Explaining the SPAC Crash

Andrew F. Tuch

Few scholars have done more to illuminate little-understood but vitally important areas of corporate and securities practice than Michael Klausner and Michael Ohlrogge. Their work has been an essential guide to the boom in special purpose acquisition companies (SPACs). Once a remote corner of securities practice, mergers of SPACs suddenly became a mainstream method for taking companies public. And just as suddenly, they faltered. The boom having now ended, Professors Klausner and Ohlrogge ask: “Was the SPAC Crash Predicable?” It is the title of their latest article. The answer, they think, is yes.

In the article, Professors Klausner and Ohlrogge replicate much of the analysis of an earlier, critically important study coauthored with Emily Ruan. At the time, the group promised a “sober look” at SPAC transactions and presented compelling evidence that SPACs are a rigged game. That evidence attracted strong industry skepticism but has since become broadly accepted. The influence of their findings is apparent in the Securities and Exchange Commission’s proposed SPAC reforms and in recent decisions from the Delaware Court of Chancery. ¹

A Sober Look at SPACs made vital contributions to the literature, establishing how the capital structure of SPACs stacks the odds against public shareholders who retain their shares through the course of a SPAC merger. These shareholders have the option to redeem their shares at $10 pre-merger or remain invested in the SPAC, thereby becoming shareholders in the post-merger company. A Sober Look showed that conventional SPAC features, including the issuance of heavily discounted shares to sponsors, free warrants to IPO investors, and cash disbursements to deal advisors, significantly diluted the position of public shareholders. Consequently, on a cash basis, the value of SPAC shares was substantially less than $10 per share at the time of merger. In the article’s cohort of 2019–20 SPAC mergers, the mean and median net cash per SPAC share was $4.10 and $5.70, respectively, depending on the time period. This finding suggests that around half the value that public shareholders invested was effectively lost by the time of merger.

In addition, A Sober Look demonstrated a strong positive correlation between a SPAC’s pre-merger dilution and post-merger performance. The lower a SPAC’s net cash per share at the time of a proposed merger, the lower the post-merger company’s share prices. This correlation existed immediately after the merger and strengthened as post-merger time went on (including one month and one year later)—the result of share prices falling gradually. The results were striking: on average, a reduction of one dollar in net cash per share resulted in a corresponding decrease of one dollar in post-merger value for SPAC shareholders. Furthermore, at the point when post-merger prices settled, post-merger SPAC shares were worth roughly the same amount as the net cash per SPAC share at the time of the merger—far less than the redemption price of $10. This suggests that, in negotiating merger terms with SPACs, target companies were aware of the dilution inherent in SPACs and that public shareholders, rather than target shareholders, bore those costs.

Was the SPAC Crash Predictable? builds on A Sober Look by assessing a significantly larger number of transactions over a longer and more recent period of time. The new findings are consistent with the earlier ones. First, dilution is extensive, as evidenced by mean and median net cash per share of $6.40 and $7.10, respectively. Second, Professors Klausner and Ohlrogge again identify a strong positive correlation between pre-merger dilution and post-merger performance, measured at various intervals after the merger. Once more, the evidence suggests that public SPAC shareholders rather than target shareholders bear the costs of dilution inherent in SPACs.

Based on this statistical analysis, Professors Klausner and Ohlrogge conclude that the SPAC crash was predictable: knowing that public shareholders’ interests were heavily diluted, we should have predicted that these shareholders would want to exercise their redemption rights, jeopardizing the viability of SPAC mergers. The game was not sustainable. Indeed, as Professors Klausner and Ohlrogge also demonstrate, SPAC redemptions eventually spiked, leading to abandoned deals or deals delivering little cash to targets.

In Net Cash Per Share: The Key to Disclosing SPAC Dilution, Professors Klausner and Ohlrogge join with Harald Halbhuber, an experienced Wall Street lawyer and advisor to SPACs, to detail how net cash per share in SPACs should be calculated and disclosed to public shareholders. In SPAC Governance: In Need of Judicial Review Klausner and Ohlrogge tackle the corporate law implications of the SPAC structure, arguing—in reasoning consistent with that later adopted by the Delaware Court of Chancery—that SPAC fiduciaries’ conduct should be reviewed under the entire fairness standard. In Is SPAC Sponsor Compensation Evolving? A Sober Look at Earnouts, they address sponsor earnouts, rejecting claims by SPAC advocates that these techniques for remunerating sponsors address concerns about conflicts and dilution.

Professors Klausner and Ohlrogge could hardly be more authoritative. But, inevitably, their work also leaves us with unanswered questions. Among them is why the SPAC crash did not arrive sooner. Even after A Sober Look’s publication and the significant attention it attracted, public investors continued piling into SPACs.

Second, why were market prices so slow to reflect the value of post-merger SPACs? Professors Klausner and Ohlrogge show that on the day after a merger, the market valued post-merger companies above $10, indicating a market view that these deals were value-increasing. But prices then dropped gradually, declining to the net cash value some 12 months later. This evidence is hard to square with our conventional understanding of markets’ informational efficiency. Even after A Sober Look laid bare the expected relationship between pre-merger dilution and post-merger performance, the market valuation process only slowly yielded accurate figures on SPAC targets.

While the SPAC boom has ended, SPAC-related scholarship will have continued importance. Interest in alternatives to traditional IPOs remains strong, and the appetite for SPAC mergers may rebound if deal terms shift, as they have in the past—or at least if investors believe they have shifted. The SEC has yet to finalize its reforms to SPAC regulation. And the rush of SPAC lawsuits shows no signs of abating.

1. See Special Purpose Acquisition Companies, Shell Companies, and Projections, 87 Fed. Reg. 29458 (proposed May 13, 2022) (to be codified at 17 C.F.R. pts. 210, 229, 230, 232, 239, 240, 249, 270); In re MultiPlan Corp. S’holders Litig., 268 A.3d 784 (Del. Ch. 2022); Delman v. GigAcquisitions3, LLC, 288 A.3d 692 (Del. Ch. 2023); Laidlaw v. GigAcquisitions2, LLC, No. 2021-0821-LWW, 2023 WL 2292488 (Del. Ch. Mar. 1, 2023). See also In re XL Fleet (Pivotal) Stockholder Litigation, No. 2021-0808-KSJM, (Del. Ch. June 9, 2023).