Member Exclusive   //   April 12, 2022

Unpacked: How the SEC’s SPAC proposal could impact retail startups’ exit strategies

The U.S. Securities and Exchange Commission (SEC) is cracking down on special-purpose acquisition companies (SPACs), one of the most popular methods of going public for many brands.

Last month, the SEC introduced a new set of rules that, if adopted, would force firms being acquired through a SPAC to meet the same regulatory standards as a traditional initial public offering. Under these new rules, the SEC hopes to address some common concerns such as inflated future outlooks and conflicts of interests. 

SPACs — or blank check companies — are essentially shell companies created to acquire private businesses and take them public without having to go through the traditional IPO process. They have become a common avenue to go public for many brands, with companies Grove Collaborative, Bark and Hims & Hers all going that route over the last two years. Though SPACs spiked in recent years, a number of companies that went public via SPAC proceeded to underperform following their debut. Now, with the new host of rules, more brands may be discouraged from going public via SPAC, experts said.

This latest SEC proposal came after the SPAC market experienced an immense amount of growth. In 2021, a total of 613 SPACs listed publicly, compared to 248 in 2020 and just 59 in 2019, according to data from SPACInsider. So far, 56 SPACs listed publicly this year.

Hype probably had something to do with the initial SPAC fervor. A few startups that went public via SPAC, like DraftKings, initially performed well on the public markets (DraftKings’ stock today is above its opening price but well below its 2020 peak). In the months that followed, a slew of other companies tried to follow suit.

There are several reasons why brands would want to pursue a traditional IPO. The most obvious one is to raise capital. However, SPACs are a much faster way of going public, speeding up the process by as much as three to six months compared to 12-18 months for a traditional IPO, according to data from KPMG. But there are a few other perks. When private companies get acquired by a SPAC, they also gain access to expertise that a traditional IPO might not provide, experts explained to Modern Retail. SPAC sponsors are typically experienced financial professionals who can offer management expertise or tap their network of contacts to do the job.

“In that merger, you get support, and then opens up doors to additional funding through private investment, public equity-type funding,” Andrew Hogenson, global managing partner of consumer goods and retail for Infosys Consulting, said. “With the craziness in the market and the volatility but also the amount of growth that we were seeing [last year], I think a lot of companies were trying to take advantage of that as quickly as possible — and that provided both the fastest and easiest path to get there.” 

Now that the landscape is changing, here’s a look at what the new SEC rules would do and whether or not it could impact other brands that were considering going public.

How the proposal would impact brands 

The SEC’s most recent proposal came after a number of companies lost significant value over a short period. Shares of half of the firms that completed a SPAC deal over the past two years dropped 40% or more, according to data from the Wall Street Journal. Thus one of the major rules the SEC plans to pass is to address concerns around SPACs’ overly bullish outlooks. The current rules allowed private companies being acquired to make rosy projections that typical IPOs wouldn’t allow.

“SPACs would publicly say what they think they would be worth in generating profits five years from now, but those forecasts were not heavily scrutinized,” said Ted McHugh, managing director for financial communications at Edelman. “The SEC is now suggesting that they’re going to hold those companies more accountable to those forecasts, and it’s called removing basically the safe harbor agreement, which more or less states: ‘Don’t hold us accountable to what we say right now. That’s going to be adjusted.’” Conversely, companies that went public through a traditional IPO are limited in how much they are able to disclose in their forward-looking projections.

Apart from the projections, SPACs would also be required to disclose more information about their sponsors’ compensation, conflicts of interest and sources of dilution. “To simply put it, it adds an increased level of transparency into the market for SPACs,” McHugh said. “Over the long term, it creates more of a sustainable platform and environment for SPACs to be used for companies to go public and have sort of a high level of trust among investment professionals.”

What happens to the SPAC market now?

Retail startups that have pursued a SPAC deal over the past couple years, have on the whole, struggled. Since its public debut in June, Bark, the company behind BarkBox, has lost over two-thirds of its value and is currently trading under $4. Almost a year after fitness company Beachbody went public through a merger with home-fitness bike maker Myx Fitness and blank check firm Forest Road Acquisition Corp, the company is now trading below $2.  

Several retail companies that went public through SPAC include startups that have yet to turn a profit. As was the case with Hims & Hers, a digital health startup launched in 2017 that went public in a $1.6 billion SPAC deal in early 2021. The company recorded a net loss of $31.2 million for the fourth quarter of 2021, compared to $5.2 million in 2020.

“A SPAC was another potential way for early-stage companies to go public who maybe were not considered ripe enough for an IPO and didn’t have enough of a track record or multiple years of performance,” Jeff Schultz, a member of multidisciplinary law firm Mintz. “It appears that SPACs have attracted more early-stage companies than the traditional IPO.”

If the SEC’s SPAC proposal were to be enacted, experts said this would likely put a pause to the flow of brands going public through this method.

The SEC voted 3-1 to propose the new rules on SPACs. As a result, Schultz said the proposal will likely pass to some degree. “They may not all survive, but it will be adopted in some form probably before the end of the year,” he said.

That being said, the threat of the new rules hasn’t deterred some brands from continuing to pursue SPAC deals. Grove Collaborative, which sells eco-friendly home essentials and personal care products, is currently in the process of going public through a SPAC deal. Virtual beauty try-on app developer Perfect Corp announced plans to go public last month through a $1 billion SPAC deal, and last week, beverage supplier Westrock Coffee said it going public in a $1.2 billion SPAC deal.

Robert Lamm, chair of the securities and corporate governance practice at the Gunster Law Firm, said regardless of whether the SEC’s rules are passed, quality SPAC deals will likely still occur. “My suspicion is that the good deals will still happen,” he said. “Good deals usually do get done regardless of the framework in which it’s pursued.”