Is It Too Late to Join the SPACs Craze?

In 2020, investors looked to make a quick buck using novel investment schemes such as driving up the price of “meme-mania” stocks using social media. (Russell Investments, Seeking Alpha). One of the most popular get-rich-quick schemes in 2020 was to invest in special purpose acquisition companies (“SPACs”). Id. SPACs are “blank check” public companies established to use investors’ capital to find and purchase private companies—a process known as a reverse merger—which private companies then become publicly traded. (Scott Deveau, Bloomberg Law; David Stein, Money for the Rest of Us). By May 2021, initial public offerings (individually, an “IPO”) of SPACs raised $100 billion in capital, already matching the total capital raised for SPACs in 2020 and setting a record for capital raised in SPACs in a single year, with over six months remaining in calendar 2021. (Russell Investments, Seeking Alpha; Emily Graffeo, Business Insider). However, the rest of 2021 has seen investors lose interest in SPACs and short-sellers swarm to bet on the failure of the investment vehicle. (Emily Graffeo, Business Insider; Scott Deveau, Bloomberg Law). By July 2021, “total short interest in active SPAC securities hit $2.36 billion, up more than threefold from the start of the year.” Id. Now, commenters have predicted a “weak” future for SPACs. Id. This article delves into reasons behind SPACs’ fall from grace and provides warning signs for American investors seeking to invest in SPACs.

 Understanding the reasons behind the meteoric rise of SPACs will help explain the current, bearish outlook on the investment vehicle. One of the primary reasons SPACs became popular is because SPACs largely bypass the long and grueling IPO process. (Kevin Gordon, Liz Ann Sanders, Charles Schwab). Instead of going through the traditional IPO process, SPACs begin with a sponsor—typically a former corporate executive, private equity firm, or even a celebrity. Id. The sponsor partners with an underwriter to bring the SPAC public. Id. Once a SPAC is public, investors can buy and sell shares of the SPAC on the market and the SPAC has two years to find a company to merge with or purchase. Id. Interestingly, investors provide capital to the SPAC sponsor without knowing what type of company the SPAC will ultimately acquire, justifying the “blank check” nickname. (Greg Iacurci, CNBC). If no deal can be made within the two-year deadline, the SPAC dissolves and returns money to investors. (Scott Deveau, Bloomberg Law). The relative ease of creating a SPAC, the promise of cash returns to investors, and the support of celebrities such as Shaquille O’Neal have all contributed to the rise in the popularity of SPACs within the last two years.

So why do short-sellers suddenly have little confidence in SPACs? Short-seller Spruce Point Capital Management (“Spruce Point”) points to the ease with which companies with “inferior business models” can go public, thanks to SPACs. (Scott Deveau, Bloomberg Law). An example provided by Spruce Point is Genius Sports, a mere “middleman” whose sports betting tools are at the mercy of both professional sports leagues and sportsbooks. Id. Another concern short-sellers have regarding the SPAC market is an excess supply of capital. Id. As of August 2021, research shows that 75% of SPACs are still searching for a private company to merge with, meaning “around $131 billion of capital is [yet] to be deployed.” Id. The enormous pool of capital waiting to be distributed and Genius Sports’ speedy rise to being publicly traded lend credibility to earlier concerns that SPACs’ curtailment of the typical IPO process and their aggressive two-year deadlines for making deals incentivizes cutting corners on due diligence. Id. Because sponsors are entitled to a 20% stake in a SPAC, sponsors are motivated to find a deal, “[a]ny deal. Even one that is bad for investors could make them a lot of money, and [making a deal] would be preferable to liquidating the SPAC.” (Duncan Lamont, Schroders). In other words, sponsors are far more motivated to realize their 20% stake in the SPAC by finding a deal than to return money to investors after failing to make a deal.

Additional reasons exist as to why investors need to be wary of SPACs. The 2021 SPAC selloff was also a response to a joint announcement by the U.S. Securities and Exchange Commission (the “SEC”) and Congress, stating the need for regulation over SPACs. (Russell Investments, Seeking Alpha). One regulatory concern is SPACs often identify targeted industries yet have no obligation to reverse merge with a private company within the same targeted industries. (SEC Investor Bulletin). Hence why the “blank check” branding can be troublesome; investors buy-in without knowing which type of company the SPAC will acquire or whether it will even find a viable candidate. (Greg Iacurci, CNBC). Even more troubling is the fact that although SPACs promise to redeem investors when a reverse merger is announced, investors may not necessarily be able to recover their initial investments. Id. The ability to recoup initial investments depends on whether an investor was able to purchase SPAC shares at the initial listing price, which is typically $10 per share. Id. Investors are entitled to “$10 per share plus some interest;” thus, “[i]f they bought higher-priced shares on the open market,” they would take a loss if they chose to redeem shares. Id. Finally, SPACs can be costly to the average investor. A typical sponsor equity stake is 20% which means the cost to public investors can be “much higher than the costs associated with traditional IPOs.” (Kevin Gordon, Liz Ann Sanders, Charles Schwab). These sponsor shares “dilute the ownership of the company’s shareholders…in a way that doesn’t occur in a traditional IPO.” (John Jenkins, Deal Lawyers). When a company’s ownership is diluted during an IPO, an investor’s money buys less of the company than if ownership was not diluted.

SPACs offer clear advantages to investors and private companies considering going public. The timeframe is quicker than a traditional IPO: a typical SPAC merger occurs between three to six months on average, whereas an IPO usually takes between twelve to eighteen months. (KPMG US, Chicago Business Journal). Additionally, SPACs are shell companies with uncomplicated business operations, meaning that it can afford to forego time-consuming SEC disclosures. Nevertheless, the advantages may not outweigh the disadvantages; SPACs are riddled with red flags. The oversaturation of capital, risk of sponsors conducting hasty due diligence, lack of regulation, and real possibility of losing money all indicate that it might be too perilous to enter the SPAC game at this time.