Crash Course on SPACs

By Samuel Berkun

U.S. markets have arguably reached the most speculative environment in century-dated history. The current environment can be likened to that of the Dutch Tulip Bubble, effectively dubbed “tulipmania,” in the 17th century during which tulip prices soared twentyfold before falling by more than 99%. There are a few muddled proposals as to how such wide-ranging speculation came to be (for me, I argue—ample liquidity, increasing access to brokerage services, gamification of markets, and lack of regulatory infrastructure) but there is only one product that is certain to have contributed to the ongoing frenzy…SPAC’s.

SPAC’s, also called blank-check companies, stands for Special Purpose Acquisition Company’s and are shell firms that list on a stock exchange with the sole purpose of acquiring a private company to take it public. SPAC’s are speculative in nature as the company they will ultimately be acquiring is unbeknownst to the IPO investor. While they are not a new phenomenon, 2020 was certainly a notable year for SPAC’s; raising $82 billion dollars. The blank-check fever hasn’t suppressed just yet. In the hopes of picking another Virgin Galactic or DraftKings winner (which both came public via SPAC deal), investors have poured money into SPAC’s at three times the pace of last year—almost $80 billion raised since the start of this year. Nearly 5 new SPAC’s are created daily and there are almost 400 outstanding SPAC’s awaiting an acquisition target.

How it works:

A SPAC begins by leveraging a well-known sponsoring partner/group along with an experienced management team. The SPAC typically issues founding shares (about 20% of outstanding float) and the remaining 80% is open for the public to purchase after the blank check company’s initial public offering. A SPAC’s management team will usually announce an industry or sector of interest as well as a market capitalization size for the company they plan to purchase. For example, a SPAC may announce they are looking to purchase a company in the electric vehicle industry at around a $2 billion dollar valuation.

Once the SPAC has IPO’d, management has 18-24 months to purchase a company or else the SPAC will be liquidated, and proceeds are returned to public shareholders. Once an acquisition is announced, shareholders have the ability to redeem their shares if they do not approve of the company being acquired.

SPAC’s have become a preferred way to bring companies to market as it is a way to reduce friction and costs associated with typical IPO’s or direct listings. In fact, the average SPAC merger process takes as little as 3-4 months. Additionally, SPAC deals give investors the flexibility to “opt-out” if they ultimately get cold feet.

Let’s not forget though that SPACs are pure speculation, it’s in its DNA. Companies acquired by SPAC’s are usually not well established or profitable with high growth potential and thus have tremendous volatility associated with their share price. A SPAC’s share price can sometimes fluctuate 30-50% in a single day. In the past week, a decline in shares of the overall SPAC market has led to drawdowns of 20%. Over the last 2 years, these investment vehicles have certainly proved to be a driving factor of the speculative frenzy and effective in quenching the appetite for risk.