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Visible Hands: Space for SPACs? 🦄
Gross proceeds from SPAC IPOs have exceeded $56.3B thus far this year, more than the combined amount for the prior nine years. Why are so many private companies now choosing to go public this way?
Gross proceeds from SPAC IPOs have exceeded $56.3 billion thus far this year, more than the combined amount for the prior nine years. With headlines like “2020 is the Year of the SPAC”, why are so many private companies now going public through this method and what does this mean?
First, the basics: SPAC stands for Special Purpose Acquisition Company or a fancy way of saying a blank check. A sponsor investor forms a blank check company and raises capital in an initial public offering (“IPO”) of this entity. Within two years, the IPO proceeds are used to acquire one or more unspecified businesses to be identified after the IPO. Then, the target company reverse merges into the public SPAC entity. Essentially, you are betting that the masterminds behind the SPAC will find a promising company. (If you don’t like the target, you can get your money back before the merger closes.)
Appetite for this type of strategy has grown. In 2018, there were only 46 SPAC listings; there are 148 and counting this year. SPAC transactions in 2020 include DraftKings, Hims, Opendoor, and Playboy, and prominent investors are sponsoring SPACs, from Pershing Square (#BillAckman) to Softbank.
Fascinating considering how SPACs used to be associated with failure and fraud (in 2015, 10 people allegedly pocketed millions from SPAC deals with illegitimate companies!) Recent developments in SPAC structures have increased certainty around acquisition approvals and made it easier for acquired companies to go public.
Remember, the WeWork attempted IPO debacle of 2019? They went the traditional route: first announce the deal and file to go public, and then solicit investors and see if anyone would buy stock and at what price. Not to mention the rigorous public filings that come with an IPO (throwback to when pundits criticized WeWork’s sloppy disclosures...). What if WeWork IPO’d through a SPAC?
However, SPAC fees are substantial. The SPAC needs to pay IPO fees to investment banks and pay advisers to negotiate the merger. And the sponsor behind the SPAC generally gets a big cut as a reward for looking for the target. According to Matt Levine of Bloomberg, “SPAC fees are about a quarter of the money raised, 3 or 4 times as much as you’d pay in an IPO, albeit better disguised.” Let’s not forget that only 31% of the SPAC IPOs from 2015 to September 2020 had positive returns, significantly behind traditional IPOs in that same period.
Regulators have started to also focus on SPACs. The Securities Exchange Commission (SEC) Chairman Jay Clayton has noted his interest in understanding the incentives, equity holdings, and compensation of SPAC sponsors through more disclosures. The SEC recently stated that companies going public through a SPAC must wait 12 months to file short-form registration statements, seemingly removing regulatory shortcuts. Regulators are basically saying, “We are paying very close attention; we want to make sure that there is not some kind of loophole being created here.” That said, the aforementioned short-form registration is less extensive compared to an initial registration statement many IPO companies go through and is available to many companies that meet certain SEC criteria one year after going public. Note, the “De-SPAC” transaction when the target company is acquired entails similar requirements to an IPO, including audited financial statements.
SPAC sponsors and target companies are certainly not all saints, as evidenced by the recent scandal with Nikola (which merged with a SPAC in June) for falsifying their technology to investors. Given the growing interest, are there enough disclosures to keep sponsors and companies accountable?
As an investor:
Although SPACs are interesting ways to become investors in unicorns, don’t forget these could be disappointments (see FMCI, a SPAC that investors believe would be the vehicle for Impossible Foods but instead acquired another lesser known plant-based food brand), so do your research on the sponsor and their track record, make sure you’re comfortable, and remember to diversify your investments
As a citizen:
Note that SEC Commissioners are appointed by the President. Chairman Clayton was appointed by President Trump, and approved by 51 Republican Senators, 9 Democrats, and 1 Independent. The general election will play a role in deciding who the future SPAC rulemakers will be
Relatedly, four ways a Biden administration could impact the SEC: (1) increase ESG disclosures, (2) less fervor for expanding private markets, (3) more clarity on “Regulation Best Interest,” which raised standards on brokers who sell advice to retail investors, and (4) more scrutiny of dual-class shares
As an employee:
If you’re on the management team or board of a company considering IPO-ing through a SPAC, make sure to diligence the sponsor and see whether they will provide strategic and operational insights to your organization
As a consumer:
Not gonna lie. This is the first time when we’re at a loss about how to tie in a stakeholder role into our lead story. So we’re just gonna use this space to remind you again to vote.
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