SPACs have actually been around since 1993 when they were created by David Nussbaum and the Gladstones. They have gone through previous times of popularity and drought, but have recently seen a resurgence due to newer SEC regulations that have instilled more trust in them as investment vehicles, as well as the control they allow the company owners to maintain versus if they were purchased by a private equity firm.
Many in investment finance have claimed that 2021 is the year of the Special Purpose Acquisition Company, but what is this investment tool that is being touted by the likes of business and media personalities such as Larry Kudlow and Mark Cuban, to celebrities such as Shaquille O’Neal, Alex Rodriguez, and Serena Willians? Here is some basic information on the popular investment option that saw 112 companies go public in 2020, and will soon likely rise to 500 by the end of 2021.
Why is there a demand for them?
Traditional IPOs are expensive, complicated, time consuming, and end up being a lot of work for something that can fall apart at any time. You begin with a roadshow, often viewed as a dog-and-pony show, where the company has to sing for their supper to investors. The companies then have to negotiate with the investors based on a valuation that is uncertain until shortly before the opening bell. Meanwhile, those investors are generally institutional, so there is no guarantee that they will understand how the company’s vision for growth correlates with the numbers on the pro forma. In case that is not appetizing enough, the companies are expected to divulge the details of their secret sauce for those investors to judge for their analysis of likelihood for future success.
Right now there is a record amount of money flowing into the public markets at the same time that the number of public companies has dropped dramatically. Over the last 20-30 years the number of public companies has dropped from around 8,000 to just over 4,000. Since stock exchanges make money by bringing on new companies, they have supported the push from SPACs in the market.
In addition, the New York Stock Exchange would not list any SPACs until three years ago, launching their first in May 2017. But since then, the NYSE has listed more than 60 SPACs, and they were the top lister by volume for 2020.
How did they get started?
David Nussbaum, Roger Gladstone and Robert Gladstone of GKN Securities popularized the structure in the 1990s. The idea of SPACs became less popular during the downturn of the tech bubble, but experienced a resurgence in 2003 due to the lack of opportunities for mid-market investors to back successful experienced business operators. This lack of funding options pushed entrepreneurs to seek alternative forms of public funding. SPACS allowed late-stage fundraising for companies that did not want to participate in what some call the “popularity contest” of an IPO, as well those in new and emerging industries where funding was still scarce.
If you want to do a SPAC, you would start with your own investor roadshow drumming up investors while informing them of your investment philosophy and the type of company you are looking to merge with or acquire. You would also let them know that in exchange for their investment, they will receive shares of the acquired company, usually at $10 a share plus warrants or fractions of warrants.
Once you have enough money raised, you IPO your empty company. The IPO process is considerably easier since there is nothing to do reporting on. Once the empty company is listed on an exchange, you then start looking for companies to acquire. You have 18 months to find such a company, or else all investor money, which is held in escrow, is returned to the contributing parties. Once you find the company you want to purchase, and the company says yes, you negotiate the amount with them. The partners in the SPAC would then have a chance to determine if they want to be invested in that company, or if they want their money back.
Is there a downside?
The sponsoring entity usually expects to get 20 percent of the company’s shares for cheap. The company getting sponsored might also find it harder to get long-term investors since those who invest in SPACs on the stock market generally have different goals than the larger institutional investors who are usually first money into traditional IPOs. Investors may also question the level of due diligence since it may be less than what the Securities and Exchange Commission requires of the traditional IPOs.
The cost can also be a potential negative, since a SPAC underwriter typically gets 5.5 percent, on top of bank consulting fees, and other expenses related to the process. For comparison, an investment bank overseeing a traditional IPO may charge 1 to 7 percent of what the company raises. This has the potential to be significantly less than the fees associated with a SPAC, however it can also end up being more if at the higher end of the range.
SPACs can be useful tools for investing in the success of a great company with a bright future and a solid management team. Providing an alternative to the private equity option, SPACs can present a potentially large upside, however you will want to ensure that there has been extensive research into any figures provided by the acquisition target. As evidenced recently by previously red-hot Nikola, there can be a temptation to misstate figures to make the company more attractive to suitors.
If you are an entrepreneur who has built significant traction and would like to learn more about whether merging with a SPAC would be your best option, reach out to the team at Myers CPA and we will be happy to review your details and discuss.