While special purpose acquisition companies (SPACs) have been around for decades, they have attracted unprecedented interest and investment since the first wave of the Covid-19 pandemic. Amid this recent boom, the entrepreneur Richard Branson, retired all star Alex Rodriguez, and other celebrities have all sponsored their own SPACs. But all this hype has come with considerable controversy as well as added regulatory scrutiny. And for good reason. SPAC-related excesses have been well documented and have raised questions about the underlying suitability of these investment vehicles. The US Securities and
Exchange Commission (SEC)’s admonition – “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment” – indicates the credulity with which some approached the recent SPAC bubble.

So, what is a SPAC? How does it work? Who are the players? What are the risks and opportunities? And is the recent SPAC surge in the United States a one-time flash in the pan or something more enduring?

What’s a SPAC?
A SPAC, or “blank cheque company”, is a publicly traded corporation created to facilitate a merger, acquisition, or “combination” to take a privately held business public. SPACs in the US have a build-in time limit, usually of 2 years, in which to consummate a transaction involving at least 80 per cent of the initial investment otherwise the capital is returned to investors.

SPACs raise money much like other publicly traded companies and initial public offerings (IPOs), through public-equity investment, among other sources and mechanisms, including private investment in public equity (Pipes).

To bring a SPAC to market, the management team creates the blank cheque company to register with the SEC, publicly list on a national securities exchange, and raise capital. That capital is then held in trust while the management team identifies potential private companies to acquire. When that identification phase is complete and the target selected, the SPAC will deploy its capital to acquire or merge with that firm, thereby taking the target public in what is commonly referred to as a “de-SPAC” transaction.

Though SPACs have long been overshadowed by IPOs, SPAC investments have soared over the last several years, from US$13 billion in 2019 to US$96 billion in the first quarter of 2021 alone.

The year 2021 saw a grand total of 679 SPAC IPOs globally worth a combined US$172.2 billion. At one point, in fact, there were more SPAC offerings than IPOs.

Why SPACs?
Despite their mythos and grandeur, IPOs present significant barriers to entry. They require considerable time and cost to complete and their after-market challenges and regulatory burdens can render them impractical. Successive waves of the pandemic, with their supply chain disruptions and associated market volatility, have further exacerbated the pitfalls of the IPO market.

Meanwhile, as central banks have pumped capital into the economy and cut interest rates to stave off a pandemic-induced global recession, investors have been desperately searching for yield and some have looked to SPACs as a quicker and less arduous alternative to the IPO.

The good…
Compared to traditional IPOs, SPACs have much shorter turnaround times and tend to be less expensive to facilitate. This ostensibly gives SPAC investors and managers more agility to strike while the iron is hot. Opportunities and their profits can be realised over a much shorter time horizon – 6 months or so – compared to traditional IPOs, which can take years to bring to market.

SPACs likewise provide quicker access to public funding and a faster exit for those who want to cash out, all while avoiding the traditional IPO dog-and-pony show. The SPAC process also can reduce price volatility, since a binding valuation is agreed upon and approved among the stakeholders before the merger takes place, in contrast to a traditional IPO where the underwriters tend to guide the valuation process.

SPACs have proven especially lucrative for the owners of the private companies that are taken public as well as the SPAC sponsors. SPAC investors, however, haven’t always fared as well.

The bad and the ugly
Multiple studies of SPAC performance over the past few years indicate that SPAC sponsors and the founders of the acquired company accrue the most benefits. The investors who bankroll the projects tend to receive far less than they put in. Despite their supposed complicity, SPAC investing is more complicated than putting in money and getting back more.

The deflating SPAC bubble and its associated scandals have created a more cautious environment among investors and led to increased oversight from investors groups and regulatory bodies. The SEC has stepped in to clarify how SPACs work, and disappointing SPAC filings have spurred investigations and class-action lawsuits. All of which means investors need to exercise their due diligence and approach SPACs with caution.