AND MAX HILL

Estimated reading time: 4 minutes

The article in brief:

• The SPAC market is currently facing challenges including high liquidation rates, high redemption rates, and increased volatility due to longer SEC approval timelines and lower floats.
• Between 2020 and 2022, over 1,000 SPACs IPO’d, leading to a gold-rush atmosphere, but many SPACs are now struggling to find targets as their deadlines approach.
• As of July 2023, approximately 32% of SPACs issued in the 2020-2022 period have liquidated, which is double historical levels, and there has been an increase in deal failures.

Currently, the SPAC market is facing various challenges:

• High liquidation rates.
• A high redemption rate where shareholders opt to take cash in trust vs. participate in proposed business combinations.
• Meaningful spikes in volatility caused by the longer SEC registration approval timelines and lower floats due to the higher redemptions.

In this first of our two-part discussion on the state of the SPAC market in 2023, we discuss the high liquidation rate relative to historical levels.

From SPAC Surge to Sea Change

2020 and 2021 represented historical growth in the SPAC market, with 248 and 613 SPAC IPOs, respectively. Between 2020 and 2022, more than 1000 SPACs IPO’d, with more SPACs created in these two years than in the previous 20. Due to this new flood of SPAC supply chasing what was ultimately a finite pool of private companies looking to go public, there was almost a gold-rush-like atmosphere. This atmosphere caused the SEC to step in and meaningfully extend its review times for new deal mergers, and this pressure caused the market to stall in mid-2022. At that point, fewer SPACs were being issued, and deals took longer to complete, but most SPACs still had time to find a target and complete a business combination. However, SPACs have started pushing against combination deadlines as that time has eroded.

Traditionally, SPACs had between 1.5 and 2 years to complete a business combination. That time is running out for most SPACs, and most potential targets have receded into the background. These pressures, lower level of retail interest, and institutions pulling support from the space via a lower volume of PIPE funding and higher redemption rates when deals do close, which we will cover in our next discussion installment, have led to the liquidation wave currently hitting the market.

Riding the SPAC Liquidation Wave

As of July 2023, of the ~860 SPACs issued in the 2020 to 2022 period, 277 or ~32% have liquidated, which is already approximately double the historical levels before 2020 (SPAC Insider reports ~13% for all SPACs issued from 2009-2019).

Breaking these levels down further, of the 248 SPACs issued in 2020, 57 (or ~23%) were liquidated. Of the 613 SPACs that IPO’d in 2021, 162 (~36%) liquidated.

Additionally, the announcement of a target isn’t the value signal it used to be. In years past, it was assumed that SPACs would almost always close their announced target (>90% success rate), but recently, we have seen higher rates of deal failure after target announcement: In 2022, 94 deals closed while 20 liquidated with a target announcement, a failure ratio after the announcement of 17.5% (and 124 SPACs liquidated without an agreement). In 2023 (through July), the ratio increased to 34.8% as 45 deals closed while 24 liquidated after a target announcement (and 116 SPACs liquidated without an agreement).

Ignoring vintage, in aggregate, in 2022, 238 SPAC deals liquidated or closed a business combination. Taking account of these 238 SPACs, 94 closed business combinations and 144 deals in total liquidated. This implies a ratio of ~1.5x the number of liquidations versus combinations. In 2023, with 185 events through July, this ratio expanded to 3.10x as 140 liquidations occurred relative to just 45 combinations.

Ultimately, most SPACs issued in 2022 are still in their search phase, so there is time for the tide to turn. Still, based on 2020 and 2021 vintage deal liquidation levels, we expect to see the percentage of liquidations increase, especially considering the ratio of liquidations to consummations illustrated in the data so far in 2023. This sentiment echoed in conversations with our clients who invest in this space. In the recent words of a manager for a client who held > 50 SPAC positions at the cycle’s peak, “… everything is dead in the water”.

Charting SPAC Post-Liquidation Waters

How is the market adapting going forward? New SPAC deals generally have a more limited business combination window of 12-18 months, reducing the needed upfront capital to run the search process. SPACs also now include more flexible provisions allowing SPAC management to extend the SPAC’s search period unilaterally for shorter or more prolonged periods as agreed to by shareholder vote. We’ve also seen private placement investors pushing for more limited forfeiture clauses and PIPE providers pushing for more enhanced economics, such as grants of Founder Shares when the commitment is called.

Ultimately, this liquidation wave shows that there was meaningfully more execution risk investing in this market than many founders and investor partners originally considered. For instance, during conversations with certain investor clients between 2020 and late 2021, execution was regarded as a near certainty (note: other VRC clients did understand that this was likely not the case and had a more cautious outlook). Clients with the rosier outlooks at the time have since left the market.

These shifts in sentiment and performance have had a direct impact on our valuation inputs, as well. Our review scope includes all securities considered private or illiquid in this market, including Founder Shares, Private Placement Warrants, PIPE commitments, and De-SPAC shares still in lock-up. Relative to earlier in the SPAC cycle, we now assume a lower likelihood of deal likelihood from the start (pre-target announcement), and we assign a less meaningful increase in deal likelihood following a target’s announcement (where previously we would assume up to a 95% likelihood of close following announcement, we now shift to lower to a ~65% expectation, reflecting recent higher combination failure rates).

Generally, while the potential rewards were always relatively high, the apparent increase in execution risk to capital for Founder Share investors and Private Placement Warrant purchasers now merits a higher return requirement than previously assumed. This is especially true in the context of weak De-SPAC performance for deals that do close.