“SPACs are capturing the greatest wealth creation opportunity in history”.
-Vivek Ranadivé, Silicon Valley Investor and Owner of the Sacramento Kings
Special Purpose Acquisition Companies (SPACs), also known as “blank checks companies”, have been around for years but just recently they have had a huge soar in Wall Street.
But what is a SPAC? A SPAC is a corporate shell usually sponsored by well-known investors that goes public by issuing shares and raising money with a plan to find a private company to buy or to merge with. The interesting part is that if the merger happens, the target company becomes a listed company without an initial public offering (IPO).
Bill Ackman, CEO of Pershing Square Capital Management, defines the context as a “unicorn dance” where “we want to marry a very attractive unicorn on the other side [target company] that meets our characteristics and we’ve designed ourselves to be a really attractive partner [SPAC with its capital]”. This merger puts the target company under much less scrutiny then it would if it issued directly a typical IPO, this has caused and still causes much controversy.
What are the steps to launch a SPAC?
- Sponsors (SPACs managers) create the legal entity and they do a roadshow to raise funds and make their company public. At this stage, the SPAC doesn’t even know yet which company it will acquire, and neither do its investors.
- Once the sponsors have raised enough funds and made the company public, they have to find targets and acquire one of them.
So, in brief, investors are effectively buying the target’s company IPO in advance without knowing what the target company is or the price that will be paid. However, investors in SPACs do have some protections as they can redeem their shares if they don’t like the acquired company or if the SPAC doesn’t acquire any company in a specific timeframe, usually 24 months.
It is important to consider that even though going public through a SPAC sounds definitely easier, it certainly more expensive. As a matter of fact, while in a typical IPO the banks require a fee that’s around 7% of the IPO funds raised, SPACs pays the investment banks a fee around 5,5% of the money raised and towards the merger phase there will be another round of investment bank fees. In addition, SPACs will often give 20% of the shares for free to the sponsor who manages the operations (the cost is passed on to the target company). So, the cost of this process will be around a quarter of the money raised which is three or four times as much as an investor would normally pay in terms of fees to participate in a normal IPO.
SPACs in 2020
In 2020, the money raised in blank-check companies IPOs has almost quadrupled. Analysts say that the growing mainstream acceptance of SPACs helps fuel this year’s boom, as well as the coronavirus pandemic. Why? Because in volatile markets a company’s valuation can crash overnight. With a SPAC there is more certainty of execution. You know earlier in the process that the deal will be done, whereas IPOs get derailed at the last minute every time.
This year, many of the companies that are going public through SPACs are seeing big valuations. In September, United Wholesale Mortgage agreed to go public in the biggest SPAC deal ever with a $16 billion valuation. This marks a huge shift from the 1980’s when predecessor of the current day SPACs were called “blind pools” and these “pools” had suspicious ties to Penny- Stock frauds. In the subsequent years, tighter rules and regulations helped add credibility and increase investor confidence.
Now as SPACs gain popularity, more blue-chip institutions and well-known investors are buying in. For example, Goldman Sachs and the New York Stock Exchange that never listed SPAC IPOs are now listing them.
Still, some critics remain concerned that companies going public through SPACs aren’t getting as much scrutiny as those following the typical IPO procedure.
A striking example is that of Nikola ($NKLA) which went public with a SPAC in June and has been accused of fraud in a firestorm of allegations by Hinderburg Research. Federal regulators are raising concerns as well. Now, the Securities and Exchange Commission is analyzing how blank-checks companies disclose their ownership and how compensation is tied to an acquisition.
The future of SPACs
The rise of SPACs will definitely create more competition for sponsors, which will benefit companies looking to go public, as well as investors. However, as the SPACs more common, the need for tighter regulations and scrutiny will prove necessary and essential to prevent widespread fraud and financial misconduct. The regulatory commission has to be as fast as the expansion of SPACs.
SOURCES:
Wall Street Journal articles
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