Private equity firms rocketed to new heights in 2021 on the back of SPAC mania and an unprecedented dealmaking market, only for the rockets to seemingly run out of fuel.
The year saw 613 IPOs involving special purpose acquisition companies (SPACs), according to the reporting website SPAC Research, raising $162 billion and crushing the previous year’s record-setting 248 SPAC IPO debuts worth $83 billion, with more than half of the 2021 debuts taking place in the first three months of the year.
The SPAC market seemed to reach its zenith in March, at 166 IPOs, among them the Culver City-based biotech ImmunityBio Inc., which reached a high of $45.42 in the week following its debut. But the stock suffered a swift plunge in the early days of April 2021, trending down to $6.29 as of market close on Jan. 7.
The massive pullback in deals down to 10 last April, was primarily attributable to an announcement by the Securities and Exchange Commission, in which it issued accounting guidance classifying SPAC warrants as liabilities rather than equity instruments, according to Gerard Hoberg, a professor of finance at the University of Southern California’s Marshall School of Business.
“SPACS overheated,” Hoberg said. “Bad returns and bad incentives came into the model, and this caught the attention of regulators by 2021, so the SEC spoke up and chilled the market. They indicated that the warrants need to be expensed.”
The scrutiny made investors skittish, Hoberg said, leading to relatively lackluster SPAC debuts for the back half of 2021.
With signs indicating the downtrend is now reversing, experts are confident the SPAC market and the private equity funds that supercharged it are coming back leaner, stronger and smarter.
Joshua DuClos, a Century City-based finance attorney with Chicago-based Sidley Austin, described the upswell in SPAC activity in the early months of 2021 as “a perfect storm,” with the onset of Covid-19, the sudden freeze in mergers and acquisitions, and the overall volatility in the market serving as primary contributors.
“The SEC has had SPACs in its portfolio for review for a while now, but until this past year, it was never meaningful enough to beat the drum about,” said DuClos, who serves as co-leader for the firm’s SPAC group. “Now, because of the sheer volume of increased investor interest, they saw it as a political imperative to come out and say they’re watching it.”
The rule change on warrants “did throw a wrench in the system in April,” according to DuClos, requiring many SPACs to redo their accounting statements at a time in which accountants capable of delivering it were in short supply. Otherwise, he said, most of the rule changes announced by the SEC in the past year haven’t had a dramatic impact.
Getting more sophisticated
DuClos, who has counseled clients on alternative deal structures like SPACs for nearly a decade, said that while Southern California’s SPAC market suffered because of the slowdown, it has remained an area of interest for potential mergers thanks to its place as an epicenter for finance, tech, health and other industries.
One L.A.-based SPAC IPO in the six months following the SEC rule change was The Beachbody Company Group, based in Santa Monica, which as of Jan. 7, had fallen more than 80% from its post-IPO peak. But deal activity picked up in the final two months of the year, including public offerings on the Richard Branson-backed aerospace company Virgin Orbit, based in Long Beach, and clinical medical researcher the Oncology Institute in Cerritos.
Mark Stone, SPAC lead for the Beverly Hills-based Gores Group, said that as private equity investors grew more cautious in months following peak SPAC euphoria, his company’s qualifications for public offerings became more sophisticated. The more skeptical approach was necessary due to increased risks of litigation after post-IPO price drops, Stone said, as investors might argue they were misled by projections and “hoodwinked” into buying.
“The result, I think, is that the (SPAC IPO issuances granted) are for companies that are more mature,” said Stone. “We want them to be able to tell investors why the SEC should feel comfortable with your projected growth in the years ahead.”
DuClos voiced similar optimism about the future of the SPAC market, noting that despite the mid-year downturn, 50% of all IPOs throughout the year were through SPACs.
“They really became competitors to venture capital financing or traditional IPOs. How that continues, and whether that continues at the pace it has, is hard to say,” DuClos said. “But they have to recognize them as competitors.”
SEC watch
If litigation doesn’t address concerns over incentives in deals, Hoberg said regulation likely could.
“The bad incentives relate to the sponsors getting wealthy even if they do bad deals. So, if the SPAC is about to expire, they have incentives to quickly do any deal even if it has bad returns,” said Hoberg. “This is because the sponsor gets a large equity stake, and that is valuable even if a bad deal occurs. But they get nothing if no deal is done.”
Regulations might put a damper on private equity firm’s expectations for the short term, but Hoberg said they’d work to the industry’s benefit in the long run. But any new rules are entirely in the realm of speculation, he said, based on the SEC’s recent track record.
“Regulation’s a tricky matter, and the regulators have to weigh new rules very carefully to ensure there’s no unintended consequences,” said Hoberg.
Additional Content on Private Equity Firms
Compatible Capital
While private equity firms are known for investing in companies that show special promise or have a unique position in a given market, these firms often focus their investment in a particular market or several markets in industries that are synergistic. The capital they raise can help companies implement new strategies and boost innovation. Private equity firms often bring on associates with backgrounds outside of the finance world in order to build teams with deep expertise in a particular market segment.
Manhattan Beach-based K1 Investment Management, for example, focuses solely on enterprise software companies. The firm believes that the market opportunity in enterprise software is driven by the increased productivity achieved from deploying application technologies. It cites the rapid adoption of software-as-a-service and traditional license applications as current powerful drivers of the economy.
Sawtelle-based Vance Street Capital invests in engineered solutions companies in the medical and industrial markets. The firm targets companies that have succeeded in their market by solving complex challenges for blue-chip customers. In December, the firm acquired Scottsdale, Ariz.-based Plastic Design Corporation, a contract manufacturer of micro-molded plastic components for the medtech market.
Hermosa Beach-based Marlin Equity invests in businesses across multiple industries — many high-tech — where it believes its capital base, industry relationships and network of operational resources can strengthen a company’s outlook and enhance value. The firm acquired Kansas City, Mo.-based SKC Communications in December, a company which designs, builds and manages technology for collaboration using audio/visual, unified communications and collaboration technology, cloud voice and headsets to seamlessly connect customers’ employees.
RLH Equity Partners, based in Westwood, invests in companies that deliver services to business, health care and government clients. The firm provides capital and assists management teams as they navigate challenges associated with rapid growth. It has invested in Miami-based clinical research organization Biorasi, for example, to help advance its complex clinical trials methods.
With a sector-focused approach, Clearlake Capital Group, based in Santa Monica, lists its core target sectors as technology, industrials and consumer goods. Clearlake currently has over $60 billion in assets under management, and its senior investment principals have led or co-led over 300 investments.
Many private equity firms offer services to assist companies of various stages in a variety of markets. But those that specialize or leverage experience in a particular field have the potential to create opportunities for companies that generalists might not be able to offer. Conversely, a firm that might not align exactly in industry focus but that has the resources or vision a company is seeking could be a beneficial match. Finding the right investor can be as crucial to the success of a company as getting the needed funding.
Vicente Capital Partners
Brentwood-based Vicente Capital Partners makes investments including expansion capital for founder-led businesses, buyouts of corporate subsidiaries, recapitalizations and manage-ment buyouts. The company also helps businesses recruit for key positions, advises on strategic decisions and analyzes the profitability of product lines.
Its investments are generally $10 million to $30 million, with a focus on business-to-business software and professional services. The investments are structured as preferred stock or structured equity. Vicente Capital’s revenue has been growing at a rate of 15% or greater annually, according to the company. Companies the firm has invested in include Carlsbad-based Intellectual Technology Inc. and Santa Monica-based Archer Education. Realized investments include Santa Monica-based
Rent.com.
