Special Purpose Acquisition Companies (SPACs) have seen a meteoric rise between 2020 and 2022, sparking interest from investors.
Over the last few years, SPACs have revolutionized the public market entry for many companies, emerging as a viable alternative to IPOs, and offering a quicker way to go public.
Since 2020, over 960 SPACs have debuted according to data from Statista, with over 400 companies going public by merging with SPACs.
Let’s explore SPACs, understand the surge in their popularity, the mechanics behind their operation, and their benefits to sponsors, investors and target companies.
SPACs, often referred to as "blank check companies”, offer a fresh and intriguing way to list on the public markets, diverging from the conventional initial public offering (IPO) route.
At their core, SPACs are shell companies established to raise capital through an IPO, to merge with an existing company.
The SPAC model is unique because, unlike traditional IPOs, SPACs go public without any assets or optional business, apart from the funds raised for a future acquisition.
Understanding SPACs
The SPAC structure is useful for a few reasons, since it provides a faster track to the public markets, and reduces regularity scrutiny, making it an appealing alternative for businesses going public.
SPACs originated in the 1990s, but were initially viewed with skepticism due to regulatory concerns and mixed performance, but evolved over the decades, gaining credibility and refinement.
The early 2000s saw improved regulatory frameworks enhancing its appeal, and by the 2010s SPACs began attracting notable investors and corporate leaders, signaling a shift in perception.
The period between 2020 and 2022 marked their zenith in popularity, driven by favorable market conditions and investor interest in quick, flexible public listing options, reshaping the landscape of new public offerings.
The SPAC Process Today
SPACs are conceived by sponsors, who are typically a team of investors or experienced business leaders having expertise in particular sectors like energy or technology.
Sponsors then create these SPACs, by investing their capital to cover the initial expenses, and then raise money through an IPO.
In the initial stages, Investors in a SPAC IPO buy units, which comprise shares and warrants, with the funds raised from the offering being placed in a trust account.
Post-IPO, the SPAC has a set timeframe, usually 18-24 months, to identify and propose an acquisition of a target company, with the phase involving meticulous searching and due diligence to find a suitable private company that could benefit from going public.
Usually, SPACs have discussions with between 20-100 merger targets in the specific sector it is targeting. Once a target is identified, the SPAC negotiates a merger or acquisition, which involves various details like the valuation, structure, and incentives.
The proposed deal is then subject to approval by SPAC shareholders. If approved, the SPAC and the target company merge, and the latter becomes a public company.
If the SPAC fails to complete a transaction within the designated timeframe, it must return the capital to investors, dissolving the entity.
SPACs vs Traditional IPOs
SPACs and IPOS offer distinct paths for companies going public, each with its unique pros and cons.
In a traditional IPO, a company undergoes a rigorous, often lengthy process, involving detailed financial disclosures, underwriting by investment banks, and extensive regulatory compliance.
Thus, IPOs provide market validation and can attract institutional investors, but the process has previously been costly and time-consuming.
On the other hand, SPACs provide a quicker, more streamlined option for companies looking to go public, reducing time and regulatory hurdles.
However, SPACs can carry higher risks and costs due to their speculative nature and reliance on sponsor reputation, making them a more uncertain, albeit faster, alternative to traditional IPOs.
Who Benefits from SPACs?
SPACs offer a structure that is rewarding to sponsors, investors, and target companies, who are each driven by distinct incentives.
The sponsors typically receive 20% of the SPAC's equity as compensation for a successful merger, motivating them to identify and merge with a lucrative target.
For target companies, especially startups and growth-stage businesses, SPACs offer a faster, more straightforward path to public markets compared to traditional IPOs.
Investors also stand to benefit from SPACs as they get to access companies early in their growth cycle, with the potential to generate significant returns, while offering downside protection, with the ability to redeem shares at the IPO price if they don’t agree with the merger target.
Performance Analysis of SPACs
Post-merger performance of SPACs has yielded mixed returns, especially over the last few years.
While fee companies have posted significant growth and returns, a majority of stocks have significantly underperformed the broader market even when compared to the performance of traditional IPOs.
Market data from valuation research shows that companies that went public through SPACs in 2022 and 2021 on average lost between 67% and 59% of their value.
Successful SPAC deals like Symbotic and DraftKings have enabled the companies to attain rapid market entry and capital growth.
However, there are several instances like Nikola and Lordstown Motors, which have faced regulatory and operational setbacks, leading to a slump in their market value.
Of the companies that have gone public through SPACs since 2020, 23 have declared bankruptcy, with over 110 companies losing more than 90% of their value, and trading below $1/share, according to a report by Forbes.
Broadly, there have been several factors that have led to the underperformance, including over-optimistic valuations during the merger process, inadequate due diligence, and the speculative nature of the merger targets.
Moreover, the influx of SPACs in the last three years has led to increased competition for quality target companies, resulting in rushed deals without enough due diligence.
Furthermore, sometimes, the incentive structure for SPAC sponsors focuses on deal completion rather than long-term performance, which can lead to misaligned objectives with investors looking at value creation.
The Future of SPACs
New SPAC listings have experienced a sharp decline in 2023, from the peak of 613 IPOs in 2021 to just 24 in 2023, according to a report from Statista. furthermore, the total funding raised has also declined from $162 billion in 2021 to $2.7 billion in 2023.
The downturn is attributed to the disappointing performance of newly merged SPACs and an uncertain future macroeconomic outlook.
Over 300 SPACs have liquidated in 2023 and returned the money to investors, but 200 SPACs are still searching for target companies, indicating a challenging environment for both new and existing SPACs.
The future of SPACs holds more regulation and scrutiny, especially based on the proposed rules by the U.S. Securities and Exchange Commission (SEC).
These rules aim to improve the clarity and usefulness of information provided to investors, addressing concerns over target company valuations, conflicts of interest, and potential dilution issues.
This increased legal and regulatory oversight might lead to a more cautious approach in SPAC formations and mergers.
Additionally, the challenges faced by dual-class SPACs in Delaware, as evidenced by recent court rulings, suggest that future SPACs may need to adapt their structures and strategies to comply with evolving legal standards
SPACs have taken the investment landscape by storm. Hailed for their flexibility and speed in taking companies public over the last few years, SPACs have faced significant challenges recently, including market volatility and increased regulatory scrutiny.
The regulatory landscape has also notably evolved, with a notable shift towards greater transparency and investor protection. While the future of SPACs seems to be aligning with more stringent standards, their role in the financial ecosystem remains significant.
