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  • Writer's pictureStefan Schmierer

SPACs To Replace IPOs, Hong Kong Exploring Listing Regime

Also called a blank-check company, SPACs (Special Purpose Acquisition Companies) are shell firms that list on a stock exchange. They have become an increasingly popular way for start-ups to access individual investors, as well as acting as a cash cow for the wealthy individuals who create them. Recently, SPACs have become increasingly sought after in replacing the traditional IPO process.

A SPAC is a company with no commercial operations, instead formed with the sole purpose of raising capital through an initial public offering (“SPAC-IPO”) for the purpose of acquiring a currently existing company.

Invented by “Nuss” and “Miller” in 1993

Invented in 1993 by investment banker David Nussbaum and lawyer David Miller – also known as “Nuss” and “Miller” – SPACs intend to give private firms another way to access everyday investors. SPACs adopt a simple model: raise funds from public markets, funnel the funds into a newly established SPAC company and then find a listed company to merge with. SPACs as a result, have seen widespread attention and demand due to the indiscriminate and simplistic nature in which virtually any individual could get involved.

Since the summer of 2020, SPACs began surging on the stock market and the momentum has only continued to grow stronger. In fact, SPACs have taken popular companies like DraftKings Inc., a sports betting firm, and the space tourism focused Virgin Galactic Holdings Inc. public. Indeed, even the likes of celebrities – including Jennifer Lopez “J-Lo” and Alex Rodriguez "A-Rod" – have partaken in SPAC action.

In contrast to the traditional IPO, which often encounters high financial risks and legislative barriers, a SPAC-IPO provides a less financially risky option to raise capital.

SPAC-IPOs comparable to backdoor listings

A SPAC is generally a newly established company, with its sole purpose being to accumulate the financial contributions from participants and to use these contributions for the acquisition of a listed company. The SPAC is formed by stakeholders with nominal capital of approximately 20% interest in the SPAC. The remaining interest is typically held by public shareholders through “units” offered in an IPO of the SPAC shares.

After a SPAC-IPO, the company typically has 18-24 months to identify and complete a merger with an existing public company, comparable to a backdoor listing. Going beyond this time frame would therefore see liquidation of the SPAC and the IPO proceeds would return to public shareholders.

SPACs worth US$ 70 billion in 2020

The SPAC boom is particularly prevalent in the United States. Despite the pandemic dealing a blow to the global economy, SPACs saw a total of US$ 70 billion generated through these IPO measures in 2020. Moreover, the 206 SPAC deals of 2020 accounted for 52% of all the IPO capital raised in the United States. The upward trend suggests that the SPAC boom shows no signs of slowing down, as US$ 26 billion were raised in January 2021 alone.

18 to 24-month deadline for SPAC deals

The financial value of SPAC deals has also seen a dramatic increase. Examples include Tesla’s rival Lucid Motors with their largest SPAC deal to date at an amount of US$ 24 million. SPAC listings can also avoid volatility and uncertainties prevalent in the traditional IPO market. This is because of the requirement for SPACs to return their proceeds if they do not complete the merger and acquisition process by the 18–24-month deadline.

However, the SPAC boom has triggered fears among several groups of investors. The upward trend for demand for SPAC-IPOs come alongside the record levels of retail traders emerging within global markets. An example of the trading frenzy are stocks like GameStop Corp. and cryptocurrencies such as Bitcoin and Ethereum.

Moreover, the increase in retail investors brings a larger number of buyers with a low understanding and knowledge of investment. As a result, the increased publicity of SPACs brings risks with it, if the market is not as educated or receptive as expected. Secondly, some SPAC mergers do not fare as well as successful counterparts.

Cash redemption, shareholder dilution brings risks

There are further drawbacks for those looking to introduce SPACs to the market, such as the risk of uncertainty as a result of capital shortfall from potential cash redemption by investors. If redemptions exceed expectations, the liquidity of a SPAC may become uncertain and risk the future of the SPAC. Additionally, there is a risk of shareholder dilution.

Share dilution occurs when a company issues additional stock, which therefore reduces – dilutes - existing shareholders’ ownership in the company. Despite a preference for SPACs because of the fewer financial barriers, the removal of such requirements may also see potential issues later. Examples of this include restatements, incorrectly valued business assets, and even potential lawsuits.

Hong Kong exploring SPACs listing regime

Despite recent discussions between financial regulators regarding whether to allow SPAC listings, the listing of such is not currently permitted in Hong Kong.

In March 2021, financial secretary Paul Chan said he had instructed the Securities Futures Commission (SFC) and Hong Kong Exchanges and Clearing (HKEX) to explore suitable listing regimes (including SPACs) to enhance the city’s competitiveness as a fundraising hub while safeguarding small investors. However, a major issue particular to Hong Kong lies in securing liability insurance for SPAC directors and officers against incorrect statements and negligence in relation to business assets and performance. For the time being, although Hong Kong is welcoming the SPAC way into the public market, we may need to wait out the SPAC boom in the long run before it is implemented properly in the domestic market.

SPACs are an alternative method of access to public capital. Despite the potential drawbacks, mainly laying in the financial sphere, a SPAC listing can be a faster way for companies to go public. With a continuously increasing demand for SPACs within the United States markets, there is potential for Hong Kong to implement appropriate measures, as we might just be at the beginning of the SPAC boom.

This article is co-authored by Stefan Schmierer and Kayley H

Whilst every effort has been made to ensure the accuracy of this article it is general in nature and does not constitute legal advice of any kind. You should seek your own personal legal advice before taking legal action. We accept no liability whatsoever for loss arising out of the use or misuse of this article.

RS_SPAC Newsletter_May 2021
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