SPACs have breathed new life into U.S. markets following waves of de-listings in the wake of the enactment of the Sarbanes–Oxley Act of 2002. They have offered a number of structural advantages when compared to a traditional IPO, including the ability to present a pre-revenue investment thesis to retail investors and greater control over stock pricing when going public—thereby avoiding the IPO “pop” (i.e., the perceived underpricing of IPOs, arguably at the expense of issuers).

For the first time, retail investors have been given access to companies that otherwise would likely have gone through multiple rounds of additional venture capital funding prior to entering the public markets.

The SPAC surge has been fueled by central banks pumping funds into economies worldwide to combat pandemic-induced woes. SPACs are a desirable alternative to low interest rates for retail investors flush with cash.

The allure of SPACs, which give investors the option of redeeming their SPAC stocks (typically at or near the price of their investment) if they do not like the acquisition presented, is clear. Proponents argue that there is little downside to investing in these vehicles given current market conditions.

But we are potentially reaching an inflection point. Critics say that the market is oversaturated, with SPACs that often seem to be characterized more by hype than by substance. Given the sheer dominance of the vehicle, it is guaranteed that some portion will not live up to expectations.

The fact that SPACs typically target early-stage companies only heightens the risk. Already, some hedge funds are shorting select SPACs. S3 Partners LLC, a research firm that tracks short activity in U.S. markets, identified that short positions in SPACs, which totaled $724 million at the beginning of 2021, have jumped to $2.7 billion in less than three months.

The market may be poised for a backlash against its current darling. This article considers some potential catalysts which, in the face of poor stock price performance, may result in a dampening of the SPAC frenzy.

*This article was first published in Bloomberg Law.

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