2020 was the year of many things: the coronavirus pandemic, Black Lives Matter protests, an unforgettable presidential election. It was also the year of the Special Purpose Acquisition Vehicle, or SPAC (pronounced “spack”).
So far this year, 201 SPACs have raised over $69 billion on public markets, compared to just 59 SPACs raising $13.6 billion in 2019, per SPACInsider. What’s more, SPACs have attracted a wide range of big-name sponsors and investors, from the likes of hedge fund investor Bill Ackman, to former House Speaker Paul Ryan, to music mogul Jay-Z.
Now, with 2021 approaching, SPACs are positioned to continue their hot streak. Stock market investors need to get up to speed on all things SPACs – and fast.
How do SPACs work?
SPACs – also known as “blank-check companies” – are, first and foremost, publicly traded companies. But unlike most listed firms, SPACs do not have commercial operations, or business plans, or teams of employees. Rather, SPACs are something of a financial intermediary between private and public markets. SPAC sponsors – those who bring the SPAC to market and decide which company to target – list a SPAC on a public stock exchange for the sole purpose of merging with, or outright acquiring, another company.
Investors who buy shares in a SPAC are basically funding that SPAC’s future M&A activity – but without knowing what firm that SPAC will target. Most SPACs come with a two-year horizon, meaning sponsors must complete a deal within two years, or else the SPAC will be liquidated and IPO proceeds will be returned to investors. Hence, investors are not betting on a SPAC’s future performance as much as they’re betting on an SPAC’s ability – or more accurately, the SPAC sponsors’ ability – to identify and execute a merger with an attractive firm within a two-year window.
What are the benefits of SPACs?
Well, it depends on who you ask–because the appeal of an SPAC is different for each market participant.
SPAC sponsors – those who bring the SPAC to market and decide which company to target – gain easy access to capital and the flexibility to deploy that capital as they see fit. Most SPAC sponsors are financial market or investment professionals, or esteemed business executives with industry expertise. For sponsors, SPACs are an easier mechanism for raising and investing capital than raising a formal private equity or venture capital fund. SPACs also present a potentially lucrative exit, since SPAC sponsors receive a share of equity in whichever company they merge with.
SPAC investors – those who buy up shares in the listed SPAC before a merger target is identified – benefit from the large potential upside of completed transaction, and risk-free conditions before any merger is completed. That is because all IPO funds are placed in an interest-bearing trust account, and that money can only be used to complete acquisitions. Hence, if a deal never goes through, investors simply recoup their initial investment with a modest interest return.
For private companies, merging with a SPAC is an easier way to list on a public stock exchange than an initial public offering. The traditional IPO roadshow is a long and cumbersome process that involves wooing investors and filing a lot of paperwork with the SEC. Merging with an SPAC is comparatively simple. Another benefit is that a company’s initial IPO price can swing wildly back and forth in the hours before listing as bankers gauge investor demand. With SPACs, a company’s valuation is agreed upon in advance, which offers greater stability to founders and existing shareholders.
Investors in a private company – typically venture capital and private equity funds – also benefit, since SPAC deals typically price higher than private transactions and traditional IPOs.
What are the risks of SPACs?
Investors face the brunt of SPAC risks. For one, that’s because investors don’t know what company a SPAC will merge with. It’s the financial market equivalent of telling a waiter, “just surprise me.” You might love your meal – or it might be terrible.
By extension, SPACs can be risky to investors because companies don’t always receive the thorough vetting and due diligence of a traditional IPO, which can weigh on future performance. A WSJ report found that a majority of companies that merged with SPACs in 2015 and 2016 lost money.
Investors – particularly, retail investors – also bear the risk of investing in startups that, absent SPACs, may not be ready for public market activity. An instructive example is Hyliion (HYLN), an electric vehicle services manufacturer that went public via SPAC in October.
After the SPAC Tortoise Acquisition Corp. announced in June that it would be merging with Hyliion, the SPAC’s stock price soared from $10 to $53 by late September, driven by enthusiasm for the buzzy electric vehicle sector. But when the Hyliion-Tortoise merger was completed in October, the stock’s value quickly halved as skittish investors feared that Hyllion – which has generated just about $1 million in pro-forma revenue this year – had become wildly overvalued. To be sure, investors may still profit off Hyliion in the long run, but those who invested in September are currently in the red.
The point being, a traditional IPO is more likely than an SPAC to ascertain the true market value of companies at their time of listing. Bankers who underwrite and structure IPOs act as a buffer between private companies and public market investors. In this way, traditional IPOs offer safeguards to investors whose enthusiasm for emerging industries and charismatic founders may outweigh the instinct to conduct due diligence, or cloud their judgement on investing at the right time.
SPACs may also present some structural market issues. By encouraging investor speculation and allowing private companies to bypass the IPO process, some commentators worry that a SPAC bubble is brewing. In such a scenario, public market investors would be left footing the bill for SPAC-enabled companies that go bust.
What’s in store for SPACs?
After a banner year, SPACs are poised to continue growing in 2021. Investors and private companies are more comfortable with the model. High demand is likely to encourage more financial and business executives to continue sponsoring their own SPACs.
Plus, the 2020 frenzy has created many SPACs that have yet to merge with other companies. That means SPAC supply is high, leaving private companies and their backers with no shortage of opportunities to make their public market debuts.
At the same time, SPACs may face greater regulatory scrutiny under the Biden administration, particularly from incoming Treasury Secretary Janet Yellen, who has expressed concern about financial regulatory rollbacks under the Trump administration.
While nothing is guaranteed, one thing appears close to certain: that SPACs will continue to play an outsized role in public and private market activity for the foreseeable future.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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John Hyatt
John Hyatt is a freelance journalist covering financial services, market structure, stocks and IPOs, and private equity. Prior to entering journalism, John worked in public relations for clients in financial services, investment management, fintech and cryptocurrency. John is currently receiving his M.A. in business and economic reporting from NYU as a Marjorie Deane fellow.
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