A SPAC, or Special Purpose Acquisition Company, is an entity with no commercial activities, built with the specific purpose of acquiring a company. SPACs are also sometimes called blank check companies.
SPACs have seen some serious growth this year. By March 19, SPACs raised $87.9 billion -- more than all of last year’s $83 billion. Since Covid -- and even a little before that -- SPACs have been gaining more interest from investors.
How SPACs work: big fish looking for small fish
A whale shark weighs 19,000 kg and survives by swimming around with its mouth wide open and feeding on smaller creatures like plankton and fish.
In the financial waters, SPACs are kind of similar. Only they zero-in on one small fish -- a promising company.
SPACs are usually assembled by a bunch of investors or Wall Street professionals. They’re built solely to raise capital to acquire a company they deem will succeed as a public entity. SPACs do that by selling stock -- usually at $10 a piece. There’s also a warrant included, in case investors want to buy more stock later at a fixed price.
First, there’s the IPO stage, where the SPAC’s management team -- also known as its sponsors -- raise money from interested investors.
Once they have the money, they start fishing for a company to acquire. There’s a deadline here -- usually about two years. If the SPAC doesn’t manage to find a company to acquire or merge with by then, investors get their money back with interest.
The story of the SPAC
SPACs have been around since the 90s. They started out with a pretty dodgy reputation, seen as a shady way of going public -- a route only desperate companies would choose to take.
Since no one knew the investors taking part in the deal, and no one knew the company that was aiming to go public, SPACs’ rep pretty much stayed in last resort territory.
That view changed in the early 2000s, when Citibank became the first mainstream bank to work with SPACs -- the IPO markets had shut, so it was the only alternative. The number of SPACs going public has gone up and down together with economic cycles since their first appearance about thirty years ago. But they’ve been getting really popular again.
In just the first quarter of 2021, 298 SPACs went public, breaking their records. That’s more than all of 2020, which included 248 SPAC IPOs.
“The 2020 and 2021 year to date SPAC boom is a gold rush,” said Scott Rostan, founder and CEO of Training the Street, a financial learning services company. “Capital is plentiful, so growth-stage, private companies are taking advantage. And public investors have supported the SPACs, giving them the fire power to execute the mergers.”
SPACs versus traditional IPOs
Traditional IPOs require regulatory and investor scrutiny, hiring an investment bank for underwriting, road shows, and pitch meetings. They also take 4-6 months to complete.
SPACs are sort of the quick-fix alternative to traditional IPOs. Their track records depend on the reputation of their management teams. Because of this, companies going public via SPACs don’t need to worry about things like roadshows or gaining investors’ interest in their products. They end up listing much quicker this way.
“SPACs can help companies go public three months faster than other methods,” said Shanka Jayasinha, founder of S&J Private Equity. “Companies may also decide to go public through a SPAC because of the structure they offer. SPACs are already funded by investors and led by appointed managers, who all have their own reputation. This gives a more transparent and shorter route to capital as well as the type of investors the company will be having relative to an IPO organised with a traditional investment bank.”
Why are SPACs so SPAC-tacular right now?
Even before the pandemic, SPAC IPOs were increasing -- that had to do with how booming the market was back in 2019. Covid has only accelerated the SPAC speed.
Because of the market volatility, the pandemic caused a lot of companies to postpone their IPOs. Others, though, chose to reroute through a SPAC.
One reason is the shift in market liquidity, said Mark Williams, Chief Revenue Officer for the Americas of Datasite, a software company that facilitates M&A deals.
“The liquidity governments have put into the market, especially in the US, and some of the ways that the costs of SPACs have decreased have made them an attractive option for a lot of companies.,” said Williams.
Then there’s the fact that the management teams behind SPAC deals are becoming more filled with names that potential investors are actually familiar with. This has led to more trust and fewer disclosure demands.
As an example, hedge fund manager Bill Ackman, who already has a SPAC under his belt, said at the end of March he is planning for a second after his first deal is done -- even after missing the first SPAC’s self-imposed goal.
Another point to mention is the increased interest we’re seeing from retail investors. For these types of investors, it may be more challenging to invest in traditional IPOs, since shares tend to not be as readily accessible to everyone.
“It is generally very difficult for retail investors to participate in traditional IPOs since the allocation of shares is controlled by the investment banks underwriting the transaction,” said Moira Conlon, president of Financial Profiles. “In a traditional IPO, shares are typically allocated to large institutional investors and a select group of private clients. In a SPAC transaction, there is a level playing field where all investors have equal access to purchasing shares in the open market.”
Fintechs and SPACs
Because fintech is booming right now, it’s become an exceptionally big target for SPACs. Consequently, we’re seeing a lot of fintech and SPAC deals taking place.
“There is a lot of growth [with fintechs], and there seems to be significant demand in the public market for high-growth companies and higher-growth stocks," said Brendan Carroll, senior partner and co-founder of Victory Park Capital Advisors. The company formed a SPAC that recently merged with Bakkt Holdings, a digital asset company.
BankMobile, a subsidiary of Customers Bancorp, went public through its merger with SPAC Megalith Financial Acquisition Corp. back in January.
On February 3rd, Payoneer merged with SPAC FTAC Olympus Acquisition Corp., valuing the fintech at $3.3 billion. Later that month, MoneyLion too announced its merger agreement with SPAC Fusion Acquisition Corp. later this year.
European trading app eToro announced it’s going public via a SPAC back in March. The startup is merging with the Fintech Acquisition Corp. V, and agreed to a valuation of $10.4 billion.
On April 22nd, Pagaya listed to go public through a SPAC valuing the company at $8 billion. That same day, SoFi resubmitted its merger filing with the Securities and Exchange Commission to go public via a SPAC.
Why the US may be perfect for SPAC growth
99% of the funds invested in SPACs last year were in the US. 96% of the SPACs listed in the first ten months of 2020 were in the US.
The US has different rules for SPACs. For example, investors can vote to approve a company the SPAC proposes to acquire, or redeem their funds if they don’t support the deal. That’s not necessarily the case in other countries, which could be why we’re seeing so many European companies listing in the New York Stock Exchange.
But SPACs aren’t without risks
First, there’s the fact that investors are basically going blindly into these deals. Even if they have an option to back out later, for those two years, their invested funds belong to the SPAC. Additionally, because they’re on a deadline, SPAC sponsors are mostly just looking for a functioning acquisition -- not necessarily the best one out there. That means the SPAC could end up overpaying for a target company.
Then there’s the side of the target companies themselves: They run the risk of having their acquisitions be rejected by shareholders. On top of that, if the deal does go through, they still have to give the sponsors 20% of the founder shares.
SPAC deals also aren’t as scrutinized for risks as traditional IPOs. That in itself can lead to pretty rocky outcomes.
Finally, experts are concerned that the amount of SPACs going public now could overheat the market and make it harder for the economy to recover.
Are SPACs going to stick around?
SPACs have a tendency to swim in and out of the limelight. Right now they’re popular because of market conditions, said Datasite’s Williams. They won’t disappear, but they may not be such a go-to choice forever.
“I think other funding sources or capital opportunities will become more attractive as things ebb and flow,” he said. “SPACs have been around for a long time, [but] market conditions have made them very attractive right now. So I don't think they'll go away. But I think there will be a response from other funding areas, and they'll cool off a little bit.”
Then there’s the case of supply and demand. The market can only hold so many SPAC deals.
“SPACs are here to stay as vehicles for companies to access public markets. But the current volume of SPACs is not likely to sustain,” said Jeff Crowe, managing partner at Norwest Venture Partners. “There is still a large number of SPACs that will need to find merger targets over the next couple of years. They just can’t all happen over the next couple of months.”