By Nataly Kehyayan, Staff Writer
In 2020, investors saw 248 SPACs enter the market, a 320% increase from 2019. Special Purpose Acquisition Companies are shell companies that do not hold any assets or serve any purpose other than to raise money through a non-traditional IPO to eventually merge with another company.
When a company is too risky, or there is not enough interest from investors, it can be hard to find a bank that is willing to go through the underwriting process with them. SPACs are a good method for such companies to raise money. Another problem that these blank-check companies solve is the significant undervaluation of traditional IPOs which leaves plenty of capital on the table at the expense of publicized firms. SPACs are becoming increasingly more generous in the amount of money they are willing to pay to these target companies.
The process is fairly straightforward. First SPACs are formed by investors, venture capitalists, or PE firms. When the IPO stage begins, investors are not usually aware of the potential companies that might be acquired. This is mainly to avoid further investigation by regulators. For this reason, the market is interested in the reputation and the experience of the management team, since that is almost all the information they can work with. The sponsors of a SPAC do not usually get paid before the company proves a satisfactory performance, which incentivizes better management.
After the IPO, SPACs have 24 months to determine a private company that they will acquire or merge with. The private company then becomes public through the SPAC instead of going through a traditional IPO process. Unlike traditional IPOs, where there are no ROI (return on investment) guarantees, and if a SPAC cannot eventually decide on a company to acquire, investors will receive their money back. To a certain extent, this compensates for the risk of uncertainty regarding the undetermined future plans at the time of initial investment.
Each unit of share is normally priced at $10 and is also accompanied by a warrant that allows investors to add more shares to their portfolio after the company goes public. Once the company to be acquired is decided, it is listed on a stock exchange to start trading. The average market return of a SPAC’s warrants is 44.3% over a one-year period and 52.8% over three years. This premium is a common advantage that warrant investors have over common share investors. However, between 2015 and 2020, only less than a third of SPACs were profitable.
One could ask if the rise in popularity of these companies is just a fad, but the truth is that they allow companies to acquire some capital prior to an IPO success story. “[SPACs] are hot because they are filling an important hole in those capital markets: They’re providing companies with a quicker and cheaper way to go public than the traditional IPO, and more certainty about the price they’ll get when they sell a stake in their business,” writes James Surowiecki.
Unlike venture capitals, SPACs attract a larger investor pool. This could be both an advantage or a disadvantage since it is easier for shareholders to opt-out of the deal when they want, which erodes investor loyalty. They also have a say in the company’s decision-making.
SPACs have had some highs and lows in popularity in the past decade. Initially, there were accounts of fraud, scams, and compliance issues that gave SPECs a bad reputation. Although the SEC has since set regulations such as where the money would be kept while the company looked for target acquisition and the number of years that the search could continue, there is still some skepticism towards the reliability of these investments.