Imagine being approached to invest in a company by one of Wall Street’s most successful pundits, or even a famous movie star or sports personality. You’d be keen to know more, right? But what if it turns out there isn’t actually a company? At least not as yet, anyway. How likely would you be to part with your money? This is the pitch being given by owners of special purpose acquisition companies, or SPACs, a deal structure that has become exponentially popular over the course of 2020 with big names like Shaquille O’ Neal, popstar Ciara and former US Speaker of the House Paul Ryan all jumping onboard the SPAC train.
Simply put, a SPAC is a vehicle through which private investors bring companies to public markets. It is a shell company, with no actual commercial operations, that is created for the sole purpose of raising capital through an initial public offering (IPO) in order to acquire a private company. Also known as ‘blank cheque’ companies because they allow investors to contribute cash without prior knowledge of how their capital will be spent, SPACs have been around since the early 1990s, with the most recent resurgence reflecting investors’ search for better returns in a low rate world.
SPACs are generally formed by individuals, or sponsors as they are called in this instance, who have a strong public profile such as industry leaders, investment bankers or even celebrities in order to attract investors and capital. They are registered with the SEC meaning investors can buy shares in a SPAC before a merger or acquisition takes place.
Common stock in SPACs are generally sold for $10 apiece and initial investors also receive a kicker in the form of warrants which give them the option to purchase more stocks at a fixed price later on. All the funds raised are ring-fenced in a trust until the sponsor identifies a company of interest which will then be taken public through an acquisition using the capital raised in the SPAC IPO. Once the deal is approved and the merger takes place, the SPAC starts trading as a new company under a new ticker. Should the SPAC fail to merge with or acquire a company within the two year deadline, it is liquidated and all investors receive their money back.
One of the biggest advantages of SPACs is that they are much faster in taking a company public than the traditional IPO route. While an IPO can take anywhere between 12 and 24 months to finalise, a SPAC merger can take place in 5 or 6 months as it doesn’t require a roadshow to entice potential investors. For private companies, the regulatory burden is reduced significantly as regulatory demands in a SPAC merger are much less onerous and less costly than in a traditional IPO. From the perspective of SPAC investors, they have the option of redeeming their shares if the acquisition is not to their liking, essentially giving them a money back guarantee. In addition to this, the warrants received are akin to a risk-free bet on the success of the SPAC and may turn out to be worth a lot depending on the acquired company. Another advantage for investors is the opportunity to own a much bigger stake in the merged company relative to the number of shares that they would be granted in a traditional IPO as a large number of these tend to be oversubscribed.
Unfortunately, there are several disadvantages to being a SPAC investor as well, the first of which is that investors essentially go in blind, with no idea as to what their acquisition target will be. Also, because companies that merge with a SPAC face less scrutiny, there is a real possibility of misrepresentation of the company in order to attract investors. SPAC sponsors can earn a significant profit from an acquisition even if it proves unsuccessful for investors and so there is a high probability that conflicts of interest may arise. Another massive risk pertaining to SPACs was highlighted by the SEC in an alert to investors where they warned that ‘it is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment’.
Research has shown that most SPACs actually do not fare very well and underperform the broader market after a deal is struck. The results tend to be far better for sponsors with a high level of expertise however, such as former CEOs or industry experts. One of the more recent, noteworthy SPAC deals involved Richard Branson’s Virgin Galactic in 2019, where venture capitalist Chamath Palihapitiya bought a 49% stake for $800 million via his SPAC Social Capital Hedosophia Holdings. The biggest SPAC deal to date took place in July 2020 when Bill Ackman, the founder of Pershing Capital Management, sponsored his own SPAC, Pershing Square Tontine Holdings, raising $4 billion in its offering.
Despite the risks, the long running boom in private equity and venture capital, along with historically low interest rates, mean that more investors are willing to park their money in SPACs in the hope of getting lucky with an acquisition that pays off big. 2020 was a particularly significant year for the blank cheque market with 248 deals totaling over $83 billion compared to 2019, which saw 59 deals worth $14 billion. Given that the first quarter of 2021 has already seen the amount of capital flowing to SPACs top $97 billion with almost 300 listings, it’s pretty clear that investors need to fasten their seatbelts and watch this space!