Special Purpose Acquisition Companies—Investment or SPACulation?

March 8, 2021— Special purpose acquisition companies (SPACs) have been around for decades but gained wide recognition in 2020 as an increasingly popular, alternative method of going public following a surge in initial public offering (IPO) and merger activity. In 2020, 248 new SPACs came to market, encompassing 53% of all IPOs for the year, and raised a cumulative $83 billion—more than five times 2019’s volume (Figure 1). This year started off with a bang as well, with more SPAC IPOs in January and February than all of 2019 combined. In this blog post, we provide a high-level overview of the SPAC structure and the key reasons behind its sudden resurgence. While the explosion of activity might be tough to sustain, we believe SPACs will increasingly be viewed as a viable route to public markets due to the distinct advantages they can provide versus the traditional IPO process, as well as growing acceptance from sponsors, targets and investors alike.

Figure 1: SPAC IPO count and gross proceeds raised by year

Data as of February 22, 2021. Source: SPACInsider.

What is a SPAC?

A SPAC is a “blank check” firm that is formed to raise capital with the sole objective of finding a private business to take public. In the traditional IPO process, a firm makes its public debut issuing its own shares to investors. SPACs offer an alternative route to public markets, in which a private firm joins forces with an already public SPAC, and ultimately becomes the controlling party with its own ticker symbol. Outside of the target firm, key stakeholders include:

• Sponsor team. Commonly composed of seasoned executives with deal-making experience, the team sets up the SPAC, raises funds, and is responsible for its success or failure in acquiring a target within a fixed timeframe, typically two years (Figure 2). Sponsors are compensated with “founder shares” that equal 20% of SPAC equity as well as warrants, a potentially lucrative payout if successful, but if a deal is not consummated, they expire worthless.
• Shareholders. They invest in the sponsor team’s ability to create a public company that will be rewarded by the market, and vote on whether to approve or reject the chosen deal. IPO investors receive units composed of a SPAC common share, typically priced at $10, and some amount of fractional warrants, which also trade on the secondary market. Regardless of their vote or the SPAC’s success, public investors can redeem shares at the IPO price plus accrued interest after the merger is announced.

Figure 2: Typical SPAC timeline from IPO to merger completion

Source: WTIA.

Why might a company choose to go public via a SPAC instead of an IPO?

The SPAC process and structure differ in a few ways that can potentially offer unique advantages depending on the company and market environment:

• Faster speed to market. Going public via a SPAC can take three to four months rather than one to two years for a standard IPO.
• Greater certainty of execution and pricing. Deal terms are negotiated privately before an announcement takes place and are less influenced by market conditions.
• Ability to offer forward-looking projections. The target company can present financial forecasts in their conversations with prospective investors, which is not allowed in the IPO process. This feature can be a strong selling point for earlier-stage businesses, with limited financial history, but a high-growth path ahead.
• Strategic partnerships. SPAC sponsor teams often include esteemed executives who can provide strategic direction and connections, and are frequently retained as board members.

Why did SPAC transactions surge in 2020?

• A ballooning supply of mature private companies. With steady inflows into private markets over the past decade, companies have stayed private for longer and private markets have expanded relative to public. According to the Milken Institute, up until 2007, public firms outnumbered private equity-backed private companies in the U.S. However, by 2018, there were more than twice the number of private equity-backed firms relative to their public peers. Meanwhile, private equity and venture capital firms extended their hold periods, with the median time to exit tripling between 2005–2018. As the pandemic took hold and the IPO market temporarily froze, private equity firms’ attention shifted to stability of portfolio companies, and SPACs provided a convenient and relatively quick way to monetize mature portfolio investments.
• Increased acceptance of SPACs as a legitimate path to public markets for high-quality firms. SPACs historically held a less-than-pristine reputation as a vehicle that allowed shady financial sponsors to generate returns by bringing low-quality companies public at the expense of unsuspecting retail investors. As a result, companies that could gain liquidity through the IPO market did not view SPACs as a viable option. However, the quality of SPAC sponsors has improved, and SPAC structures have become more shareholder friendly, making the SPAC route an increasingly compelling choice—even for companies that have the option of a traditional IPO. A growing crowd of experienced financiers have entered and lent credibility to the space, which has helped form a positive feedback loop, attracting more high-quality sponsors and innovative companies, which in turn has lured in more institutional and retail investment.
• The pandemic made features of SPACs appealing for prospective targets and investors. With unnerving market volatility and an uncertain path forward in the worst of the pandemic, SPACs provided a path to public markets with greater certainty of execution and pricing. For investors, the option to redeem shares for their initial cost and additional warrants embedded in SPAC units provided institutional investors with an easy return on investment and minimal downside risk—an especially desirable combination in a highly volatile and low-rate environment. Extremely strong market activity and rising valuations in the second half of the year made the prospect of going public increasingly attractive, and SPACs provided an abbreviated method of doing so.
• Growing interest from retail investors. In 2020, SPAC targets were highly concentrated in exciting industries popular with the retail crowd, including clean energy, biotech, and space travel. Virgin Galactic, a commercial spaceflight company, was one of the first targets to drum up retail interest following its announced merger with Chamath Palihapitiya’s Social Capital Hedosophia in October 2019. According to Bank of America, 40% of SPAC trading on its platform from July to December 2020 was driven by retail, relative to just 21% of each S&P 500 and Russell 2000 stock trading. Retail investors have typically been shut out of IPO allocations in the primary market, excluding them from participation in the often sizeable first day “pop.” In contrast, buying SPACs pre-merger provides retail investors with a unique opportunity to capture upside that’s comparable to what the pros reap following a merger announcement, when SPACs shares often see significant price appreciation.

Core narrative

While the media has increasingly focused on whether the market is overly saturated with SPACs searching for targets, we believe that the environment remains conducive for continuing activity given the large number of private companies that is constantly being refreshed. Growing competition among outstanding SPACs has had a positive impact in helping to drive evolution of the structure in a way that better aligns the interests of all stakeholders. A prime example is Bill Ackman’s Pershing Square Tontine Holdings, which notably does not include founder shares—a key source of dilution that allocates asymmetric windfall to SPAC management teams. Given the abundance of SPACs searching for targets and the continuous flow of new IPOs, we would expect to see the structure continue to transform in ways that accrue greater benefit for the target and shareholders. While a market dislocation or underperformance of SPAC acquisitions could subdue the enthusiasm of targets or investors from current levels, it seems likely that SPACs’ positioning as a viable alternative to IPOs is here to stay. We will continue to closely monitor SPACs for opportunities and insights where we believe it could add value to client portfolios.

Disclosures

Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of Wilmington Trust or M&T Bank who may provide or seek to provide financial services to entities referred to in this report. M&T Bank and Wilmington Trust have established information barriers between their various business groups. As a result, M&T Bank and Wilmington Trust do not disclose certain client relationships with, or compensation received from, such entities in their reports.

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