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Thursday, Sep 28, 2023

Tight Regulation Cools SPAC Market

The popularity of companies going public through a SPAC has cooled since the first half of last year, but that hasn’t stopped investors from expanding the herd of L.A.’s tech unicorns.
About 50 companies have gone public via special purchase acquisition companies or SPACs in this year’s first quarter, according to the reporting website SPAC Research. That compares to a record-breaking first quarter of 2021 when 314 companies went public via SPAC.

A SPAC is a company formed to pool capital in anticipation of an acquisition, with a limited time period to finalize a deal. The popularity of these so-called blank check companies faded fast, according to Andrew Harper, partner at the law firm Sidley Austin LLP. The turnaround was driven primarily by warnings of increased oversight from the Securities and Exchange Commission and a series of disappointing debuts that have followed since.

“The market got shaky, and a lot of the de-SPACs just weren’t performing all that well,” said Harper, who provides strategic consulting to companies ranging from newly formed startups to late-stage private businesses.

The SEC made good on its warning late last month, moving forward a proposal that would require SPACs to provide additional disclosures about ownership and permanence forecasts. While Harper suspects the SEC signaling its actions would prove “helpful” in the long-term, it may come with some onerous reporting requirements in the short term.

“I think the SEC’s focus is a little bit misguided, because we’re not talking about public stocks sold to general retail investors; we’re talking about private companies selling to sophisticated investors,” said Harper. “People don’t realize the effort that goes into public reporting.”

Avoiding those reporting requirements has been a primary selling point of SPACs, Harper said, and the threat of losing that benefit has had an understandably negative impact.
“I’ve had these conversations with clients, but it just makes sense,” said Harper. “They’re thinking, ‘If we’re going to be putting all this effort into creating an infrastructure for regular reporting, what benefit are we really getting from being private at this point?’”
A primary benefit of a startup is that it’s privately held or venture backed, he said, allowing it to move nimbly in a way that companies that are subject to public reporting can’t.

“If they’re suddenly required to make all of these disclosures, I’m worried it could stifle business and rob companies of one of the primary benefits of being private,” said Harper.

Tech ecosystem

In spite of the sudden chokehold on SPAC debuts, investor money has continued to flow toward L.A.’s most promising startups, primarily those in or near the tech industry.
Among them is the Marina del Ray-based unicorn Whatnot Inc., which recently earned a valuation of $1.5 billion following three seed rounds that netted the company $220 million in funding.

Whatnot Chief Executive Grant LaFontaine said the company, which was created as a modern alternative to online auctioneers such as eBay for collectibles and pop culture items, has made good on recent expansion plans, doubling the number of full-time employees from 75 to 150. LaFontaine said Whatnot has expanded from Pokemon cards and sports collectibles into fashion, NFTs and other markets.

“We saw a new generation of collectors entering the market, millennials with a bit of nostalgia and more income. Everything that was old is new,” said LaFontaine. “We’re continuing to hire and scale our business, which has increased our offerings beyond just traditional collectibles.”

Los Angeles tech companies naturally benefit from the area’s reputation as an epicenter for tech and media, said Jim Andelman, co-founder and managing director of the Santa Monica-based early VC investment firm Bonfire Ventures. But they’ve benefited as well from the diversity of Southern California’s industries. While Bonfire Ventures focuses exclusively on startups in B2B software, Andelman said there’s no shortage of opportunities thanks to the diversity of Southern California’s industries.

“I think one of the great things for L.A. is the diversity; not just the people, but the business ecosystem, from SpaceX to ServiceTitan to gaming to the biosciences,” said Andelman. “That bodes really well for us, for the focus on B2B software. Having tracked this market for 17 years, it has never been better.”

Andelman said there was enthusiasm for service-based app startups, including the West Hollywood-based salon & spa appointment manager, Boulevard, and the Playa Vista-based food ordering platform, ChowNow. He also highlighted the success of the Culver City-based Scopely Inc., which as of October 2021 was valued at $5.4 billion. Andelman said a key element shared between these companies is a seasoned executive team with successful track records.

“I’m super bullish on Los Angeles, as the ecosystem matures, there’s more founders, and success begets success,” Andelman said. “It takes a while for markets to achieve that critical mass.”

‘More cautious’

While startup coffers keep filling, many L.A. unicorns are likely wary of the fast track to the public market thanks to the meteoric rise and fall of SPACs and subsequent SEC scrutiny, said Mehdi Khodadad, a partner at Sidley Austin’s Century City office who represents technology and life science startups.

“I have a lot of clients that have been dealing squarely with these issues right now. The last 18 to 24 months have been a wild ride for these issuers,” said Khodadad

The SPAC boom forced companies to consider going public when they wouldn’t have otherwise, Khodadad said, and those that haven’t yet debuted are understandably more cautious after the SPAC plummet. While investors hoping for a repeat of the 2021 quantity of SPACs might be disappointed, Khodadad suspects the long-term result will be an improvement in the quality of offerings. Nonetheless, he echoed Harper’s concerns about the potentially dampening effect of increased scrutiny by SEC regulators.

“SPACs are having to give up economics on their side, they may have to give up the sponsor and founder economics, the shifting warrants; they may have to subject their own shares to things like earnouts,” Khodadad said.

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