No longer mere SPAC-ulation
Special-purpose acquisition companies, known as “SPACs” or “blank cheque businesses”, are recognised by the Financial Times (“the FT”) as the next big thing in finance. The statistics speak for themselves in terms of volume and value: SPACs have raised over three times this year-to-date compared to 2019, with the USD48bn sum accounting for 1 in 5 dollars raised from initial public offerings (“IPOs”). 2020 has also seen the largest SPAC IPO of all time when Pershing Square Tontine, fronted by hedge fund manager Bill Ackman, listed on the New York Stock Exchange (“the NYSE”) at a value of USD4bn.
SPACs are touted as an alternative route for private companies wishing to go public. These vehicles are essentially shell companies created for the purpose of acquiring an already operational private company, using the finances raised from the SPAC’s own investors and IPO proceeds. Such mergers exemplify a type of reverse listing, and enable private companies to bypass the lengthy, expensive, highly-publicised IPO procedure. Compared to a traditional IPO, SPACs have a few distinct attributes. They generally have a set time limit, typically 2-3 years, during which managers will seek to identify and close a merger deal. Failing that, the SPAC is wound up and its funds will be returned to shareholders, alongside interest earned in the meantime. Furthermore, SPACs, being mere shell companies with a singular purpose, have no operations of their own—hence, their main selling point lies in the expertise and name recognition of founders.
According to Norton Rose Fulbright, the recent boom in SPAC activity can be attributed to the COVID-19 pandemic: economic uncertainty has shrunk the demand for traditional IPOs, while struggling private companies are seeking straightforward access to thriving equity markets to raise capital. Banks are capitalising on this new trend, as Kirkland & Ellis notes a “huge increase in high-quality, first-time issuers”; additionally, the institutional backers that are building an expertise in SPACs are not the traditional underwriters of IPOs, signalling a shift in power in the banking sector.
SPAC-tating from the sidelines
The US presides over 99% of finances raised globally through SPACs this year. In stark contrast, a total of zero new SPACs have launched in the UK in 2020. The London Stock Exchange (“the LSE”) is rightfully concerned about sluggish IPOs and, hoping to jump onto the trend that is aiding a recovery for the NYSE, is reportedly in early strategic talks to kickstart the demand for SPACs in the UK. However, there are notable differences between the procedures in the two jurisdictions that explain why SPACs prefer to list in the US.
Investors have greater flexibility in the US model, which allows shareholders to vote on a potential target company and get their money back immediately if they disapprove. However, no such shareholder approval is required in the UK, which may tie up investors’ funds for the duration of the SPAC’s lifetime, unable to be redeemed until the merged entity is re-listed or the SPAC fails, whichever is the sooner. Hence, institutional shareholders in the UK may not be convinced unless they fully support the SPAC’s management team, such that successful fundraising is only viable for the most well-connected and trustworthy founders.
Another difference is that when a UK-listed SPAC buys a private company, the transaction is considered a reverse takeover by authorities, which triggers suspension of the SPAC’s shares. In order to be re-admitted to trading, the SPAC must publish a prospectus including detailed information on the merged entity, and receive approval. This causes a significant time lag—in fact, several SPACs that listed on the LSE in 2017 remain suspended to this day. Thus, transactions are usually much faster in the US, which only suffers from the waiting time when filing shareholder approval.
SPACs carry quite a high degree of uncertainty on multiple levels, which entices risk-taking US investors and alienates risk-averse UK financers. Ironically, the UK system with its lack of voting and redemption rights fails to capture this sentiment, giving flexibility to founders at the expense of shareholder protection matters. Analysts therefore propose changes to the UK’s SPAC rules to entice European SPACs away from the NYSE, starting with removing the share-suspension requirement to combat investors’ concern of locked-up funds.
A SPAC-trum of opportunities
The biggest pull of recent SPACs is not necessarily their structure, but rather that they provide investors with an opportunity to work with an expert founder team. More often than not, banks themselves recruit buyout veterans and executives to front SPACs, benefiting from their connections, knowledge and investment track record. In addition, investors are protected from risk if an acquisition does not take place within the specified time frame, as they may redeem funds through “money back” features. This bears a resemblance to investing in low-risk bonds with lock-in periods, yet has the potential of far greater returns. Essentially, investors receive private equity-style deals with the liquidity of public markets—shares and warrants in SPACs are highly tradeable securities.
On the other hand, a major concern is the thin disclosure procedure that SPACs go through before listing—it is therefore incredibly important that investors can trust founders to do their due diligence before acquiring a company. The FT theorises that Wirecard, a German fintech company, was able to sustain a fraud at its core for years without discovery due to the lack of proper scrutiny when it went public. Through reverse listing into a shell company, Wirecard avoided the need for a comprehensive prospectus and serves as a cautionary tale to wilfully-blind investors. An additional uncertainty for investors is the fact that target companies are not known before the SPAC’s public listing, and information is limited to the founders’ general acquisition strategy—there is no way of knowing what shareholders are buying into, and no easy way out once a deal is announced.
There are few downsides to going public through a SPAC from the perspective of private companies seeking an exit. Most importantly, there is greater certainty than traditional IPOs, where a valuation and share price are set largely independently by underwriters and are only finalised at the last minute. Contrariwise, acquisitions by SPACs have essentially the same process as any merger: ongoing closed-door negotiations on financial terms that tend to give companies higher valuations and price certainty in advance of a deal. Since these are bilateral conversations, target companies may find themselves with bargaining power as opposed to leaving their fate at the hands of the market. Furthermore, executing a deal with a SPAC is simply cheaper and quicker without the process of filing an IPO prospectus and being scrutinised by regulators; all done with the aid of expert SPAC managers.
Despite the inherent risk of investing in a UK SPAC, the outlook is not entirely grey. The lax shareholder protections incentivise private companies to list through SPACs, which will lead to a higher volume of successful acquisitions and encourage star managers to pursue SPAC opportunities. As long as institutional investors are prepared to put trust in SPAC founders at the expense of autonomous decision-making, there will be demand for these vehicles in the UK. It only remains for the LSE to figure out how regulations can adapt to cultivate this rising trend.