Does it Sparc Joy? Cleaning Up the Spac Space

• Jurisdiction: United States,Federal
• Citation: Vol. 57 No. 1
• Publication year: 2022

Does it SPARC Joy? Cleaning Up the SPAC Space

G. Max Miseyko

Does it SPARC Joy? Cleaning Up the SPAC Space

Cover Page Footnote

J.D. Candidate, 2023, University of Georgia School of Law; B.A., 2011, University of Florida. The author thanks Professor Usha Rodrigues for her insights, advice, and research that made this Note possible.

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DOES IT SPARC JOY? CLEANING UP THE SPAC SPACE

G. Max Miseyko^*

For the last few years, the special purpose acquisition company—SPAC—was one of the hottest investment trends on Wall Street. In a SPAC, an investment vehicle with a limited lifespan (usually two years), a sponsor raises money from investors up front with the goal of finding a target company to take public via a reverse merger with a publicly traded shell company. Once touted as a democratized way to access public markets that avoids the rigors associated with traditional initial public offerings (IPOs), those characterizations came under fire in 2021 as academics and regulators spotlighted the hidden costs and misaligned incentives that the SPAC structure precipitates. As a one-time deal that allows investors to opt out of a proposed merger, the SPAC lacks the "reputation" component that underpins private equity relationships by constraining agency costs and opportunism.

Enter the special purpose acquisition rights company—the SPARC—a reconceived SPAC model that would allow investors to opt in when the sponsor identifies a good deal. This Note highlights how the SPARC promises to reintegrate the reputational component that the SPAC lacks by facilitating repeat deals and reframing the sponsor-investor relationship as a long-term one.

For the SPARC model to become a reality, the Securities and Exchange Commission (SEC) needs only to pass a rule proposed by the New York Stock Exchange (NYSE) that would enable SPARC sponsors to issue tradeable Subscription Warrants before raising capital. Instead, the SEC issued a raft of proposed rules intent on killing the SPAC, prompting the NYSE to withdraw its proposal. This Note calls for the SEC to scrap the bulk of its proposed SPAC rules in favor of a revised rule allowing the issuance of Subscription Warrants for

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compensation that incorporate an oversubscription privilege to match investor appetites with target company funding needs.

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TABLE OF CONTENTS

I. INTRODUCTION...................................................................316

II. SPACGROUND...................................................................319

A. THE SPAC'S PLACE IN THE PUBLIC FUNDING MARKET .................................................................................319
B. SPAC NUTS AND BOLTS.............................................323
C. SPACS VERSUS TRADITIONAL IPOS AND PRIVATE EQUITY .................................................................................325

III. THE SPARC OF AN IDEA..................................................336

A. A SPARC IS BORN......................................................336
B. HOW SPARCS WOULD WORK...................................... 341

IV. ADOPTING THE SPARC....................................................344

A. REINTEGRATING REPUTATION: THE ADVANTAGE OF THE SPARC SERIES VS. THE LIMITED LIFESPAN SPAC...........344
B. OTHER SPARC STRUCTURAL ADVANTAGES................348
C. COUNTERING THE SPARC CRITICS............................351

V. CONCLUSION.....................................................................356

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I. INTRODUCTION

Many market commentators declared 2020 "the year of SPACs," but they were wrong—that honor goes to 2021.¹ By 2021's year-end, the U.S. IPO market raised more than $315 billion, nearly doubling 2020's record-total of $168.7 billion.² And it was the special purpose acquisition company (SPAC) that largely drove the growth, with SPAC IPOs accounting for sixty percent of all U.S. IPO filings and around fifty-one percent of all proceeds.³ Despite experiencing a second quarter slowdown while investors digested the prospect of increased regulatory scrutiny,⁴ the SPAC market eventually resumed its torrid pace even as SEC staff informally signaled that the Agency would propose new SPAC rules in the first quarter of 2022.⁵ After a meteoric rise to prominence that was unimaginable pre-COVID,⁶ the SPAC threatened to dethrone the traditional bookbuilding IPO method⁷ as the dominant method of public

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funding.⁸ That is, until the SEC issued the SPAC's death warrant in March 2022.⁹

A SPAC is a type of blank check company listed on an exchange whose sole purpose is to acquire a target company seeking to become publicly traded.¹⁰ When a SPAC buys a target firm and executes a reverse merger,¹¹ "the firm gets its spot on the exchange."¹² For the target firm, merging with a SPAC "is a backdoor way of doing an initial public offering."¹³

Several factors have driven the SPAC's recent popularity: the influence of high-profile backers (called sponsors), "a better understanding by the market of the SPAC structure, the well-established complementary private investment in the public equity (PIPE) financing market," and the SPAC model's potential attractiveness to companies wanting to go public while maximizing marketability and retaining "more control over valuation and share price" compared to a traditional IPO.¹⁴ But 2021 also exposed

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fissures in the SPAC structure.¹⁵ Regulators focused on SPAC warrant classification and Private securities Litigation Reform Act (PSLRA) disclosure issues.¹⁶ Increased redemptions drew attention to structural flaws that tend to produce rampant shareholder dilution.¹⁷ A lawsuit¹⁸ pitted prominent academics and a former SEC Commissioner against the country's biggest M&A players, ultimately challenging the SPAC's entire investment model.¹⁹

A reconceptualized SPAC—the special purpose acquisition rights company (SPARC)—rose to meet those challenges.²⁰ Conceived by Pershing Square CEO Bill Ackman in response to a string of challenges that ultimately derailed his record-setting $4 billion Pershing Tontine (PSTH) SPAC,²¹ the SPARC promises to reinvent the SPAC IPO process by eliminating the SPAC's two-year time limitation, replacing the SPAC's opt-out with an investor opt-in, and offering sponsors the ability to "chain" SPARC deals together.²² By transforming the SPAC from a one-shot deal into a publicly traded instrument of ongoing concern, the SPARC would revitalize the role of reputation that constrains agency costs and curtails opportunism in private equity relationships—constraints that the SPAC desperately needs.²³

To become a reality, the SPARC only required SEC approval of an NYSE Proposed Rule that would have allowed sponsors to issue tradable Subscription Warrants before raising any capital.²⁴ That once-expected approval never came, with the NYSE withdrawing its proposal in light of the SEC's decidedly anti-SPAC position.²⁵ But

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with the "ability for the approval of a revised rule" preserved, the SPARC concept remains viable.²⁶ Should the SEC eventually change its stance on SPACs and choose to empower investors, rather than paternalistically "damming up the SPAC river,"²⁷ the overwhelmingly positive comments to the NYSE Proposed Rule indicate that investors would welcome the SPARC with open arms.²⁸

The SPARC's promise cannot be grasped without first understanding the SPAC's shortcomings. Part II of this Note situates the SPAC in today's public funding market, explores its relation to traditional IPO and private equity models, and raises questions about its structural viability. Part III chronicles the rise of the SPARC and examines how it could work in practice. Section IV.A explains how the SPARC could revitalize the role of reputation, enabling the SPARC model to succeed where the SPAC has failed. Section IV.B presents unique structural benefits offered by the SPARC. Section IV.C attempts to counter criticisms aimed at the SPARC. Finally, Part V concludes by calling for the SEC to abandon its SPAC rule proposal and instead approve a revised version of the NYSE Proposed Rule that would make SPARCs a reality.

II. SPACGROUND

A. THE SPAC'S PLACE IN THE PUBLIC FUNDING MARKET

"Going public is the process of offering securities—generally common stock—of a privately owned company for sale to the general

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public."²⁹ Typically, a private company issues its first shares of stock for public sale through a conventional IPO.³⁰ This process usually entails hiring an underwriter³¹ (often an investment bank) to develop a registration statement to file with the SEC, underwrite certain risks, and coordinate special meetings with potential investors called roadshows.³² The underwriter forms a syndicate of investment banks to gin up interest from retail and institutional investors, distribute a portion of the shares, and maintain investor enthusiasm once the company's shares begin to trade publicly.³³ While retail investors³⁴ are nominally able to partake in this process, the typical high demand for shares of a new IPo—largely due to the practice of underpricing³⁵ —incentivizes underwriters to allocate the majority of shares to regular institutional customers.³⁶

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As a result, retail investors are largely unable to purchase shares until the original buyer resells them and the predictable retail demand accompanying the first day of trading virtually guarantees a profit for investors fortunate enough to buy original IPO shares at the offering price.³⁷ As IPO shares frequently fail to maintain the retail-fueled price surges that characterize early trading, retail investors who bought shares in the open market often get the short end of the stick.³⁸ The traditional IPO process "has revealed itself to be undemocratic at best and manipulative at worst."³⁹

Alternatively, firms may access the external capital available in public markets via non-traditional routes, "the most popular [being] a reverse merger."⁴⁰ "A reverse merger is a...