Drew Bernstein
Doug Ellenoff shares his perspective on what’s fueled the SPAC boom and why this trend has legs
In the past 18 months, many of the biggest names in finance have embraced SPACs, as they became an obsession of both retail investors and the financial media. So far in 2021, 264 SPAC IPOs have gone public, raising $77 billion — a pace of over $1.5 billion per trading day. This compares to 71 operating companies that have IPOed thus far this year, raising $30.1 billion.
As a preeminent SPAC legal guru, Doug Ellenoff has been toiling for decades with SPAC sponsors and underwriters to refine this investment vehicle through various market cycles. His firm, Ellenoff Grossman & Schole, has served as legal counsel on 74 different SPAC IPOs in 2021 alone, more than any other law firm. So, we felt lucky that MBP’s Drew Bernstein was able to catch up with him to get his views on what is fueling the SPAC boom and if it is a bubble likely to burst any time soon (spoiler alert, Doug doesn’t think so.)
MBP:
Just a few years ago, SPACs were this arcane corner of the corporate finance market, and now they’ve blown up to dominate the IPO market in recent months and be one of these hottest trends that people talk about in investing. What do you think led to this transformation?
Doug Ellenoff:
There’s a combination of things. You have to have the proper foundation in place, and that took 20 plus years to occur. That foundation was primarily premised on sponsors using the SPAC mechanism to take private-equity-like, EBITDA-positive companies public that wouldn’t otherwise get public in a traditional underwritten offering.
Then 2020 hits, Virgin Galactic gets funded, and it captures the financial media’s attention. On the heels of that, then Bill Ackman of Pershing Square does his multi-billion-dollar SPAC. A program that had been gaining acceptability in increments was all of a sudden at the front of the stage. Different people who had reticence about the program for many reasons, most of which actually were not correct, start to take a harder look. Then Draft Kings gets funded, and then five electric vehicle companies get funded, and it goes from being a private equity program to a crossover venture financing round.
That transition has captured people’s attention.
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MBP:
As of yesterday, your firm had served as legal counsel for over 70 SPAC IPOs just in the first ten weeks of 2021. How long do you think this pace of issuance can be sustained?
Doug Ellenoff:
I like to distinguish not whether or not it’s a bubble, but how long can this pace be sustained? It will cool down. All things do. But that doesn’t somehow make the program less useful. It just means that it’s come very far, very fast.
But when you pull back, it’s not just, “Oh, this is a hot product, let’s jump into it because it’s the latest, greatest trend." There is half the number of public companies as when I was a young professional. Most of those companies are now populating private equity and venture portfolios. So, it’s a pendulum conversation.
The SPAC allows private companies to access competitive capital from institutional investors, not retail investors, in a way that hasn’t been explored previously. So, if there are 10,000 portfolio companies in private equity and venture portfolios, a few hundred SPAC acquisition financings don't alarm me. So, I don’t think the trend stops because regulators are concerned about celebrities involved with SPACs. I believe that the SPAC program has proven its usefulness and demonstrates that there are not enough underwriters willing to underwrite interesting companies and provide opportunities for portfolio managers at the largest money management firms.
But I hope that the pace will slow. We did 70 SPACs last year and 70, as you point out, in the first ten weeks of this year. So, we want it to slow!
MBP:
Can you talk about the profile of the SPAC sponsor and how that has changed? Is there a particular sponsor background that leads to success in securing an attractive target?
Doug Ellenoff:
Good question. When we first started with SPACs, these were legitimate small-business people trying to buy businesses they thought would be interesting public companies. Many people like to dump on them as if the program was disreputable back then — it's just the opposite. They were the trailblazers, and we should recognize them as such, including the underwriting firms. But they were less well-known people.
By the mid-2000s, the sponsors' profiles did start to change, and they were very successful entrepreneurs who wanted to buy businesses again. By the late 2000s, you had TPG and Apollo dipping their toes into the SPAC market. Today, every significant private equity and venture firm wants to know, "What's your SPAC strategy?" And it’s not a one-off SPAC, in many cases. They are creating institutions, what we call serial SPACs, backed by analysts and firms — it’s a new version of a private equity firm. Some people call them SPAC factories.
We have lots of SPAC sponsors who weren’t sure if they could attract deal flow. And they did one SPAC, and all of a sudden, they’re inundated with deal flow. Then our SPAC sponsors call us in a panic and want to get their second or third SPAC, or second, third, and fourth SPACs out in the market! We’ve taken to calling those opportunities twins and triplets.
MBP:
Right now, there’s over $130 billion of SPAC proceeds that need to be deployed over the next two years, with billions more raised each week. Some people have asked, “Could there possibly be enough targets to make sustainable public companies?” As an insider, what are you seeing during these searches?
Doug Ellenoff:
That goes back to my earlier answer that thousands of privately-owned companies could go public, not even counting the divisions of public and private corporations. Because we have had such a dearth of public companies, this doesn’t alarm me or concern me in any way. And the headline figure — $130 billion in your example — is a head-fake number because that’s money sitting in the trust that is subject to redemption. If you look at the cash stays in at closing the business combination as permanent capital, you’ll have a much better indication. In many cases, the SPAC only keeps the simultaneous PIPE capital.
How much value is in private equity portfolios today? $3 trillion. So, we are talking about less than one-half of 1% of that.
Now we’re taking these earlier stage companies public in a way that traditional underwriting would not. People will say, “Doug, well, these are pre-IPO ready stories.” Well, who decided that? These are billion-dollar market opportunities or billion-dollar private enterprise value companies. The portfolio managers at Fidelity and Wellington and T. Rowe Price, and Janus want access to those possible returns. Those folks are validating SPAC investors through the PIPE, not the retail investors.
So, where’s the concern there? In the aftermarket trading, we have to be a little bit more careful because of the Robinhood effect, for sure. But then they’re coming in after institutions have already placed their bets. That sounds like a pretty good dynamic to me.
How PIPEs De-Risk the SPAC Transaction
MBP:
In the past, SPAC transactions usually focused on positive-EBITDA companies. But over the last year, we have seen pre-profitable, and in many cases, pre-revenue companies coming public through a SPAC, including some of the most splashy and well-recognized names. What obstacles does that pose in terms of getting the transaction to close?
Doug Ellenoff:
It doesn’t present any because we’ve de-risked the transaction with the PIPE. You’re right that you have to make sure that the management team and the company are ready for their future public responsibilities, but frankly, that was true of the EBITDA-positive companies as well.
MBP:
One of the differences between a traditional underwritten IPO and a SPAC merger is that they have a lot more latitude to provide forecasts and forward-looking information — in many cases, going multiple years into the future. What advice do you provide to your clients regarding the liability that they’re taking on? Do you think the SEC will seek to narrow that gap in disclosure practices between these two means of going public?
Doug Ellenoff:
Your observation is fair and correct. But we’re dealing with a confidentially marketed PIPE to institutions. The numbers must have a basis in reasonableness. We ensure that the entrepreneurs lay out the assumptions in those numbers so institutional investors can do their sensitivity analyses. They can agree or disagree. They can negotiate the deal or walk from the deal. At the end of the day, the PIPE is populated by institutions. So, I don’t find it concerning in the slightest.
Those same numbers end up in the 8-K when the deal is announced for the public to see, so there’s no fair disclosure concern there. Anybody in the secondary market can see what has been provided in the test-the-waters materials.
To address the second part of your question, SPACs respond to a shortcoming in our capital markets. Rather than say, “How do I suppress the SPAC market to make it less interesting and less competitive?” Why not say, “Wow, everybody said that private companies don’t want to go public. We’ve pretty much busted that argument with the SPAC market. How do we make the IPO market more competitive? How do we improve this further?”
Even if you close the disclosure gap the way you’re talking about, I tell you the SPAC market is here to stay. The SPAC market is an outsourced underwriting function to the most sophisticated businesspeople — private equity, venture capital operators — to choose what companies they believe ought to be public. There’s always going to be a role for SPACs.
MBP:
Let’s talk a bit about the target perspective. It sounds like you have seen a sea change in the receptivity among private companies considering a SPAC for a merger now that these deals are in the news and better known?
Doug Ellenoff:
One cannot underestimate the impact that financial and social media has had on the program's awareness. A year ago, a SPAC sponsor still had to explain away the stigma and many issues relating to going public through a SPAC. Why is it better to go public through a SPAC than an IPO? Today, when our sponsors go live so the world can see they’re doing a SPAC, they’re getting dozens and dozens of requests to take meetings. That’s why I think after 25 years, the SPAC program can take a bit of a bow and say, “It really is different.”
MBP:
Is that as a result of enthusiasm by sell-side M&A bankers, or is it really that people who are running private businesses or venture-backed businesses now see this as a desirable path for their future as a public company?
Doug Ellenoff:
Well, there are several reasons, and they’re all substantive reasons. The first one is they’ve seen a lot of these stocks outperform until this recent market disruption. In the last year, stocks did a double, triple, quadruple — whether it’s Virgin Galactic, QuantumScape, Lucid Motors, even a few weeks ago. So, the targets say, “A, that’s interesting. B, there’s a lot of money to raise from these PIPEs quicker, with more certainty than running around Sand Hill Road and trying to raise the money there.”
I myself get emails every day from private companies looking for me to introduce them to SPACs.
Sponsors with Skin in the Game
MBP:
Another thing that’s changed quite a bit over the last couple of years is the SPAC warrant coverage, and to a lesser extent, the sponsor promote. What do you see in the latest crop of deals, and how do you see people trying to align the incentives better for long-term value creation?
Doug Ellenoff:
As the market matures, you certainly will see ongoing iterations as there have been for 25 years. But notwithstanding Bill Ackman’s SPAC, where he made a lot of hay about how he better aligns his interest [by eliminating the promote], it’s almost a year later, and he’s not announced a deal. Whereas many other SPACs have announced their agreements with the traditional 20% promote. What investors realize — and what the SEC does not understand when they talk about the asymmetry of the promote — is that it’s an ask. The sponsors are putting up millions of dollars to make the IPO happen, which is a binary outcome. If they don’t get a deal done, they lose all of it.
MBP:
That’s different from how it was ten years ago. Sponsors have skin in the game today.
Doug Ellenoff:
Because as we’ve gotten smarter and more reputable, the economics for the sponsors have gotten worse. Right? That’s hysterical.
At the time of the business combination, you need to look at the data to see what percentage the sponsor has to either forfeit or put on a vesting schedule tied to future appreciation. Or, if it’s a double trigger, it will also be connected to some financial metric. So, they’re not always walking away with the 20%. But they are doing quite well for themselves.
MBP:
I’d like to dig into the increase in either PIPEs or forward purchase commitments as a way to have certainty in terms of the amount of committed capital. How has that evolved, and what do you see in the successful deals?
Doug Ellenoff:
Back ten years ago, if a SPAC had a target, it would be no easy task to convince you to do a deal with me because I’m sitting on a pile of “faux capital” that’s subject to redemption. PIPEs did not exist back then for purposes of SPAC acquisitions. Once we announced the deal, we could get our deal done if the stock traded up because the money would not redeem from the trust. But if it traded down, the deal either had to be repriced, or it wouldn’t get done.
As the SPAC concept matured, the sponsors often knew the people at Fidelity and Wellington and could get them comfortable taking a look at the deals. All of a sudden, the PIPE becomes the de-risking feature of this SPAC. So, today 90% of all SPACs use a PIPE. The sponsor can now say, “Hey, sign a deal with me. We’ll say what your valuation requirement is. You get to control it, which you don’t get to in an IPO.” And the target says, “If you don’t deliver X millions of dollars, I’m not doing the deal with you.” As opposed to an IPO, which could involve nine months and many millions of professional fees upfront, we can sign the LOI. We do the confidentially marketed PIPE, and I would have the institutional investors interested at that valuation for that amount of money. Or you walk away, and it hasn’t cost you that much. So, that’s the utility of the PIPE. Institutions commit in the first instance, and then people who bought in the IPO or the secondary have the optionality to either stay in or redeem.
How Targets Can Get "SPAC-Ready"
MBP:
If a target is considering a SPAC as a viable path or even their best path to getting public, what type of work should they do to be in a strong negotiating position? Understanding that, as you pointed out, there’s a lot of potential deals out there.
Doug Ellenoff:
Nobody wants to go public for the sake of going public. It’s because you want to raise funding to accelerate your business plan. For the last year, there’s been an enormous appetite for all of these opportunities, not only electric vehicles but battery companies and many life science deals.
These are entrepreneurs who have scrambled to put their businesses together over many years, and they have a lot of work that they need to do to be IPO-ready or even de-SPAC-able. The first thing is you have to have two to three years of audited financials. And they need to be audited by an accounting firm that’s PCAOB-ready, which means that they’re SEC-approved.
If you’re really smart, you want to have your SOX Section 404 compliance in order, which means that all of your policies and internal controls are laid out, so you’re not doing that on the fly after you go public. And you’ve put together a board of directors that is appropriate for the public markets. I can say these things in a matter of minutes, but it takes hundreds of hours to implement them.
MBP:
That would then put them in a stronger position when a SPAC approaches them to be attractive and get the best valuation?
Doug Ellenoff:
And to sign a letter of intent and get in front of the investors quickly. Because if I am waiting for your numbers to get audited, I’m not going to get you in front of the investors because you’ll be "old and cold" by the time they see the deal.
SPACs Are Going Global
MBP:
Great point. Recently, there has been a surge in Asia-based sponsors launching SPACs. Why might the SPAC be well-suited to the Asian markets, and what additional obstacles do you see to completing a deal successfully?
Doug Ellenoff:
This may surprise your audience. But I think every exchange in the world should have a SPAC initiative. There are private companies across the globe. Canada has launched a SPAC program. Italy historically has done it. Hong Kong is exploring it. But for the most part, over the last decade, this has been a US game, with maybe five or 10%, at most, of the SPAC sponsors focused on buying foreign assets.
International high-end folks who have avoided the SPAC market now accept it. So, worldwide high-end private equity and venture operators are reaching out to US law firms and brokerage firms to have their initiative — whether it’s a Southeast Asian-focused SPAC, Middle Eastern SPAC, and a lot of PRC and Asia SPACs. We have Latin American and emerging markets. There will be a substantial increase this year in offshore Cayman SPACs.
MBP:
If you look at the number of SPACs in the past few years that have dissolved and returned the trust proceeds, there are very, very few. Why is that? With the explosion of funded SPACs, do you see that changing?
Doug Ellenoff:
Again, we have seen the de-stigmatization of the program this last year. It was amusing to me when former SEC Commissioner Jay Clayton made comments in October [on CNBC] that we need to add new disclosure that with all these SPACs, it’s going to be harder and harder to find a deal. That was true a year ago, but it’s the opposite now! You put out your fishing lines, and six to 10 fish are just throwing themselves at your lure. We put that disclosure in, but I just don’t believe it.
There will come a time, where it’s true. But here’s what I would say to your audience. If you’re going to sponsor a SPAC, and you haven’t done enough in your business life where people want to do business specifically with you, then don’t do a SPAC. But if you’re one of these people known within your industry, and they genuinely want to work with you — as opposed to being the lowest cost access to the public markets — then you’ve got something.
MBP:
We talked about the de-stigmatization of SPACs. And just part of the stigma is that historically SPACs, post-closing, have not generated value for shareholders. One could argue that the SPACs of the last 18 months are a pretty different animal from that sample set from SPACs in the past. But are there any characteristics you have observed that mark a deal that’s more likely to generate value for shareholders over time, as opposed to fizzle out?
Doug Ellenoff:
I want to challenge some of the assumptions of the research. I appreciate your distinction between the last 18 months and the decade prior because how do you lump it all together? But even the previous 18 months, we had insurance-tech deals, we’ve got aerospace deals, we’ve got cannabis deals, energy deals. You have to parse through the data, which everybody’s too lazy to do, and then benchmark it against the appropriate index. Then, we will have a legitimate conversation as to whether or not SPACs underperform.
In every private equity portfolio by many of these same people, you have winners and losers. So, the great thing is — and I have friends who have bought 100 SPACs — if all I ever do is buy from the IPO to the business combination and then redeem, that’s probably going to be one of the best performing asset classes in history because you don’t lose money.
But what we’re talking about is post-business combination, and then we should recognize that in the last 18 months, these are either pre-revenue or high-growth, crossover series-D-round sort of deals. You better give more time to hatch than the ones that were EBITDA-positive. I can tell you that sponsors wouldn’t be doing this if they hadn’t made much money — which was not true the prior decade. And institutional investors wouldn’t be doing the PIPEs if they had been losing money the last six months.
I think it is a fascinating intellectual exercise to determine if these sponsors who have capital at risk and understand particular industry dynamics can select deals better than an underwriter who’s just getting a brokerage fee. You have to make many more distinctions to answer that question, and I think the time horizon is not six months or a year. It’s more like three to five years.
Is There a "SPAC Bubble" Building?
MBP:
I expect you won’t accept the premise, but if some people argue, SPACs are currently experiencing a bubble, what might cause that bubble to burst?
Doug Ellenoff:
If we’re comparing it to the dot com bubble, I don’t accept that. The diversity of the companies involved are not all startup, dot com companies. I do think there’s a lot of congestion. That’s not going to burst the bubble, but it’s going to slow things down. The SPAC infrastructure, the lawyers, the accountants, the investment bankers, the transfer agents were not built to sustain this level of activity this quickly.
And the number of deals that are trying to secure their PIPEs is so substantial investors don’t have time for all these meetings. I think that that will slow it down and stretch it out. But as for popping it, it has been suggested that there may have been deals last year that had actual fraud. I don’t know if it’s true or not. But it didn’t derail the conversation. There is so much institutionalization with the sponsors, the banks, the law firms, the accounting firms that I don’t think this will burst. I think it’s going to slow.
MBP:
I notice you don’t seem overly concerned about the incentives caused by the sponsors’ promote, or the dilution to the target company?
Doug Ellenoff:
I’m glad we circled back to that. What is the one truism about companies going public through an IPO? Private companies trade at a 10-20% discount to their public market comparables. By definition, there is the “IPO pop” on the listing day.
MBP:
And there’s also the underwriter’s discount.
Doug Ellenoff:
Fair enough. So, if you are an enterprise value private company of a billion dollars, the logic goes that you'd be $1.2 billion if you were already public. Right? So, think about a SPAC merger between a billion-dollar-enterprise-value private company and a $250 million SPAC, where the sponsors have five million founder shares worth $50 million. The way they’re justifying that $50 million is out of that arbitrage to find a company with a value in the public market sufficiently above the $50 million to justify their promotion. Otherwise, it gets forfeited or cut back in some way.
Doug Ellenoff:
So, what’s happening is that the PIPE investors who are coming in will still benefit from that IPO pop — it’s a battle between the PIPE investors and the sponsors, two groups of very sophisticated investors.
Is it the proper ratio of who’s participating in that 20% bounce? It’s not affecting the target because they weren’t going to get it anyway. And the existing SPAC IPO investors are still participating when it goes from $10 to $12 a share after the deal is announced.
That’s why I say that it is not harming either the target company or the IPO investors.
MBP:
That is an elegant explanation of why the sponsors deserve to get this money, and I hope that they all pay you a commission out of their promote shares for giving them moral justification for their riches.
Doug Ellenoff:
I would make a lot more if that were the case.
MBP:
This has been delightful. SPACs are such a hot topic right now, and it’s wonderful to speak to someone who has participated in the evolution for decades and seen where it’s come from and how far it has come in such a short time.
Doug Ellenoff:
My pleasure.
