Let’s Discuss SPACs!
So what is the Enigma called “Special Purpose Acquisition Companies” or SPAC’s ? SPACs are a product of financial innovation that offer an indirect route to taking private companies public as opposed to a traditional IPO process. SPACs raise funds from investors and get listed on the stock exchange with the aim of finding a private company to buy or merge with in a specified time period. In case the SPAC sponsors fails to find and complete a merger in the pre-agreed time frame, the SPAC is dissolved and the funds are returned to shareholders. In case SPAC’s end up finding a suitable target company, they perform a business combination (typically a reverse merger) with the private target company wanting to go public. Essentially SPACs are an alternative to traditional IPOs for private companies. The process map below summarizes the SPAC lifecycle process.
Why Private Companies Have Preferred Going Public Via SPACs? SPACs as a product had been around for decades, they have always had an unsavory reputation. Before 2020, only companies whose financials would typically not survive intense public scrutiny as part of the traditional IPO process would have considered using SPACs to go public. All of that changed in 2020, when SPAC mania overtook financial markets as prominent financial firms and private companies (mainly) start-ups embraced SPACs as a faster and easier route to the public markets than an IPO.
For Private Companies wanting to go public, SPACs offer certain advantages over the traditional IPOs as these companies end up avoiding public scrutiny and onerous disclosure requirements of the rigorous IPO process thereby achieving lower overall transaction costs. Price remains a key element as well since in a SPAC merger the price is negotiated privately between parties (SPAC management and private company founders) as against a market driven initial price determination process of IPOs. In essence, SPACs offer the obvious advantages of lower transaction costs, less onerous disclosures and more price certainty.
SPAC Activity Update- Numbers Have Fallen !
2021 was a watershed moment for SPACs in the US as more than 613 SPACs completed their IPOs , raising more than US$162 Billion compared to 248 SPAC IPOs raising US$83.4 Billion in 2020. SPACs represented 61% of all IPOs on US-listed exchanges in 2021. SPAC activity particularly sky-rocketed in the first quarter of 2021 with 298 SPAC IPOs raising around US$87.9 Billion however the activity slowed down in the second and third quarters of 2021. SPACs rebounded in the fourth quarter of 2021.
Stocks in 2022 are off to a terrible start with the S&P 500 down close to 20% since the start of the year as of May 2023 mainly as a result of the burgeoning inflation, rising interest rates , tightening monetary policies , supply chain disruptions associated with the war in Ukraine and the ensuing commodity price crisis. 2022 has so far been the anti-climax for SPAC mania whereby the number of SPAC IPO’s have fallen to a mere 67 raising a total of $11.6Billion.
So What Is Holding Back SPACs in 2022 !
- Increasing Regulatory Scrutiny: SPACs have always remained under the microscope as there have been increasing concerns about disclosure aspects in relation to the offering documents prepared in the transactions. Regulation is going to get tougher for SPACs going forward as there have been numerous warnings from The Securities and Exchange Commission (SEC) about a lack of clarity on various disclosure requirements by SPAC managements. According to The New York Times, SEC has also opened dozens of investigations into SPACs and is proposing tighter rules. Increased regulation would make SPAC deals less profitable for everyone including the financing institutions that arrange these transactions because they would have to commit more resources to comply and as a result the financial world appears to be pulling back from SPACs.
- Bear Market Territory in 2022 Signal the Free Money Era is Well and Truly Over: Markets have had a volatile year in 2022 so far and with increasing interest rates worldwide as part of monetary tightening to counter inflation, SPAC activity is set to be further tested. SPACs saw their prime in 2021 when the markets were flushed with pandemic era excess liquidity however all the underlying liquidity conditions have taken a 180 degree turn. There won’t be any liquidity related respite for SPACs in the foreseeable future.
- Checkered History of Financial Innovation Has Kept Investors Skeptical: Given that financial innovation has had a checkered history including the sub-prime mortgage crisis linked CDOs in 2008 , SPACs have always had a unsavory reputation and prior to 2018 were only used by companies as a medium to avoid onerous financial scrutiny of an IPO process. That checkered history now seems to have caught up with the SPAC boom of 2021 as investors become skeptical and quality takes precedence over execution ability in 2022.
