SPACs Spick and Span?

Context: A critical analysis of Special Purpose Acquisition Company (SPAC), which has gained traction as an unintended consequence to COVID.

Defining SPAC:  It is a legal shell company that is set up by investors with the sole purpose of raising money through an initial public offering (IPO) to eventually acquire another company, a fast track to take it public.

• The US IPO market saw almost 500 companies go public during the pandemic, raising about $174 billion, while 248 SPACs raised $82 billion during the same period.

Advantages SPACs offer over traditional IPOs

• Faster processing: SPACs can be done within 3-4 months with fewer restrictions.
• Companies have more freedom: due to lack of brokers, detailed Security and Exchange Commission (SEC) scrutiny, companies can give projections to investors and raise funding at multiple points in time.
  • The costs of a traditional IPO are both the direct fees that companies pay to investment banks, as well as legal fees, due diligence fees, commissions, etc.
  • There is a higher indirect cost of under-pricing IPOs or ‘leaving money on the table’; Studies indicate that in 2020, about $34 billion was left on the table.’
• Greater certainty about a deal: IPOs often fall apart at the last minute because of volatility in the markets, while SPACs are much more predictable.

Problems associated with SPACs

• Investors will be at the mercy of the sponsors: Because SPAC investors simply trust the reputation of the sponsors and have no historical record of the target company to check prior to investing.
• Moral hazard embedded into the transaction: Profit of sponsor is assured irrespective of the final outcome of the SPAC as they don’t need to hold on to the shares for any mandatory period.
• In need of regulation: The limited ownership disclosure requirements and the big kicker in compensation being tied to an acquisition make it ripe for regulation.
• Post-merger investors will suffer: There are empirical evidences shows that stock prices will fall due to SPAC dilution, and thus post-merger investors will suffer negative returns after assuming risks.

Conclusion: In sum, whether SPAC traction is just a Covid-induced side-effect or truly an elixir for start-ups depends on how SPACs perform in more ‘normal’ times.