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01Mar

What’s So Special about SPACs?

My barometer for when an arcane finance topic has crossed into the mainstream tilts when my twentysomething artist daughter asks me about it. We’ve already had two such events this year- first came the “short squeeze” around the GameStop fiasco. Now we have Special Purpose Acquisition Corporations (SPACs), which even Hollywood celebrities are suddenly embracing as the “it” investment vehicle.

From A-Rod to Jay-Z, with Serena Williams and former House speaker Paul Ryan somewhere in between, SPACs are flashing no shortage of star power. Given the hype, casual observers can be forgiven for not realizing that SPACs have been around since the mid-90s as a relatively boring and seldom-used capital structure. Thanks to a confluence of factors, however, they’ve raised more funding over the past 15 months than in the preceding 20 years combined.

Why the burst of enthusiasm? First, let’s consider the basics. A SPAC is quite literally and accurately named- it’s a public corporation established with the special purpose of making an acquisition. Historically, its shareholders were typically a small number of institutional investors, who in most cases knew the founding team and placed faith in its ability to identify and negotiate a sound acquisition. SPACs are often called “blank check” firms for this reason- its prospectus might offer some indication of intent such as the sector or size of acquisition targets, but management is given broad discretion for its shopping spree.

So why did this 25-year-old model achieve overnight success? Consider founders’ growing frustration over the bureaucratic IPO process- the extensive disclosure requirements, the uncertain pricing dynamics, the lead times of as long as 12-18 months that make it difficult to “time the market.” Wall Street mavens suddenly realized it’s a lot easier to take a shell company public- after all, how much disclosure can be required of an entity with no operations?- and merge it with a unicorn a few months later.

Now consider the backlog of private startups that have achieved scale over the past decade bankrolled by investors looking for a lucrative “exit,” the appetite of individual investors to play in IPOs historically open only to high rollers, and the frantic hunt for high-yield investments in an extended low-rate environment. These conditions make for a perfect SPAC storm. Sure enough, more firms have gone public through SPACs than through traditional IPOs in recent months.

As with many sound ideas, however, overexuberance can ruin a good thing. There were 248 SPACs formed in 2020- accounting formore than half of all IPOs- and another 131 in the first two months of 2021.  Are there enough sufficiently mature companies for these entities to target?  If their sole purpose is to complete an acquisition, won’t a supply/demand imbalance lead to overvaluing of the relatively scarce viable target firms, setting the stage for future price collapses?

Also recall that in the original SPAC model, investors essentially placed bets based on their knowledge of a SPAC’s leadership’s deal making acumen. With the investor pool expanding to the general public, knowledge of these players has largely vanished.  This is probably why many of the new breed of SPACs has turned to celebrity name recognition for leverage. Somehow I doubt those A-listers will be part of the actual negotiations, however. I also doubt most individual investors have read the fine print detailing the cut of proceeds the insiders take off the top, much like a hedge fund.

Deployed properly, a SPAC is a clever idea that may have the added benefit of forcing adjustment of some unnecessarily onerous IPO rules. There are growing signs we’ve moved beyond the “deployed properly” stage, however.

Hear our recent BIGCast on SPACs, including a discussion with Forbes contributor Jeff Gapusan, here.

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