In an article published last month, the Wall Street Journal chronicled the difficulties that many of the SPACs launched during the SPAC IPO frenzy in late 2020 and early 2021 are having trying to identify a suitable merger target. Many of the SPACs, the article suggested, might be forced to liquidate; still others, the article suggested, could “pursue low-quality companies” as the SPAC sponsors seek to “stave off possible losses.” I had occasion to recall the Journal article as I read the allegations in a newly filed SPAC-related shareholder derivative suit. The new lawsuit illustrates the one of the types of litigation risk some SPACs could face as they mull last minute mergers before the approaching end of their 24-month search period.
The May 18, 2022 Journal article, entitled “Stock Selloff Crunches SPAC Creators as They Race to Find Deals” (here) noted that SPACs are “running out of time to find companies to take public, potentially leaving their architects without deals and saddled with sizeable losses.” The article explains that on average the backers that organize SPACs must invest between $5 million and $10 million of their own money to launch a SPAC. The SPAC has 24 months to find a merger target; if it does not, the organizers must liquidate the SPAC and return the funds to investors. If this happens, the SPAC organizers lose their initial investment.
However, the Journal article notes, market turmoil, supply chain woes, as we well as fact that many prior SPAC mergers have turned sour, have made a SPAC merger a much less attractive proposition for prospective targets. (Indeed, the Journal article notes, in recent months, several companies that had agreed to merge with a SPAC had gotten cold feet and called off the deals.) Moreover, with over 280 SPACs facing deadlines in the first quarter of 2023 alone, there simply may not be enough companies that will want to merge with a SPAC. According to SPACInsider, as June 20, 2022, there are 590 SPACs now seeking merger partners.
The Journal article quotes unnamed analysts as saying the “a larger percentage” of SPACs “won’t find mergers,” and saying further that as a result the SPAC architects may by early next year collectively lose $1 billion or more. In order to try to “stave off possible losses,” some SPACs may “pursue low-quality companies to take public at improper valuations.”
One specific risk that could arise if a SPAC turns to a low-quality company in order to try to stave off losses is that the SPAC might wind up selecting a merger partner in an industry or of a type different from that initially targeted by the SPAC. Among the problems with this kind of move is that it could well lead to litigation, as is illustrated in a derivative suit filed earlier this week.
On June 20. 2002, a plaintiff shareholder filed a derivative suit in the Central District of California against Momentus, Inc., as nominal defendant; the board of directors of Momentus; and the former directors and officers of Stable Road Acquisition Corporation (SRAC), with which SRAC merged in August 2021. A copy of the complaint in the action can be found here. Momentus is a privately-owned space industry startup.
If the names Momentus and SRAC are familiar, it is because their business combination previously has resulted in a securities class action lawsuit (as described here) and an SEC enforcement action (as described here). Among other things, the prior lawsuit and enforcement action alleged that Momentus and the SPAC misled investors by failing to disclose that multiple federal agencies had advised that Momentus’s CEO, a Russian citizen, posed an unacceptable national security risk, and that Momentus had never tested its technology in space, as claimed.
The new derivative lawsuit refers to these same allegations but focuses in addition on an allegation relating to the fact that at the time of its IPO, SRAC had said that it intended to target a cannabis/marijuana company. The complaint alleges, after describing Momentus as a “privately owned space industry startup with no revenue,” that:
SRAC tried to locate a cannabis/marijuana related company to acquire as was its stated purpose but they were unable to locate one prior to the May 13, 2021 deadline upon which SRAC would need to repay $172.5 million to shareholders if no successful merger was consummated. In order to prevent this return of money and to enrich Defendants … who would make tens of millions of dollars from the merger, SRAC entered into the merger with Momentus. To make sure that shareholders approved this last-minute deal, Defendants misleadingly touted the proposed merger and Momentus’s prospects.
The allegation in the new derivative suit complaint may illustrate the kinds of pressures that some SPACs my experience, allegedly including the pressure to complete a deal in order to avoid repaying the SPAC IPO proceeds to investors. At least according to the plaintiff’s allegation, the pressure could cause some SPAC executives to (as SRAC is alleged to have done) target an acquisition that differs from the SPAC’s stated purpose at the time of the SPAC IPO. The new complaint suggests that companies that deviate from the state purpose could, at least under certain circumstances, face an increased risk of litigation. All things to watch for as the year progresses and as increasing numbers of SPACs approach the end of their search periods.