SPAC Attack!

March 11, 2021

Over the past year, a new trend in taking firms public has garnered incredible momentum. The Special Purpose Acquisition Company (SPAC) has become a popular way to bring a company public. These so-called “blank check” companies raise capital from investors with the expectation that they will later find an attractive private company to bring public and acquire them.

Source: Bloomberg

How does a SPAC work?

Generally, a SPAC will be formed by a group of investors (or sponsors) that have specific expertise in an industry or business sector with the goal of pursuing deals in that area. The sponsors may even have a specific company in mind but want to avoid the extensive disclosure process that comes with a traditional IPO. The SPAC is then listed as an IPO and gathers investor’s dollars. The funds raised are placed in an interest-bearing trust account, which can only utilize funds in two ways: to complete an acquisition or return the money to investors. The SPAC has no existing business operations and exists only to acquire a private company.

When the SPAC finds a suitable target, it will acquire the shares of the private company using the funds raised in the IPO and will often also provide shares of the SPAC to the private company shareholders. The acquisition typically uses the legal form of a merger and ends with the private company surviving, but now as a public company.

What are the benefits of SPACs?

There are several benefits of using SPACs to take a company public. First, using a SPAC to go public can move through the going public process much more quickly, with substantially fewer disclosures required. SPAC’s typically offer slightly higher valuations than private equity deals, which is attractive to private companies’ owners.

Another advantage is by reducing the friction for a company to go public, more companies are, in fact, going public. Over the last 20 years, the number of public companies has dwindled from 7,229 in 1999 to 4,397 in 2018. More public companies provide a better option set for investors, which may ultimately result in better investment outcomes. The relative ease of the SPAC vehicle has pushed the number of public companies up. In 2020 alone, there were 219 SPACs formed.

Source: The World Bank

What are the drawbacks of SPACs?

SPACs are not universally loved. In fact, for the initial investors, SPACs tend to have underwhelming returns. By handing a manager a blank check without knowing what company they will ultimately invest in, you have no control over what company is acquired. The positive returns are generally captured by the private company owners going public and the advisors and underwriters of the SPAC. Under SEC rules, SPACs must identify the firm they will acquire within 24 months, or they must wind up and return the funds to their investors, net of costs such as management fees. This may create incentives to consummate a transaction as the 24-month deadline approaches, even if that deal does not maximize shareholder value.

Conclusion

SPACs are likely here to stay and can provide a smoother path for more companies to go public, which is a good thing for the market and investors in general. However, the pursuit of returns through direct investment in SPACs have and are likely to continue to underwhelm, warranting a cautious approach.