It would effectively make it so that SPAC investors would be able to sue if the shell company’s valuations are inflated. Likewise, because SPAC fees are the entry into the conflict of interest, the banks themselves would be considered underwriters, with all the liability that follows.

Speaking of underwriting and fees, the implied annual rate of return, expressed as yield to maturity (YTM) percentage, has been a mixed bag during the last two years.

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Fed Tapering Already Deflated SPACs

As the Fed’s interest rate hike ramped up this year, it was already apparent in February that the SPAC renaissance is over. With increased borrowing cost, there have been a slew of multi-billion SPAC cancellations, such as Acorns, BBQGuys and ServiceMax, to name a few.

The impending SEC rules are delivering the final nail in the SPAC coffin by elevating regulatory standards and diminishing valuation speculation.

Consequently, only established companies with a strong earnings record would endeavor to use SPAC IPO in the future.  Presently, there are 92 SPACs listed in 2022, representing an over 40% YTD downturn.

With SPAC regulatory obstacles placed in the way of investors, do you think we will see an increase in DeFi/crypto investments? Let us know in the comments below.