Why are SPACS suddenly so hot?

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Special Purpose Acquisition Companies (SPACs) have been all the rage on Wall Street. Almost 250 SPACs went public in 2020, four times as many as the prior year. And so far in the first two months of 2021, the pace has accelerated, with about 200 SPACs already launched.

SPACs are shell companies that list on the stock market with the intention of finding an existing private business to buy. Also known as blank-check companies because they have no operating business of their own, SPACs typically have two years to purchase a target.

The current SPAC boom is unsurprising given the long-time dissatisfaction with the traditional IPO model. Private companies, especially tech startups in Silicon Valley, have grumbled for years that the IPO process is expensive, onerous and time-consuming. Many have been staying private for longer, taking advantage of other avenues for raising capital such as venture capital firms.

In 2020 however, financial markets have been on a tear, with prices of everything from stocks, commodities to cryptocurrencies surging. This has made some companies eager to take advantage of the market euphoria and go public. Rule changes by stock exchanges over the years have also made it easier to list via SPACs.

Throw into the mix of high-profile sponsors, and it’s all fueled the latest SPAC craze. (Full disclosure: SoFi announced in 2021 a merger with a SPAC.)

Below is a step-by-step guide to how the current SPAC resurgence came about.

Related: What are SPACs?

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SPACs 101

Why are SPACS suddenly so hot?

Here’s how SPACs work:

  1. The first step tends to involve sponsors, generally former industry experts or executives. They typically pay $25,000 in what’s known as the “promote” or “founder’s shares,” obtaining a 20% stake in the company in return.
  2. The SPAC goes public on a stock exchange, listing shares at $10 each and promising to use the proceeds to find a private company to merge with.
  3. Once an acquisition is found, shareholders of the SPAC vote on the company merger.
  4. SPACs can buy firms valued at five times the money raised in their IPO. Therefore, additional funding is often raised through institutional investors in something known as a “private investment in public equity” or PIPE.

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SPACs benefits

Why are SPACS suddenly so hot?

For the private company getting bought, SPACs offer a cheaper, faster route to listing. Below are some potential benefits:

  • In a regular IPO, investment bankers, who advise companies in going public, alone can eat up 4% to 7% of an IPO’s proceeds in fees.
  • The IPO process typically takes 12 to 18 months. In contrast, a SPAC merger takes between four to six months.
  • Regulators review SPAC mergers, but more forward-looking projections can be used to market the deal as opposed to IPO prospectuses, which require that only historical figures be shared. This can be particularly appealing to more futuristic ventures like those in electric vehicles or space travel.
  • The valuation of a SPAC target is typically determined by private negotiations behind closed doors, similar to how a deal in a merger would be struck. This can make SPAC IPO valuations less tied to the whims of public markets.

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SPAC Performance

Why are SPACS suddenly so hot?

Critics of SPACs argue that they are much too lucrative for the sponsors and bypass measures in the traditional IPO process that are designed to protect investors. Some have also warned that the flurry of SPAC launches point to a bubble.

However, defenders of the structure argue that this most recent wave of SPACs is different. They say the latest batch has more credible sponsors, who then in turn target higher quality companies.

In addition, some SPACs, like hedge-fund manager Bill Ackman’s, have tweaked the structure. Ackman’s company will forgo the founder’s shares, which have been a controversial SPAC feature, according to reporting by the Financial Times. Instead, he’ll get 6.7% of the merged company, only after investors earn a 20% return.

An academic paper by professors at Stanford and New York University law schools looked at SPAC acquisitions between January 2019 and June 2020. The study found that companies that went public by SPAC fell by an average of 3% three months after debuting, 12% after six months, and 35% after a year.

Meanwhile, those with high-quality sponsors returned 32% after three months and 16% after six months. When it came to companies with higher-quality sponsors that had been public for at least a year, there were only seven and they fell on average by 6%. The professors concluded that, “It is true that a few SPACs sponsored by high-profile funds or individuals have performed well. But these are the exceptions, not the rule.”

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How the SPAC Boom Came About

Why are SPACS suddenly so hot?

The success of a 2019 deal between one of SPACs backed by former Facebook executive Chamath Palihapitiya and billionaire Richard Branson’s Virgin Galactic, a spaceflight business, set off the current wave of SPACs. The company went public with a $2.2 billion valuation in 2019. It now has a market cap of $7.6 billion, as of March 2021.

Here’s a table that shows the number of SPAC IPOs by year and the capital raised. It shows that the number of SPACs that have listed on the stock market have steadily increased in recent years.

Only 13 debuted in 2016, but more than 200 launched in the first two months of 2021. The number of SPACs in the stock market really jumped in 2020, quadrupling from 59 to 248. The table also shows the money raised through these IPOs has also climbed dramatically, with SPACs amassing $83 billion in 2020.

Image Credit: SPACInsider /SoFi.

What’s Driving the SPAC Boom?

Why are SPACS suddenly so hot?

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1. IPO Dissatisfaction

Why are SPACS suddenly so hot?

IPOs have historically been an important step for maturing companies, signaling that a business is ready for public scrutiny, greater regulation, and increased liquidity of its equity.

However, in the past decade, tech IPOs haven’t always kept pace with the number of unicorn companies that have cropped up. Private companies have shunned the traditional listing process by either staying private for longer or seeking alternative routes such as direct listings or SPACs.

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2. Booming Markets

Why are SPACS suddenly so hot?

After the volatility in early 2020 caused by the pandemic, financial markets have soared. Investors have wagered that easy Federal Reserve monetary policy, along with numerous Covid-19 stimulus packages, will continue to prop up the economy as well as asset prices.

In addition, retail investors stuck at home due to the pandemic’s quarantine have enthusiastically returned to equity markets. All this has created a potential optimal window for private companies to enter public markets, giving them better odds of pricing SPAC deals at higher valuations.

Image Credit: Feverpitched/ iStock .

3. Rule Changes

Why are SPACS suddenly so hot?

Both the New York Stock Exchange and the Nasdaq have tried to loosen its rules on SPACs in recent years in order to attract more such listings. 

Nasdaq had dominated the SPAC market until 2017, when NYSE had the first blank-check listing on its main market, after getting approved by regulators to ease some requirements. Separately, Nasdaq tried in 2017 to gain permission to lower a number for required shareholders.

Image Credit: DepositPhotos.com.

4. Famous Sponsors

Why are SPACS suddenly so hot?

Well-known sponsors have been a defining feature in this recent SPAC wave. Well-known investors, past politicians and former athletes have all jumped on the SPAC bandwagon, setting off a flurry of launches.

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The Takeaway

Why are SPACS suddenly so hot?

Media outlets dubbed 2020 the “Year of the SPAC,” but some of the conditions that have turned SPACs into a popular IPO alternative have been in place for a while. Private companies have been long unhappy with the traditional IPO model. 

Meanwhile, the mood in the stock market has become increasingly ebullient, luring private companies into public listings. But famous sponsors – the managers behind SPACs – have been one of the key features of the recent wave.

SPACs have a checkered history when it comes to actual performance in the stock market. But some market observers have claimed that having more credible sponsors will lead to better mergers and consequently, better share prices. At least one academic study shows it’s too early to gauge whether having higher-quality sponsors will make a difference.

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