Special Purpose Acquisition Companies (SPACs) were all the rage on Wall Street, particularly during 2020 and 2021. Nearly 250 SPACs went public in 2020 — four times as many as 2019. That momentum carried over into 2021 as well, but in 2022 and 2023, interest has dropped.
In 2022, the Securities and Exchange Commission (SEC) proposed new rules for SPACs that would require more transparency, and protections for investors.
As for what drove the SPAC boom in 2020 and 2021? It was a combination of factors, and SPACs are still very much a part of the financial ecosystem. That’s why it’s important for investors to understand what they are, and what drove their popularity.
SPACs are shell companies that list on the stock market with the intention of finding an existing private business to buy. Also known as blank-check companies because they have no operating business of their own, SPACs typically have two years to purchase a target.
The current SPAC boom is unsurprising given the long-time dissatisfaction with the traditional IPO model. Private companies, especially tech startups in Silicon Valley, have grumbled for years that the IPO process is expensive, onerous, and time-consuming. Many have been staying private for longer, taking advantage of other avenues for raising capital such as venture capital firms.
Here’s how SPACs work:
1. The first step tends to involve sponsors, generally former industry specialists or executives. They typically pay $25,000 in what’s known as the “promote” or “founder’s shares,” obtaining a 20% stake in the company in return.
2. The SPAC goes public on a stock exchange, listing shares at $10 each and promising to use the proceeds to find a private company to merge with.
3. Once an acquisition is found, shareholders of the SPAC vote on the company merger.
4. SPACs can buy firms valued at five times the money raised in their IPO. Therefore, additional funding is often raised through institutional investors in something known as a “private investment in public equity” or PIPE.
For the private company getting bought, SPACs offer a cheaper, faster route to listing. Below are some potential benefits of SPACs:
• In a regular IPO, investment bankers, who advise companies in going public, alone can eat up 4% to 7% of an IPO’s proceeds in fees.
• The IPO process typically takes 12 to 18 months. In contrast, a SPAC merger generally takes between four to six months.
• Regulators review SPAC mergers, but more forward-looking projections can be used to market the deal as opposed to IPO prospectuses, which require that only historical figures be shared. This can be particularly appealing to more futuristic ventures like those in electric vehicles or space travel.
• The valuation of a SPAC target is typically determined by private negotiations behind closed doors, similar to how a deal in a merger would be struck. This can make SPAC IPO valuations less tied to the whims of public markets.
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Critics of SPACs argue that they are much too lucrative for the sponsors, and bypass measures in the traditional IPO process that are designed to protect investors. The flurry of SPAC activity in recent years also had many worried that a bubble was forming.
However, defenders of the structure argue that this most recent wave of SPACs is different. They say that more recent SPACs have had more credible sponsors, who then in turn target higher-quality companies.
An academic paper by professors at Stanford and New York University law schools looked at SPAC acquisitions between January 2019 and June 2020. The study found that companies that went public by SPAC fell by an average of 3% three months after debuting, 12% after six months, and 35% after a year.
Meanwhile, those with higher-quality sponsors returned 32% after three months and 16% after six months.
When it came to companies with higher-quality sponsors that had been public for at least a year, there were only seven and they fell on average by 6%. The professors concluded that, “It is true that a few SPACs sponsored by high-profile funds or individuals have performed well. But these are the exceptions, not the rule.”
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How the SPAC Boom Came About
Here’s a table with the number of SPAC IPOs by year and the capital raised. It shows that the number of SPACs that have listed on the stock market have steadily increased in recent years.
Only 13 debuted in 2016, but the number of SPACs in the stock market spiked in 2020, quadrupling from 59 to 248, and more than 600 launched during 2021. The table also shows the money raised through these IPOs also climbed dramatically, but has since fallen again after a blowout year in 2021.
|Year||Number of SPAC IPOs||Money Raised by SPACs|
|2023 (through June 1)||23||$1.8 billion|
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What Drove the SPAC Boom?
There were several factors that drove the SPAC boom in 2020 and 2021.
1. IPO Dissatisfaction
IPOs have historically been an important step for maturing companies, signaling that a business is ready for public scrutiny, greater regulation, and increased liquidity of its equity.
However, in the past decade, tech IPOs haven’t always kept pace with the number of unicorn companies that have cropped up. Private companies have shunned the traditional listing process by either staying private for longer or seeking alternative routes such as direct listings or SPACs.
2. Booming Markets
Context is important, too: After the volatility in early 2020 caused by the COVID-19 pandemic, financial markets soared. The Federal Reserve’s stimulus measures played a role in keeping the markets buoyant.
In addition, there was an increase in investing during this time for several reasons. All told, it created an optimal window for private companies to enter public markets, giving them better odds of pricing SPAC deals at higher valuations.
3. Rule Changes
Both the New York Stock Exchange and the Nasdaq have tried to loosen their rules on SPACs in recent years in order to attract more such listings. Nasdaq had dominated the SPAC market until 2017, when NYSE had the first blank-check listing on its main market, after getting approved by regulators to ease some requirements. Separately, Nasdaq tried in 2017 to gain permission to lower a number for required shareholders.
4. Famous Sponsors
Well-known sponsors were also a defining feature during the SPAC frenzy. Well-known investors, former politicians, and former athletes have all jumped on the SPAC bandwagon, setting off a flurry of launches.
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Despite the combination of factors that helped spark the SPAC trend, the fact remains that most SPACS — like most IPOs — are highly risky endeavors.
In addition, despite the hype around both these paths for going public, the main beneficiaries of SPACs have been those closest to the company itself. Retail investors typically don’t have access to SPAC shares until they’re in the secondary market.
SPAC activity reached a peak in 2020 and 2021, but some of the conditions that have turned SPACs into a popular IPO alternative had been in place for a while. For example, many private companies had been long unhappy with the traditional IPO model. Additionally, the mood in the stock market at the time had become increasingly ebullient, luring private companies into public listings.
SPACs have a checkered history when it comes to actual performance in the stock market. But some market observers have claimed that having more credible sponsors will lead to better mergers and consequently, better share prices.
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