The hottest financial product of the past year is the Special Purpose Acquisition Company, which we all call a SPAC. SPACs are literally blank check companies. A group of sponsors raises money through an IPO. This entity, the SPAC, is just a company on paper with no offices or actual, you know, business. The SPAC then has a period of time – usually 18 months to two years – to use that money to buy an operating company.
Sounds simple, but there are of course a few catches. First, the SPAC does not actually get the IPO proceeds at the time of listing. They typically get a small fraction to fund operations and to pay the IPO lawyers and bankers. But the bulk of the cash is held back until they announce their acquisition. At that point, the investors in the IPO can decide whether or not to participate, i.e. give the SPAC their money. This is a good background on SPAC from CB Insights and an deeper explanation of all the nuances that is far more eloquent than we can manage from Matt Levine at Bloomberg.
SPACs have been around for a long time, they are somewhat of an oddity in the American financial regulations. But at heart they are just a financial structure that comes with some advantages and disadvantages. Over the years, SPACs have had a few incarnations. They were first used by seasoned executives who wanted to roll up industries, this met with mixed results. They were then used as a way to do ‘backdoor’ listings, often for Chinese companies. Through all of this their reputations have waxed and waned. As with all exotic financial structures they attract highly motivated people, not all of whom bring good intentions with them. There have been some dubious SPACs.
The recent crop of SPACs is a bit different. Put simply, the US government’s monetary policy has driven a lot of money into the asset markets, especially the stock market, and a fair portion of that excess capital has been channeled into SPACs.
At heart, SPACs are Financial Celebrity Capital. Sponsors who have credibility with bankers and Wall Street lawyers (largely through past deals) can arrange for a SPAC. This is probably not an ideal way to allocate capital, but there are some merits.
For companies that are being acquired by SPACs, this can be a faster path to IPO. Most people would agree that the IPO process today is overly burdensome and far from efficient itself. Companies can spend two years getting everything ready and then are subject to last-minute back-room deals among the underwriters pricing the IPO. This is usually not as nefarious at is sounds, but it carries immense friction with results like companies popping100% on the day of their IPO. Great for those who can access IPO shares, not so great for the company which leaves a lot of money on the table. There are ways to mitigate this, and we dedicated a whole chapter to our IPO book, but there is inefficiency in the roots of the process.
By contrast, going public by being acquired by a SPAC, can take as little as a few months. As Matt Levine points out, M&A law is different from IPO law. A more important benefit is that it lets executive teams go public with a group of investors they know well. In a normal IPO, the company usually trades well-known venture investors for strangers in the public markets. SPACs often come with seasoned board members who can get very familiar with the company ahead of time. This also lets public market investors tap into company value growth earlier, a big problem in the last decade as companies have stayed private far longer than in the past.
As with all things, SPACs are a mixed bag with both good and bad features, and good and bad actors. There is clearly a mania in the markets for SPACs right now. This will likely taper off in the future. Capital will contract. There will be some bad outcomes. But there will also be some real successes. Perhaps the best outcome will be to provoke a real re-think of the IPO process, because SPACs, if anything, are a cry for help that the current process needs reform.