ZACH TAYLER—If provided a blank check, what might you spend it on? This is effectively the question facing managers of Special Purpose Acquisition Corporations ( “SPAC” or “SPACs”). SPACs raise money through public offerings for the special purpose of purchasing private companies, thus providing the service of bringing these companies public in the process. Although SPACs offer attractive structuring benefits, their skyrocketing popularity is primarily attributable to the reprieve they provide from the onerous, widely despised traditional initial public offering (“IPO”) process. SPACs existed decades ago, yet only recently have been identified as a sustainable alternative to traditional IPOs, amplifying suggestions that we’ve now reached the “end of the IPO as we know it.” Capitalizing on increased transparency and market-making efficiency, SPACs allow IPO transaction participants to re-align the cost structure of their IPO to be more consistent with the magnitude of each party’s true value-add, creating gains for both core participants and smaller retail investors.
So, what is a SPAC? In short, a SPAC is a non-commercial company strictly formed to raise capital through an IPO, the proceeds of which can only be used to acquire one or more existing companies. The SPAC entity itself is effectively a shell corporation, maintaining only a team of managers who evaluate potential acquisition targets. These managers typically look to use past industry experience by identifying opportunities in their areas of expertise. SPACs can provide efficiency gains as compared to traditional IPOs through both reduced underwriting costs and SPAC managers’ more accurate valuations modeled on private diligence rather than publicly filed disclosures.
To begin, a SPAC must first complete the typical IPO process itself: filing a registration statement with the Securities and Exchange Commission (“SEC”), clearing SEC comments, and undertaking a road show to find an underwriter. SPACs generally provide only vague search indicators (i.e., “mature unicorns”) when filing. Anything more specific than such indicators could require additional disclosures. Funds raised by a SPAC IPO remain in a trust accessible by SPAC managers for a limited period only to disburse for a purchase or return to shareholders. Upon purchase, the acquired entity gains direct access to public markets through the SPAC’s listing, arriving at effectively the same endpoint as with a traditional IPO.
Publicly listing a SPAC entails essentially the same process as a traditional IPO, but with one key difference: the issuing SPAC has no commercial operations. Herein lies a marketability problem. SPAC underwriters must sell potential shareholders solely on the management team’s evaluative ability, while traditional IPO underwriters can point to projections like those of potential growth in an unprofitable business. This issue has created a flight-to-quality across SPAC offerings, as investors struggle to ascertain manager competency or agree on standard terms. The top-heavy fundraising dynamic indicates that SPAC listings may further displace traditional IPOs in the high-end mega-deal portion of the IPO market.
Traditional IPOs’ problems derive from the asymmetry of interests between issuing companies and their investment bank underwriters. Companies only complete an IPO once in a lifetime, hoping for a maximum one-time payoff, while banks will offer their services to other companies, incentivizing a bias towards serial clients looking to flip cheap IPO stocks over providing optimal service to mostly one-time issuing clients. Since the Great Recession, such misaligned incentives have sent seemingly IPO-ready, high-growth companies further towards other alternatives like late-stage equity financing or direct listings. Bank underwriters’ reduced negotiating leverage can be seen in traditional IPOs as well, evidenced by previously unheard-of terms such as Snapchat’s exclusively non-voting IPO shares. Investment banks had controlled the IPO process for decades, using their gatekeeper position to restrict both issuer and investor access from one another while collecting fees along the way, but SPACs are increasingly assuming this gatekeeper function at a cheaper cost.
The recent explosion in SPAC transaction volume demonstrates the method’s wide-spread attractiveness across a variety of industries. Cutting-edge tech firms such as Virgin Galactic and Nikola, specializing in passenger space travel and renewable-powered trucks respectively, recently used SPACs to go public. Popular sports gambling platforms DraftKings and FanDuel were combined through a three-way SPAC merger this past spring, leading to a sharp increase in the combined entity’s early stock price and further drumming up of institutional SPAC support. On the buy side, Pershing Square Capital, led by industry bellwether Bill Ackman, helped raise $4 billion for its own SPAC this past July in the largest-ever fund closed to date. An array of smaller sector-specific funds has proliferated as well, including Renaissance’s recent $300 million ESG raise focused on sustainable acquisition opportunities.
Owners and management appreciate how SPACs provide a firm valuation earlier in the process, rather than waiting until the eleventh hour to receive an underwriter’s black box price. SPACs also generally tend to curate more value-focused investors in it for the long haul as opposed to traders only looking to make a quick buck off an initial bump. Majority shareholder votes are often required by SPACs to consummate proposed acquisitions, further helping reduce initial selling pressure. Companies enjoy flexibility with the SPAC method’s accelerated all-cash process, drawing more time-constrained issuers to public markets. Smaller retail investors benefit from these increased inflows to accessible markets and the elimination of insider pricing in IPO offerings. Conversely, traditional IPOs ably entice speculative traders who often purchase initial distribution solely on recommendation from the bank underwriter themselves, highlighting traditional underwriters’ conflict between maximizing raised funds while still providing a satisfying “pop” in price to client-shareholders. Such first-day bounces observed after traditional IPOs can frustrate company management and owners, whose post-IPO shares are usually subject to a lockup period throughout initial trading.
The SPAC model’s price-cutting efficiency stems primarily from a reduced role for the old gatekeepers: investment bank underwriters. Now that other transaction participants have used SPACs to establish a re-organized IPO process, expect leading private companies to increasingly no longer see the need to pay tithe to the old guard of public equity markets, at least until traditional underwriters offer more bang for their buck.
