What is a SPAC and why is everyone talking about them? (Things I learn as a VC fellow??)

SPAC = special purpose acquisition company.?

They are shell companies with no commercial operation but are created to raise capital through an IPO to acquire or merge with a private company. They do this through selling common stock, with a share price of $10 and a warrant which allows investors to buy future stock at a fixed price.?

huh? this is the mechanism↓

Mechanism of a SPAC

1. The sponsors of the SPAC (the investors that serve as a management team) raise money from external investors in an IPO, selling at $10 a share.?
2. The sponsors usually have 20% stake despite investing only 23k which is disproportionate to the other investors' stake and investment.
3. In exchange for a share, these investors are given a warrant that gives them the right to purchase a future share at a specific date and price. These shares can be bought and sold like any other open market share.?
4. When a target company is found, shareholders vote to decide whether they like the deal or not; they can get their money back if they don’t agree.?
5. When the deal is approved, the company and SPAC merges, and the SPAC trades with a new ticker as a new company.?
6. If the SPAC fails to acquire or merge with a company within the deadline (typically 2 years) the SPAC will be liquidated and investors get their money back.

LAYMAN’S TERMS: SPACs are basically cash shell that has no function other than to eventually buy or merge with another company.

They are known as “blank check companies” because SPACs provide little information to the IPO investors before investing - investors put their money in without knowing what the money is going to be used for, other than the industry or type of company.?

Sounds horrible! Why would someone put millions without knowing what it would be used for?

Well, here are the perks of a SPAC

• Early bird gets the worm. When a company IPOs, the first offerings are usually reserved for large investors, such as hedge funds and banks. This means that by the time individuals get their chance at the pie, the prices are already less desirable. A SPAC offers these individual investors to get a chance at a potentially explosive stock early.?
• Faster than an IPO. A SPAC takes 3-6 months in comparison to an IPO of 6-12 months, therefore there is less time and money cost.
• Desirable pricing for private companies. A SPAC’s conditions give better share prices for private companies. While IPO valuations are based on historical financials, in a SPAC, private companies focus more on selling themselves to the SPAC investors, who tend to have more relevant expertise and can value the business better.?
• Early price discovery. IPO prices are based on market conditions while SPACs acquisition prices are negotiated with the sponsor prior to going public.?

Ah I see.. It’s less costly for private companies, more money for investors, and just overall much faster than traditional IPOs.

Then why is there so much negative clout on SPACs?

• Potential for scams and fraud. SPACs usually have famous sponsors. For example, Chamath Palihapitiya, Bill Ackman, Shaq, Alex Rodriguez, are just some of many. They are celebrities. This is why often people invest purely because someone famous says that it is a good investment, and then lose money later on.
• It’s a way to bypass regulations. In an IPO or direct listing, the reason for the 6-12 month period is to do a back-and-forth with the SEC. A SPAC does not require the same due diligence which could lead to potential incorrect valuation of businesses. An example is the autonomous trucking Embark that was once worth 5B+ to 100M in less than 2 years. Some reasons for its fall include initial overvaluation and alleged overstating in operational and tech capabilities. All this might have been mitigated with proper screening prior to an IPO.?
• The sponsor can get more money even if the company does poorly. Remember the 20% stake sponsors get? It’s called a “Promote” and they get it arbitrarily even though they invest significantly less than other investors. This means that Sponsors can walk away with even more money even if the SPAC and its share price fails.?

So how do they perform in reality??

This study by Stanford and NYU professors, showed that “As of one year following a merger, the average SPAC had underperformed against the IPO index by 50.9%, against the Nasdaq by 17.9%, and against the Russell 2000 by 4.4%./ Both twelvemonth returns and returns up to November 1, 2021, are also far worse than investors would have received had they bought into traditional IPOs at the closing prices for the first day of post-IPO trading.”

Also, in this piece by Reuters, only 15% of SPAC targets are on track to meet or exceed forecasts.

However, despite all this data, there was a huge surge in SPAC deals in 2021. This was arguably due to the lower interest rates that redirected investors to riskier investments.

Many saw the SPACs that debuted in 2021 flail and disintegrate, only lasting a year at most. This includes the negative clout Chamath received for “calling it quits on two SPACs”. However, experts say that this downfall means that stakeholders and sponsors have learned to act more intentionally and cautiously, encouraging thorough due diligence.?

In conclusion, for private companies that are thinking of going public cheaper and quicker, it might be a fantastic option. But for investors, it is undoubtedly a riskier investment that takes a lot of trust in the SPAC.?