SPACs (Special Purpose Acquisition Companies) have been around for many years but recently they have started garnering major attention as well-known investors leading SPACs have been raising record amounts of money. In 2020, there were 255 SPAC initial public offerings IPOs worth $79.1bn (€65.6bn), according to Refinitiv. This compares with 94 deals, worth $14.0bn, in 2019, and just 16 in 2016. And, the first eight weeks of this year alone there were as many as 179 deals, raising $56.1bn.
Investopedia defines a special purpose acquisition company as: “a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company”. They are also sometimes known as “blank cheque companies” or backwards IPOs. In an IPO, a company announces it wants to go public, then discloses further details about its business operations before investors are willing to purchase their shares. A SPAC essentially reverses that process. A group of investors pool money together and the SPAC goes public as a shell company so the investors don’t know what their money will actually buy. Disclosures are simplified because the company is simply a financial vehicle with no day-to-day business operations to disclose.
Some analysts worry the SPAC boom is one of multiple signs of a market bubble, along with the GameStop phenomenon and the rising price of bitcoin and other cryptocurrencies. So why exactly have SPACs become such a hot trend and will this boom within a boom (with some similarities to the Initial Coin Offering craze) really benefit investors or is it all just hype?
Pros of SPACs
SPACs are partly sparking so much attention as a result of the market volatility created by the global pandemic. Under these uncertain circumstances, a SPAC’s in-built features of speed, control and certainty for founders who want to go public become a lot more attractive. And the trend has now built on its own hype. As influencers and famous names have got involved in SPACs – including in hot sectors like fintech, ESG, electric vehicles and digital assets – others have been encouraged to jump on board the SPAC bus too, if only for fear of missing out. Famous SPAC holders include former professional basketball player, Shaquille O’Neal, former House Speaker Paul Ryan, noted investor Bill Ackman – and last year a 25-year-old even became the youngest ever self-made billionaire – all thanks to a SPAC.
Cons of SPACs
One of the common elements between Initial Coin Offerings and SPACs is that companies acquired by SPACs can often be highly speculative, with unproven business models and little or no existing cash flow. Both risks and rewards are high.
Modern SPACs do have a better reputation than the blank cheque companies of the 1980s, many of which were fraudulent and whose consequences eventually led to new regulation. But, even so, detractors argue that SPACs circumvent the IPO listing process and that this increases risk for investors, even though SPACs are still covered by securities regulations. Sponsors who organise SPACs are often generously rewarded with equity when they close a deal, also leading to concerns about conflicts of interest – will unscrupulous sponsors simply merge with any company, regardless of quality, in order to get their payout?
The decline of the Initial Public Offering (IPO)?
Perhaps a better or broader question to ask is not “why are SPACs on the rise?” but rather “why is the IPO in decline?” The listing process for, and the involvement of an investment bank as facilitator and underwriter in, an IPO is cumbersome and expensive. The need for regulatory compliance and Board oversight makes high-growth companies less agile – meaning that many choose to stay private. SPACs go some way towards addressing these dilemmas. Many companies are also looking to the US, where investors assess companies differently – focusing more on forward valuations and the quality of the management team and less on traditional measures such as profit and loss. Even though there has been a huge growth in SPACs in 2020-21 as measured by Refinitiv, only 11 of those took place outside the US.
Yet despite all the SPAC frenzy, perhaps investors should pause and consider that even though SPACs are garnering all the headlines, traditional IPOs have still outperformed SPACs in 2021 according to recent data published by Bloomberg.
What next for SPACs?
The US has, until recently, attracted the lion’s share of SPAC deal flow but could that all be about to change as the SEC contemplates an accounting rule change that could have a dampening effect on the market? Forbes recently reported that the US government is likely to change the classification of SPAC warrants from an equity on the balance sheet to a liability. This would affect not only the benefits for future investors but also mean that the many SPACs that are currently active would be forced to restate and refile all of their financial statements. The uncertainty has already caused a cooling off of new deals.
As for Britain, post-Brexit, the UK government is considering carefully how best to promote the nation as a fintech and technology hub. SPACs are one obvious way to attract high-growth companies, and as a result of Lord Hill’s UK Listing Review the UK is now looking to reform its listing rules in 3 key areas.
Given UK investors’ more cautious approach to company valuations, combined with financial regulators’ slowness and lack of flexibility in enacting reforms, the question now is will the UK and Europe be able to keep attracting high-growth companies, or will the upsides of the SPAC boom mostly accrue elsewhere? With Goldman Sachs saying SPACs could drive almost a trillion dollars in deals in the next 2 years, it seems like a prize worth winning.