Are SPACs the Next Big Thing?
Special Purpose Acquisition Companies, or SPACs, are companies founded with no underlying business or operations, their sole purpose is to make (at least) one platform acquisition of a private firm. SPACs are set up by sponsors, entrepreneurs, and private equity experts before raising funds through an IPO and deploying them to make an acquisition, resulting in the acquired company becoming effectively publicly listed. SPACs were, briefly, hugely popular in the UK shortly after the Financial Crisis, but a series of high profile failures saw them largely disappear before making a comeback a few years ago - particularly in the US. Now, SPACs are back bigger than ever in the US, but will they cross the Atlantic and become fashionable in the UK too?
What‘s the SPAC Party all about?
There are a number of attractive features of SPACs to investors in the UK that have driven the recent increase in popularity, some of these include:
SPACs allow the investor to co-invest with sponsors that have valuable industry knowledge, expertise and access to potential acquisition targets that may not otherwise be available to investors through the public markets.
The SPAC structure is also relatively risk free for investors and they come with a money back guarantee. If the SPAC does not identify a suitable acquisition target within a certain time period then investors are entitled to the return of their investment.
For the target companies, SPACs are attractive buyers as they offer a faster, cheaper, and more stable route to the public markets than a traditional IPO. Target companies acquired by SPACs can generally expect to enjoy an expedited timeline to the public market of about 3-5 months compared to a traditional IPO which has an average of 1.5 years, as they sidestep the regulatory process of publicly listing themselves. Moreover, a traditional IPO costs at least 10% off the IPO proceeds, bit a SPAC will take the company public for only 6-8%.
Compared to the traditional IPO, SPACs also reduce share price uncertainty for the target companies since the negotiation of terms takes place privately without the book book-building process and the often cited attendant risk of mispricing and “money being left on the table”.
A Party that COVID isn’t Shutting Down
If anything, COVID has accelerated the popularity of SPACs globally. Investors are seeking new ways of allocating their funds in a climate of low interests rates and the global pandemic has put many companies in serious difficulties. This allows SPACs to acquire companies for a reduced price than expected during the SPAC planning phase. SPAC sponsors and IPO investors will like this additional leverage of their investments.
SPACs are offering greater certainty for investors in the current climate, which is only being boosted by the increasing popularity and success of SPACS. Last year, Virgin Galactic, Draft Kings and Nikola Motor Co all went public through SPACs, such high-profile deals have improved their reputation and facilitated their growth by establishing them as a legitimate way of turning a company public.
Getting the Party going in the UK
So far, SPACs are an American thing. In the first 3 quarters of 2020, SPACS in the US had raised $48 billion, growing three times over the course of a year. At the same time in the UK, SPACs raised nothing. The London Stock Exchange (LSE) is considering ways of kick-starting the SPAC trend in the UK, though UK SPACs offer more risk than their American versions.
In the UK, shareholders are not able to vote on target companies, nor can they easily pull out of a SPAC, unless the acquisition timeframe expires and is not extended, which takes, on average, 2 years. The fact that investors do not necessarily get to vote on which company the SPAC acquires in the UK is a major source of their unpopularity, since investors generally like to know what they are buying, and especially as trading of the SPAC’s share is suspended from the point of announcing the acquisition until an FCA approved prospectus is published. Successful UK SPACs therefore require a great deal of investor trust in the management team of the SPAC as their money becomes locked up for quite some time, indeed many 2017 SPACs remain in operation today.
Also, in the US, under both the NYSE and NASDAQ rules, 90% of the funds raised during the SPAC IPO must be deposited in a trust account and are subject to strict investment criteria. Additionally, the SPAC must complete, within the time period designated in the prospectus, one or more business combinations that have a market value equal to at least 80 per cent of the trust account at the time of the initial business combination. In the UK there are no such requirements. Consequently, the directors of a UK SPAC have more autonomy when identifying the acquisition targets, which can increases the uncertainty for investors.
The LSE is keen to find ways of attracting more SPACs to the UK and is considering changing some of the regulatory rules to give investors greater flexibility whilst participating in SPACs.
Are SPACs all they’re Hyped Up to be?
Wherever we have an economic agent (in this case the SPAC management, industry and private equity experts) acting on behalf of principals (the shareholders in the SPAC) we have an opportunity for the misalignment of the interests of each party, creating conflicts of interest. In this case, the shareholders have very little control over who and when the SPAC choose to acquire, and, because SPACs are established by industry insiders with pre-existing relationships and contacts, they may have the incentive to acquire specific targets that do not generate the best return for their shareholders.
More generally, not all SPACs are successful in finding a company to acquire. Eventually, they can unravel and be forced to return shareholders’ capital, which results in poor returns for investors.
What may be worse is when SPACs are pressured to complete a deal within the timeframe to escape failure. The SPAC may proceed with the acquisition of a somewhat less than ideal target company, and potentially at suboptimal terms. The result is the failure of the combined business entity and even worse returns for shareholders after the acquisition.
Therefore, its hard to say whether we will see SPACs cross the Atlantic anytime soon. The LSE is clearly eager to draw them over, but with the current limitations of UK regulations and the more fundamental drawbacks of SPACs, the party may never get going.