What Can We Learn from the UK and Dutch Experiences of SPACs?

The special purpose acquisition company (SPAC) is a cash shell listed on a public market with the sole purpose of merging with an operating company, thereby bringing that operating company on to the public market.  The SPAC, therefore, represents an alternative public listing route to a traditional initial public offering (IPO).  The market for SPACs collapsed in 2023, with only 31 SPACs listing in the US after a breathtaking high of 613 SPAC listings in 2021.  2023 also saw no US-style SPAC listing in either the UK or the Netherlands, and 2024 has continued to be a slow year for SPACs.  The pause in the SPAC frenzy gives us the chance to take stock of how the markets in different jurisdictions developed and whether any lessons can be learnt.  In my recent paper (“Going Dutch?  Comparing Regulatory and Contracting Policy Paradigms Via Amsterdam and London SPAC Experiences” forthcoming in European Business Organization Law Review), I examine the prospectuses of all the US-style SPACs that listed on the London Stock Exchange and Euronext Amsterdam in 2021 and 2022 and compare their terms to the typical form seen in the US.  London and Amsterdam were selected as instructive “test jurisdictions” based upon their contrasting regulatory approaches to SPACs.

The US SPAC

The US SPAC that dominated the public equity markets in 2020 and 2021 is a controversial vehicle.  The terms adopted by those SPACs, some of which are regulatory-driven and some of which are market-driven, ingrain incentives that led to SPAC mergers that have been value destroying for SPAC shareholders that held their shares pre- and post-merger periods.  Mergers have often been overpriced and have resulted in the introduction of poorly performing companies to both Nasdaq and the NYSE.  Two aspects of SPAC dynamics are particularly pertinent – the “all-or-nothing” nature of the SPAC sponsor’s remuneration, and the ineffectiveness of the shareholder vote as a gating mechanism to poor transactions.

The requirement that a US SPAC deposit IPO proceeds into an escrow account and returns such funds to public stockholders if the SPAC does not complete a merger within 36 months leads to an “all-or-nothing” remuneration structure for SPAC sponsors.  If the SPAC does not complete a merger within the investment period, the SPAC sponsor receives nothing; however, if the SPAC does complete a merger, the sponsor customarily receives 20 per cent of the equity of the post-merger SPAC, having subscribed to such shares at nominal cost (the “sponsor’s promote”).  The SPAC sponsor can make positive returns even if the merger is value-destroying for other continuing SPAC shareholders, and, accordingly, the sponsor is incentivized to complete a merger come what may.

US SPACs generally require the approval of its stockholders to complete mergers.  One may consider such a requirement to be an effective buttress against the SPAC sponsor’s more indulgent tendencies, since overpriced or poor merger candidates can be vetoed by the SPAC’s public stockholders.  However, US SPACs also typically allow all stockholders to redeem their shares prior to the acquisition.  Such mechanics have led to a prevalence of peculiar “approve-and-redeem” strategies, whereby stockholders approve proposed mergers, while simultaneously redeeming their shares.  On its face, such a strategy may seem nonsensical, but it is brought back into the realm of rationality when considering that SPAC IPO investors also receive warrants alongside their shares.  A SPAC warrant gives the holder the right to acquire shares in the SPAC post-merger, and, therefore, becomes worthless if a merger is not completed.  An approve-and-redeem strategy enables a holder of shares and warrants to recover their IPO investment while potentially ascribing further value to the warrants they hold.  The stockholder approval mechanic becomes nothing more than a token gesture, with one study finding that SPAC mergers are almost always approved by SPAC stockholders.

The Approach to SPACs in the London and Amsterdam

The regulators in London and Amsterdam have taken differing approaches to SPACs.  London revised its SPAC rules in August 2021 to facilitate the listing of US-style SPACs.  Previously, any cash-shell listing on the London Stock Exchange would have to suspend trading upon the leak or announcement of a potential merger.  The revised rules enable SPACs to avoid a trading suspension if they adopt certain terms, including that IPO proceeds be returned to public shareholders if the SPAC has not completed a merger within 24 months from IPO, mergers be pre-approved by the SPAC’s public shareholders, and all shareholders be given the right to redeem their shares prior to a merger.  Amsterdam, on the other hand, does not implement any SPAC-specific rules.  SPACs can broadly list with any such terms as the sponsor deems fit.  In contrast to London’s regulators, which sought to impose mandatory protections in favor of investors, the regulators in Amsterdam have determined that private ordering will result in SPACs adopting terms that are beneficial to all market participants.  Have the divergent approaches in London and Amsterdam led to the development of different SPAC markets?

Comparing London and Dutch SPACs to the US

Many of the terms imposed on SPACs by London’s regulators mimic terms typically adopted by US SPACs.  However, all London SPACs also incorporate terms prevalent in the US which are not compelled by regulatory fiat.  For example, London SPACs incorporate the sponsor’s promotes equating to 20% of the post-merger equity, and units comprising shares and warrants are uniformly issued at IPO.  The nature of the sponsor’s promote and the composition of units appear to have become a global market-standard for SPACs, with similar terms also reflected in Dutch SPACs (albeit with greater diversity as to the size of the sponsor’s promote).

In relation to the sponsor’s promote, a deviation from the stereotypical US SPAC is that all the London SPACs, and most of the Dutch SPACs, implement some form of performance-related element to the sponsor’s remuneration.  The sponsor generally receives part of the promote immediately upon the closing of the merger, but the rest is only received if the price of the shares of the post-merger SPAC exceeds specific thresholds.

Of further interest is that many of the terms imposed by regulators in London and on US exchanges notionally to protect investors in SPACs are also omnipresent in Dutch SPACs.  All the Dutch SPACs studied require a shareholder vote to approve mergers (in some cases as a result of applicable corporate laws), implement some form of redemption option for shareholders, and agree to place IPO proceeds into escrow to be released to public shareholders if the SPAC does not complete a merger within a specific investment period (spanning a range of 15-30 months post-IPO).

Are the SPAC Dynamics any Different in London and Amsterdam as Compared to the US?

With the terms of both London and Dutch SPACs replicating many of the terms of the typical US SPAC, the incentives ingrained in US SPACs which have resulted in the form becoming so controversial persist in London and Amsterdam.  The greater pervasiveness of earn-out conditions attached to sponsor’s promotes can temper, to an extent, the incentives of the sponsor to overpay for targets.  However, a study has shown that even with performance-related conditions attached, if a sizeable proportion of the promote is not subject to such conditions, the moderating influence is substantively reduced unless the promote is accompanied by a significant skin-in-the-game investment in the SPAC by the sponsor at market price.  All the London SPACs and nearly all the Dutch SPACs employing earn-outs provide for at least 40% of the promote being paid immediately upon the closing of the merger, no matter the share price.  Furthermore, only a handful of Dutch SPACs, and none of the London SPACs, also involved the sponsor substantially investing (as compared to the size of the non-earn-out portion of the promote) in the SPAC at the market price.  Overall, the earn-outs prevalent in London and Dutch SPACs are unlikely to materially change the SPAC incentives observed in the US.

A very small number of Dutch SPACs have implemented other moderating mechanisms, including that only dissenting shareholders to the merger can redeem shares, and at least a proportion of warrants are only issued post-closing of the merger.  Such terms can have a meaningful impact on the dynamics of SPACs, since they can eliminate the basis on which approve-and-redeem strategies emerge.  The shareholder vote becomes more of a genuine referendum on the merits of the merger, and the sponsor can no longer presume that shareholder approval will be achieved no matter the weaknesses of the transaction proposed.  However, the Dutch SPACs adopting such provisions are very much in the minority.  The vast majority of the Dutch SPACs (and all the London SPACs) adhere to terms that result in SPACs with incentive structures very similar to those which have resulted in poorly performing SPAC mergers in the US.

A Lesson for Regulators

The fact that SPAC terms in both London and Amsterdam have developed in a similar manner to the US is instructive.  It would appear that market forces are sufficiently robust to ensure that Dutch SPACs voluntarily adopt all the terms broadly mandated by London and US exchanges.  Those terms ostensibly protect “investors” in SPACs, giving them the ability to exit the SPAC if they do not wish to remain invested post-merger.  IPO investors in SPACs are overwhelmingly institutional investors and their sophistication and market influence restrain SPAC sponsors from attempting to list a SPAC without such protections in place.

The Dutch experience suggests that London could simply have permitted SPACs on the London Stock Exchange with merely a minimum market capitalization requirement (which would entail the need to attract institutional investors) and with no other mandated terms – SPACs would have organically adopted the types of protections currently mandated on the London Stock Exchange as they are demanded by institutional investors.

It would be erroneous though to conclude that regulations for large SPACs are redundant – they are merely misdirected.  Institutional investors can look after themselves.  Institutional IPO investors regularly exit the SPAC pre-merger, and institutional PIPE (private investment in public equity) investors who replace them often invest at a price below market price.  The problem with SPACs is that investors who acquire SPAC shares in the pre-merger secondary market and do not redeem or otherwise exit the SPAC prior to the merger, on average suffer serious negative returns.  Those investors are generally retail investors.  The SPAC constitutes a strange public vehicle where retail investors cannot rely upon more sophisticated institutional investors and efficient capital markets to indirectly protect their positions.  Pre-merger, the SPAC’s share price will have a floor more or less equal to the redemption price for the shares, even if the proposed merger is clearly value-destroying.  Additionally, those retail investors cannot depend upon institutional investors vetoing poor transactions.  The sweet-spot for SPAC regulation is to protect retail investors, not the institutional investors who will in any event be protected via private ordering.  Regulations as simple as only permitting dissenting shareholders to redeem shares in a SPAC, providing that warrants and shares cannot be detached until after the merger, and requiring sponsor skin-in-the-game investments proportional to the size of the promote could make a huge difference to the dynamics of SPACs and potentially lead to benign SPACs which are more likely to enter into successful mergers.

Conclusion

The SPAC experiment in the US has not, overall, been a successful one.  Unfortunately, the London and Amsterdam exchanges, with a desire to carve-out a piece of the SPAC-action, have fallen into the trap of assuming homogeneity amongst all investors.  Regulations are not required to protect institutional investors in the SPAC market, but where retail investors cannot “free-ride” upon the decision-making of institutional investors, regulation has a place to play in protecting their interests.  It is possible that the death of the SPAC has been exaggerated (in 2023 SPAC IPOs still constituted  43% of all US IPOs), and if interest rates fall, it is quite possible that the SPAC will see a resurgence.  The earlier global SPAC experience suggests that regulators should be wary.

Bobby V. Reddy is the Professor of Corporate Law and Governance at the University of Cambridge, and a former partner of Latham & Watkins LLP.  He is a J M Keynes Senior Fellow of Financial Economics. This post was adapted from his paper, “Going Dutch?  Comparing Regulatory and Contracting Policy Paradigms Via Amsterdam and London SPAC Experiences,” with the working paper available on SSRN, and the final version forthcoming in European Business Organization Law Review.