Special purpose acquisition companies (SPAC) have been around since the 1980s. Often referred to as a ‘blank-check’ company, a SPAC is a non-operating business backed by a sponsor that raises capital to acquire a closely held operating business and take it public at the same time. At their inception, SPACs were frequently associated with disreputable companies and largely unregulated. Oversight improved in the 1990s and SPACS spent the next few decades mostly ignored. Until now.
SPACS were created to serve as an alternative to a traditional initial public offering (IPO), when a company issues shares to the public for the first time. For a private company wishing to go public, an IPO can be a long, invasive, costly, drawn-out process. By selling themselves to a SPAC, they can avoid many of the more onerous requirements and ease their way to the public markets in months rather than the longer road of an IPO. SPACs have often been the route to the public markets for companies with no other choice.
After a SPAC receives its new capital, the funds are placed in a trust until such time as the sponsor can identify and negotiate with a company willing to sell itself to the SPAC. But conflicts of interest abound. The costs of investing in a SPAC are reflected in terms that favor sponsors over investors. For example, sponsors are typically granted a substantial share of the profits in exchange for a relatively small investment. But these benefits accrue to the sponsor only if a deal closes. If an acquisition isn’t made by a stipulated outside date, typically two years, the sponsor must return the capital along with interest. Fear of having to return funds has prompted some sponsors to enter into bad deals at the last minute. They enjoy a wide latitude of upside and very little downside.
For investors, overall SPAC performance has been poor. According to Institutional Investor, the 89 SPACs that have completed mergers since 2015 have an average loss of nearly 19%, compared to the average gain of 37% for IPOs for the same period. Only 29% of the SPACs had positive returns.
Because investors don’t know what their funds will buy, an investment in a SPAC is a bet on the sponsor. Sponsors are typically private equity firms, hedge funds, and other investors who may have specific experience in the industries they are targeting. But demand is so strong, a former Congressman and sports executive have become sponsors too, and a SPAC ETF started trading in late September. It all adds up to the hottest market for new listings since 2000; according to data provider Dealogic, 40% of the money raised for new listings this year has gone to SPACs.
With a SPAC, you are not investing, rather you are betting on the skills of the jockey. The experience to identify a good purchase candidate, the market knowledge to determine a fair value, the fiduciary obligation to negotiate with investor interest first, and the capability to bring it all together profitably. Lacking those ingredients, you should take a hard pass.
Disclosure: This is for informational purposes only and is not a solicitation or offer to buy or sell securities.
