What happens when a SPAC makes an acquisition? A cooling of the SPAC market in 2021 may be a good time to look at the full SPAC life cycle.
The SPAC market grew sharply in 2020 and early 2021 but has since cooled amid concerns over regulation
SPACs are different from traditional equities and pose unique risks for investors
Special-purpose acquisition companies, or SPACs, were created to meet a certain need for speed on Wall Street—more precisely, a faster, simplified path to an initial public offering (IPO). The SPAC market roared in 2020 and early 2021, but then sputtered to a snail’s pace amid concerns over the potential for stricter regulations, as well as a general cooling of the SPAC wave.
SPACs, aka “blank-check” companies, aren’t necessarily going away. But the market’s recent slowdown presents an opportunity to catch up on SPACs and examine unique elements and risks these vehicles pose to investors, according to Alex Coffey, senior specialist, trader group at TD Ameritrade.
For example, a SPAC has a typical life cycle that could generate a few twists or different outcomes.
“SPACs are complex and differ from traditional stocks in several ways, so investors would be wise to educate themselves and understand how these instruments work,” Coffey noted. “The primary thing investors should know is that due diligence responsibility is far greater when investing in SPACs compared to traditional companies and IPOs.”
Here are a few facts about the SPAC life cycle. But first, let’s look at how we arrived at the current state of things.
Based on total money raised, the market for blank-check companies grew six-fold in 2020 compared with 2019. In 2020, there were 248 SPAC IPOs that raised a total of $83.4 billion, an average of nearly $336.1 million per IPO, according to SPACInsider. By contrast, the 59 SPAC IPOs in 2019 raised a total of $13.6 billion, an average of $231 million per IPO.
By all accounts, 2021 looked to be picking up where 2020 left off. But in April, the U.S. Securities and Exchange Commission (SEC) issued accounting guidance that would—if it becomes law—classify SPAC warrants (which are similar to options contracts) as liabilities instead of equity instruments. The SEC guidance also raised questions over how SPACs value themselves, potentially requiring SPACs to recalculate previously issued quarterly financial numbers.
“Recent regulatory warnings have raised questions around the accounting and revenue projections for many SPACs,” Coffey said. Additionally, SPACs’ rapid growth spurred exchanges to begin exploring ways to cut red tape and streamline the IPO process. With potentially more regulatory scrutiny and the prospect of SPAC alternatives, SPAC markets may be evolving into “more of a niche role” in the future, Coffey added.
“There’s no question that enthusiasm for SPACs has waned since the peak of exuberance in mid-February,” SPAC Research stated in an April 26 report. “The market has softened, and investors are no longer scooping up anything they can find just because it has the word ‘SPAC’ attached.”
The regulatory concerns helped send SPAC stocks down sharply in April 2021. New SPAC issuance dwindled to 20 deals from April through mid-May, compared to nearly 300 during the first quarter, according to SPACInsider.
Increased volatility has increased questions. We've put together answers for the most commonly asked questions to help you get the info you need quickly.
A SPAC’s life cycle usually takes about two years, and risks to investors can change over that period. For example, investors who buy in to a SPAC before it purchases anything face the risk of not knowing just what their money will be invested in.
Here’s a simplified summary:
Step 1. SPAC leadership forms a SPAC and describes its plan for the capital it raises.
Step 2. SPAC holds an IPO to raise capital.
Step 3. SPAC either goes down Path A or Path B.
Path A. SPAC purchases a private company and takes it public or merges with a company.
Path B. SPAC fails to find a company to purchase or merge with and returns the money to investors.
According to securities regulator FINRA, a SPAC typically has between 18 and 24 months to make an acquisition. If it doesn’t, the SPAC is dissolved and funds are returned to investors on a pro rata basis (net of costs and fees which, depending on the SPAC structure, can be substantial).
Although SPACs usually have a relatively short life, that doesn’t mean things can’t get interesting or complicated. Here’s a brief summary of a SPAC life cycle from the accounting and consulting firm CohnReznick.
Formation and IPO
In the formation phase, a financial sponsor(s) assembles a management team and funds an equity stake or founders’ stock in the SPAC. The equity investment funds initial business operations to launch an IPO and identify an acquisition target. The founders’ stock often represents approximately 20% of the post-offering stock (though that ratio can vary). After selecting underwriters, the SPAC files a registration statement with the SEC to initiate the IPO.
The SPAC begins its search for an acquisition target, which proceeds in similar ways to a traditional merger and acquisition process as the SPAC identifies and conducts due diligence on potential targets. However, because shareholders can redeem shares, the sponsors must closely monitor cash to ensure sufficient funding to acquire the target and manage post-close operations.
At this point, a so-called PIPE (“private investment in public equity” financing) may issue convertible debt, which converts to stock at the behest of the private investor, thereby diluting the equity of existing shareholders. The selection process ends with a definitive agreement between the SPAC and an acquisition target.
The de-SPAC-ing process requires the buyer to obtain shareholder approval in accordance with SEC regulations. Typically, the process includes the commitment of the founders’ shares to the acquisition, a redemption offer whereby SPAC shareholders can redeem their shares, and the filing of an 8-K form with the SEC (effectively, a registration statement for the transaction).
Managing Public Company Operations
At this point, the acquisition is complete, and the company must comply with all public company reporting obligations under the Securities Exchange Act of 1934 and subsequent legislation. The transition “is a significant one for any private company, requiring enhanced governance, controls, technology, and operating procedures,” according to CohnReznick.
Now that you’ve gotten a look at the SPAC life cycle, you’ve likely figured out there are quite a few risks and uncertainties inherent in SPAC investments.
Publicly traded companies are required to regularly disclose detailed financial results in SEC filings, such as quarterly 10-K and 10-Q reports (available on the SEC’s Edgar online portal), and follow a raft of other SEC and industry rules aimed at providing investors with transparency and a comprehensive view of their financial health.
For SPACs, the regulatory bar is much lower, meaning investors should conduct more “due diligence” than they would with a traditional public company before putting money into a SPAC, Coffey explained.
Also, “SPACs can be invested in at multiple stages, and depending on the stage, there are different risks that could be unique,” Coffey commented. “For example, if you invest in the SPAC at the initial stage, you are really investing in the know-how of the SPAC’s leadership, trusting it will act with the best interests of shareholders in mind.”
Blank-check companies like SPACs may involve speculative investments or companies in development stages that don’t have a specific business plan or purpose. Or these companies may have indicated a plan to engage in a merger or acquisition with an unidentified company or other entities.
In some cases, SPACs may fall within the SEC’s definition of penny stocks or are considered micro-cap stocks, which tend to be thinly traded and more volatile than large-cap stocks.
Do the risks inherent in the SPAC life cycle mean investors should steer clear? They’re not for everyone, that’s for sure. But as venture capitalists, “angels,” and entrepreneurs know, early-stage investing is typically the one with the most risk but with the best opportunity to get in on the ground floor.
It’s not easy, especially when starting out. Successful early-stage investing requires intensive due diligence and research, and even then there are no guarantees. If you decide SPAC investing is for you, it might be a good idea to start small and spread your SPAC investment bucket across several potential candidates.
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