What is a SPAC?
A Special Purpose Acquisition Company (SPAC) has been a recently preferred method for taking a company public, particularly in the past three years. A SPAC, also referred to as a “blank check company” raises capital through an IPO and is then used to acquire an existing business, providing access to capital without going through the standard IPO path.
SPAC acquisitions are reverse mergers, except the SPAC is effectively a shell company with the intent of acquiring an operating company. A SPAC IPO’s investment thesis is usually based on an industry and region, and the SPAC typically has up to two years to merge with a target operating company, which requires the SPAC’s shareholders to approve.
Companies considering the SPAC route over a traditional IPO should be aware that there will still be a level of effort needed to prepare the business to go public. Measures include internal control enhancements (e.g. adherence to SOX), external audit requirements, increased reporting rigor and preparedness to meet reporting deadlines.
Benefits of a SPAC
SPACs benefits both investors and operating companies which require capital. The benefits of SPACs include:
- Potentially lower transaction costs associated a SPAC compared with an IPO
- Enhanced certainty of value as target companies can negotiate the price of the stock with the SPAC sponsor
- Expedited sale process for the operating company compared with a transitional IPO
- Potential access to experienced management teams such as large PE firms and their connections who are commonly behind SPACs
- Provides companies with access to capital during periods of market volatility or tight credit markets
- A perceived lower amount of scrutiny over the transaction. However, recent regulatory guidelines from the SEC indicate that oversight may increase
Private Equity firms involved with SPACs
For the many of the benefits listed above, Private Equity firms have been increasingly active in the SPAC space in the following ways:
- PE firms have been exiting portfolio companies through sales to SPACs. In fact, over half of the companies purchase by SPACs in 2020 were acquired from PE firms.
- PE firms are often competing with SPACs when bidding for investment companies. This has added additional competition in a sellers’ market due to record levels of PE/VC dry powder (globally $1.9T per Prequin).
- Lastly, many of the large PE firms are sponsors of SPACs. This has raised potential conflict of interest concerns, particularly from LPs of PE funds which are missing out on acquisition opportunities from the PE’s decision to perform a SPAC acquisition (instead of purchasing through the PE fund).
Recent trends and increased SEC scrutiny
SPAC IPOs have significantly increased since 2019, with 308 US SPAC IPOs in the first four months of 2021, compared to 248 and 59 for the full years of 2020 and 2019 respectively (per spacinsider.com). 2020 was the first year in which there were more US SPAC IPOs than traditional IPOs. The average IPO size has also increased in recent years, averaging $325M in 2021 (through to April 2021), compared with an average of $230M in 2019. As of April 2021, there are 429 SPAC IPOs which are seeking a target, including 301 which completed the IPO in 2021.
As of April 2021, recent warnings from the Securities and Exchange Commission (SEC) indicated potential regulatory crack-downs on SPACs which has led to signs of slowdowns to SPAC deals in the short-term. Specifically, the SEC issued accounting guidance which indicated that SPAC warrants should be classified as liabilities (instead of equity). This would require the companies to value the warrants every quarter as it would be considered a liability and would cause businesses to go back and revalue the warrants. Warrants are considered as sweeteners to early investors in SPACs. These are similar in nature to stock options in that it gives you the right to buy a share at a given price at a point in time, but the key difference is that exercising the warrant provides capital to the SPAC.
However, the bigger implication is the potential reduced incentive for sponsors and operating companies to use SPACs. A big part of the appeal for using a SPAC is a reduced level of scrutiny and speed to execute. In addition, there could be some implications to investor confidence through restating financials. The long-term ramifications are yet to be determined, however the underlying message from the SEC indicates potential increased regulatory scrutiny in the near future. Increased scrutiny will also require the company to exhibit diligence in record keeping, which may require enhancements to technology and operational processes., which should be aligned to the strategy of the operating company and the investment thesis of the SPAC.
Summary View
- SPACs are shell companies which are publicly listed for the purpose of acquiring operating companies. These have been increasing popular in recent years, particularly in 2020 and Q1-2021.
- There are many benefits of raising capital through a SPAC compared to a traditional IPO, including potential reduced scrutiny, shorted timelines, and increased pricing and deal terms certainty.
- PE firms have been active with SPACs, exiting portfolio companies as well as being sponsors to SPACs which has raised some conflict of interest concerns.
- Recent SEC guidelines have put a halt of SPAC IPOs, with fears of increase regulatory oversight dampening some of the key perceived benefits of SPACs mainly due to investors inability to make informed decision on stock price.
- It is unclear whether SPAC IPOs will continue at the same pace seen from 2020 and into Q1-2021. Based on a small sample period (April 2021), we may see a period of cooling from the record levels of SPAC IPOs, however this is highly dependent on factors such as further potential increased regulatory scrutiny.