The past few years have seen the emergence of an entirely new type of corporation. The so-called “Special Purpose Acquisition Company”, or SPAC, has seen an explosion in popularity. Instead of engaging in any actual commercial activity, the SPAC instead simply raises funds to buy out another company. Despite its novelty, the business model has rapidly become widespread in the United States, and is starting to appear on the exchanges of continental Europe. Yet it remains to be seen as to whether SPACs are actually here to stay, or if the fad will disappear as quickly as it sprung to life; in Britain, at least, they have yet to catch on, due to the City’s regulations undermining the model.
The SPAC model is radically different compared to that of a standard corporation. Since it makes no attempt to engage in any commercial activity, all the hopes of the SPAC’s investors rest on its ability to secure a deal with an existing, profitable private company. Importantly, the investors most likely have no clue who the eventual acquisition target will be, and are simply putting their faith in the project’s main developer, or “sponsor”. This has resulted in many SPACs basing their credibility on the reputation of the sponsor; for example, the highest-valued SPAC of all time was sponsored by famous investor Bill Ackman.
Another unique aspect of the SPAC model is the fundraising dynamic. SPACs primarily raise capital through an initial public offering, or IPO, wherein they sell off shares – usually for $10 each – with the promise that investors will be able to sell those shares once the SPAC has completed its merger. Sponsors can also sell warrants, which guarantee the right to buy a share (or fraction thereof) some time after the merger. Finally, to build investor confidence, the SPAC keeps its funds ring-fenced inside a trust, to be used only for completing the acquisitions deal, and offers investors the right to redeem their shares for the original price, risk-free with interest.
This model offers advantages to all parties involved. For the investor, the guarantees offered by the SPAC sponsor make it an attractively low-risk proposition. If the sponsor is well-known, that further boosts the appeal. Moreover, prior to the merger, the SPAC acts like an ordinary stock; it is entirely possible to buy a share in the SPAC and sell it off for more than $10 prior to the deal being announced, if confidence in the company is high enough. Finally, in a conventional IPA it is common for investors to end up with fewer shares than they applied for, due to excess demand; thanks to the warrants, this is not the case for SPACs.
On the other hand, private companies can see the SPAC as a much more appealing way to go public. Using the conventional IPO route has a number of pitfalls; for example, the company usually has to undervalue itself so that the share price appreciates in value right after launch. This is particularly so for companies that offer complex products or services, as standard investors might undervalue them due to not understanding their purpose. Dealing with SPACs remedies these issues, as they have already handled the IPO aspect, and can use their expertise to negotiate with the private company for an agreeably fair price. They are also allowed to use future growth projections in these negotiations, which they cannot during a regular IPO pitch.
Finally, the sponsor themselves get a cut of the proceeds. Generally, the sponsor’s up-front investment is only $25,000 or so, for which they take 20% of the shares. Even after using some of this to pay for the administrative costs of running the SPAC, they still usually end up making a massive profit. However, this does present an issue: sponsors are incentivised to find a deal, even if it is bad for the other investors, because for them it is still more profitable than giving up and refunding the shares.
If a poor deal is made, the consequences for investors can be substantial. If the new, merged company underperforms on the stock market, it could lead to poor returns or even a loss for investors. Many of the larger investors, predominantly hedge funds, circumvent this by redeeming their shares and then using warrants later on once a deal is announced. But this means other investors are squeezed hard, as a substantial portion of their money goes toward paying off IPO broker fees. In addition, the SPAC usually has to bring in more money for the deal, which forces them to invite new buyers as a “Private Into Public Equity” investment, reducing the initial investors’ stake.
Moreover, sometimes SPACs can simply fail to secure a deal in time. The aforementioned Bill Ackman recently had this happen to his SPAC, Pershing Square Tontine Holdings, which raised over $4bn only to have its first acquisition deal rejected by the SEC. This, coupled with ongoing litigation against the company which aimed to reclassify it (and thus all SPACs) as an investment fund, undermined his progress to the point he believed it could not find a new deal in time. As such, Ackman had to refund all investors; he has since created a so-called SPARC, which only issues the right to buy shares once a deal is announced rather than selling shares themselves. It remains to be seen whether this model will be as popular as the SPAC.
Finally, as mentioned previously, the SPAC has failed to catch on in the UK. British regulations on mergers and acquisitions require the company to produce a full prospectus before investors can sell their shares. This completely defeats the selling pitch of the model, and has ensured the phenomenon is confined to the US and now Amsterdam. But this may change. The FCA hopes that it can relax these regulations and attract new business – but even with the relaxation, the SPAC sponsor would have to abstain on a merger vote, leaving the decision at the mercy of investors. For this reason, even if SPACs have a future elsewhere (which, given their glaring issues, they may not) they are unlikely to have a future here.