Crashing the party: New SPAC rules could slash proptech deals

Regulators want to rein in blank-check mania — a move that may result in fewer but better public market debuts

(Getty, iStock; Photo-illustration by Kevin Rebong for The Real Deal)
(Getty, iStock; Photo-illustration by Kevin Rebong for The Real Deal)

Taking a proptech firm public will never again be so easy — if regulators have their way.

Many feel it would be good if they did.

Shares in proptech firms that went public over the last two years in a series of mergers with special-purpose acquisition companies, or SPACs, have continued a long downward slide into 2022, reflecting just how frothy that market became in the heady days of the pandemic, when stimulus money was flowing and some SPAC sponsors, touting spectacular growth projections, sold investors on questionable deals.

SPAC mergers tend to be hugely profitable for sponsors regardless of how well they pan out for their investors, thanks to the fees they collect for setting them up. In the worst cases, sponsors, some with limited real estate know-how, entered eleventh-hour “shotgun weddings” with targets just to complete a transaction.

“The vintage of SPACs that came to market in 2020 and 2021 in the proptech space have left investors with a number of messy stories to deal with,” said Ryan Tomasello, research director at the investment bank Keefe, Bruyette & Woods. “Performance projections have not been met, and their cash burn really calls into question, in some cases, their timeline to profitability.”

The Securities and Exchange Commission now wants to tighten the rules around SPACs, ostensibly to protect retail investors who aren’t privy to the risks of early-stage, growth investment.

Shares of proptech SPACs fell an average of 47 percent during the first quarter as investors moved away from less-profitable stocks amid a broader market sell-off, according to KBW research. By the end of March, these stocks were trading at an average of 51 percent below the standard $10 SPAC buy-in price.

While deals have slowed substantially — only two new proptech SPACs have been announced in the last six months, and just three have closed — funding hasn’t dried up. As of late April, there remained 10 potential sponsors seeking a proptech- or real estate-related target, according to the data firm SPAC Research.

Whether they can successfully take a target public will depend, to a degree, on whether regulators succeed in reforming the space.

New rules

In late March, the SEC laid out its proposed new rules for SPACs, which have historically been perceived as a “backdoor” to the public market. In essence, the SEC wants SPACs to look more like traditional IPOs, with more limited valuations and greater transparency around sponsor fees and other conflicts of interest.

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The SEC also wants to reign in the pollyannaish performance projections that have defined the market in the last two years by holding those who issue them liable for their accuracy. For many, this is the key proposal that, if ultimately approved — the rules are in a 60-day comment period — would alter the landscape.

It was those long-term performance projections that allowed less-worthy deals to make it to the finish line, and contributed to the spectacular rise and fall of share prices that have hurt retail investors, experts say.

“A lot of people took these 2024, 2025, 2026 and 2027 forecasts without the proper grain of salt,” said Dave Eisenberg, founding partner at proptech-focused Zigg Capital. “It’s really difficult to project with any certainty the performance of a high-growth business multiple years out. It’s far more art than it is science.”

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A key problem: It’s not always clear who comes up with those performance projections, and therefore who is to blame when the results aren’t delivered. The sponsor, the target company and any investment bank advising on a deal are incentivized to inflate the growth trajectory.

The use of long-term projections to sell investors on SPAC deals hinges on a technicality. When they’ve identified a target to take public, SPACs file an S-4 registration statement for SEC review — M&A-related documentation — rather than the S-1 used in traditional IPOs. Statements made in an M&A process are protected under a safe harbor provision, so the SPAC isn’t liable if projections made “in good faith” aren’t achieved. The S-4 process involves financial and legal advisors, not an underwriter.

By contrast, companies undertaking a traditional IPO must navigate the S-1 process, which involves an underwriter and is not protected by a safe harbor provision. While there is no rule stating that projections cannot be included in an S-1, they typically are not for precisely those reasons: The underwriters have liability.

In its final draft of the new rules, the SEC may opt to rewrite the definition of an underwriter to include SPAC financial and legal advisors, meaning investors could sue them if a deal turns out to be a flop — or “for anything,” according to Kristi Marvin, founder of the website

“That’s a pretty bold thing for the SEC to do, to rewrite the Securities Act of 1934,” Marvin said.

Polishing the tarnish

There are still a record number of SPACs — 600 hundred across the market — shopping for a target, but industry players described a wariness among proptech founders to entertain SPAC deals, given how poorly they have performed.

SPAC investors, importantly, have the option to redeem their shares when it comes time to approve a deal, and redemption levels have been climbing, leaving targets with only a fraction of the capital they’d expected and a smaller number of tradable shares. This makes the stock less liquid and therefore “less investible,” KBW’s Tomasello said.

Ben Kwasnick, founder of SPAC Research, expects a reckoning in the coming months when many SPACs fail to identify or woo a target. Sponsors typically have up to two years to find one.

“There’s a cresting wave of maturities over the next six, 12, 18 months that will very likely result in a huge increase of liquidations,” Kwasnick said.

The market has already started to self-regulate, according to Jay Ritter, a finance professor at The University of Florida. Hedge funds and other increasingly cautious investors are “squeezing” sponsors, forcing them to put more skin in the game up front — as much as 4 percent of the $10 SPAC buy-in, rather than the typical 2 percent — exposing them to greater potential losses, he said.

Meanwhile, major investment banks, sensing the turmoil in the market and the reputational risk of participating in it, “have really pulled back,” Ritter said. In the first quarter, that cohort participated in only three of 54 SPAC IPOs.

Zigg Capital’s Eisenberg described the caution stemming from the proposed new rules as a positive. Before, SPAC players operated on the assumption that deals could come together quickly, people could make a lot of money off of fees, and “everything was just going up and up forever,” he said.

“It was not grounded in any reality,” he said. “It was much more about marketing ability, and the ability to stay in the center of attention, which is not what investing should be about.”

Eisenberg expects there to be far fewer, but higher-quality SPAC deals in the coming years, with fewer swashbuckling sponsors and better, more mature targets with proven business models.

“There will be truer valuations,” Eisenberg said. “And the companies electing to go public via SPACs will do so without any sense of there being an extra perk.”