What's the deal with SPACs?
Why these vehicles are rivaling IPOs as an option to go public.
Q: What are special purpose acquisition companies (SPACs) and how do they differ from initial public offerings (IPOs)? SPACs are corporations formed for the purpose of raising investment capital for private companies. They are acquisition-based transactions in which an investment bank or private equity firm raises cash from SPAC investors—shares are priced at $10 per share—and places it in a trust with the goal of acquiring or merging with a private company to bring it public.
Because SPAC sponsors form the company—i.e., raise the capital—without specifying at the time what company they will purchase, SPACs also are known as “blank check companies.” When the SPAC merges with a target, investors have the option of staying in the deal or redeeming their shares for cash. By contrast, an IPO is a capital-raising event in which new shares of a private company are offered publicly for proceeds.
SPACs actually have been around since the 1990s but became more prevalent after the rapid collapse of dot-com companies in 2000-01 led to a call for greater transparency/scrutiny across the financial industry. This made the IPO process lengthier and more complicated. As a result, while delivering higher standards, the IPO market hasn’t been able to quickly turn private businesses into public companies.
Q: Why the recent surge in SPACs? A key reason why companies looking to go public may prefer to go the SPAC route is efficiency. Unlike a traditional IPO, a SPAC transaction can be completed in a few months, doesn’t require a roadshow for potential investors and involves a less extensive/time-consuming SEC regulatory process—all of which can expose a company to more market fluctuations. Another factor in the wake of Covid-19 is that social distancing has limited in-person roadshows.
Along with the ability to gain quicker access to the public markets, some companies prefer the flexibility that SPACs offer. In a SPAC transaction, a company’s performance can be evaluated over a longer-term basis versus a quarter-by-quarter analysis typical with traditional IPOs. In addition, there is less of a spotlight into a company’s internal operations with SPACs.
The dramatic uptick in SPAC-funded IPOs this year is due to the sheer number of private companies looking to go public. It’s a situation that benefits both investment banks/private equity firms seeking attractive opportunities and companies in search of funding to reach their next level of success.
Q: In terms of size, how does the SPAC market compare with the traditional IPO market? Through Sept. 20, SPACs this year have issued 112 IPOs, raising $42 billion, according to SPACInsider, outpacing the 59 IPOs that raised $13 billion in 2019. That’s more than 40% of the overall IPO market market in terms of volume. So far, companies involved in traditional IPOs have raised $51.3 billion, on par with 2019. It remains to be seen whether the SPAC market will continue this growth trajectory.
Q: Are SPACs inherently riskier given the lack of regulatory scrutiny? Initially, they did involve a higher level of risk for investors. But over time, more protections have been built into SPACs. For example, if the SPAC sponsor does not find an acquisition in a pre-determined, relatively short timeframe—typically 18 to 24 months—investors are able to get their money back, with interest. Also, if an investor doesn’t like/approve of the acquisition, they can pull out of the deal.
What that means is that SPAC investors need to perform their own due diligence. They should only consider deals initiated by high-profile sponsors with solid reputations and experience in sourcing quality deals through teams with expertise in specific sectors and industries. When reviewing the target company, it is essential that investors meet with the company’s management to understand its business model, product pipeline, potential competitive advantage and growth strategy—and be informed of any possible red flags. SPAC investing involves the same level of research and scrutiny required of any investment.
Q: What are some of the potential advantages and drawbacks of participating in SPACs? Some very attractive potential investment opportunities may only be available through SPACs. These include what are known as the “global unicorn club,” companies valued at $1 billion or more that have remained private. Research firm CB Insights has identified 491 unicorns that at some point may raise capital through SPACs or IPOs. Without the SPACs structure, some of these companies might decide to remain private.
Also, SPACs are formed by investors or sponsors with a particular interest or expertise in a certain industry or business sector. Beyond the global unicorns, some very promising “under the radar” companies might only be discovered and brought to market by a SPAC team with that niche expertise.
On the downside, the post-merger performance of companies has been mixed—with some very successful and others not. Once launched publicly, SPACs are subject to the same level of downside performance as IPOs. Investors need to perform scrupulous due diligence on every aspect of the SPAC, from the sponsor to deal terms and disclosures to the company receiving the capital.