What is a SPAC?
SPACs, or Special Purpose Acquisition Companies, are publicly traded vehicles other companies use as an alternative way to go public. These companies, also known as “blank check” companies, are essentially shell companies that do not have commercial operations. They are formed with the sole purpose of raising capital and merging with or acquiring private companies, so that these acquisitions can go public faster and with fewer costs than a traditional Initial Public Offering (IPO).
Who has gone public via a SPAC?
A number of well known companies have gone public via a SPAC, including DraftKings, Virgin Galactic, and Opendoor. SPACs have been steadily increasing in popularity for over 20 years and account for roughly 20 percent of the IPO market.
Why would a startup go public via a SPAC?
Broadly, there are three types of startup exits: going public via an IPO, acquisition, and shutting down. According to an analysis of the roughly 12,000 startup exits from Aug 2002 to March 2020, while 61 percent of startups were acquired, 35 percent failed and shut down and just 4 percent of startups underwent an IPO. Going public via a traditional IPO is incredibly costly and time-consuming, requiring multiple complicated financial disclosures. Ultimately, many startups are not positioned to undertake the process. And while traditional IPOs do not typically serve everyday investors—at least initially, because of share allocations—the average investor does have access to SPACs after they go public, before they acquire a private business. When the SPAC then makes an acquisition, everyday investors can, in theory, experience the growth trajectory associated with an IPO. In short, SPACs provide a company with a faster, less expensive tool to go public, and in doing so, also provide a faster exit for shareholders.
What is the controversy?
SPACs have had their fair share of controversy for decades. Though the Securities Exchange Commission (SEC) implemented anti-fraud rules in the early 1990s, the vehicles are once again under scrutiny. While SPAC sponsors and the private companies they acquire tend to fare quite well, investors are not always so lucky.
Critics of SPACs allege that they are mired in conflicts of interest and lack transparency, putting investors at risk, with studies showing many investors receiving less than what they put into the company. Other concerns allege SPACs often present inadequate business plans and don’t generate enough revenue, and reduced disclosure requirements mean investors may not be getting a complete picture of their investment. SPACs also don’t see share prices fluctuate or take off in the same way as IPOs. More broadly, investing in a SPAC at the IPO stage is not without initial risk, as investors do so without knowing what company is the acquisition target, and investors must rely on SPAC managers’ decision making.
Finally, SPAC earning projections have often been accused of being overblown and misleading, and a lack of legal risk allows potentially inaccurate future earning estimates to draw in investors without a clear picture. Most recently, SPAC performance has been low, with investors getting poor returns, particularly after deals have wrapped up, with many trading below original offer prices.
Where are we now?
On March 30, 2022, SEC commissioners voted to approve proposed rules regarding SPACs. The proposed rules would “require, among other things, additional disclosures about SPAC sponsors, conflicts of interest, and sources of dilution.” They would also increase disclosure requirements for “business combination transactions between SPACs and private operating companies,” and would address concerns about projections issued by SPACs and the companies they acquire. Ultimately, the goal of the proposed rules is to more closely align SPACs with the traditional IPO process. And Congress is poised to get involved as well. Sen. Elizabeth Warren (D-Mass.) announced plans to introduce legislation—the SPAC Accountability Act of 2022—that would similarly boost disclosure requirements and would also increase the legal liability of those involved in SPAC deals. While the legislation is not expected to move anytime soon, it is likely the bill will continue to put pressure on the industry as we await final SEC rules.
