Aquila Capital Partners

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What You Need to Know About SPACs

You’ve probably heard some buzz about SPACs in the last few months. SPACs, or special-purpose acquisition companies, are essentially blank-check investment companies. But what does that mean? Should business leaders be more involved in this discussion? 

These types of investments had a major spike in popularity shortly after their inception, as major celebrities and public figures began investing and making the term “SPAC” more familiar. Between Jan. 1, 2020, and Aug. 21, 2020, SPAC IPOs in the U.S. raised a record $31 billion through 78 transactions, reportedly outpacing traditional IPOs in the summer months. And in January and February of 2021, there were 70 SPAC mergers globally—six times the amount during the same period last year—with the combined value of February deals reaching an all-time record of $108.6 billion

So how have they evolved to where they are today? Why are they useful? And where are they headed?

The SPACs Market Bubble

The purpose of a SPAC is to facilitate a younger company going public and having access to resources they wouldn’t otherwise. This helps the company enter the IPO process and access capital markets—even though they aren’t quite as mature as the standard publicly traded company. Presumably, those investing in the SPAC are knowledgeable about the company and think it would be a good fit for the public markets. In a sense, the SPAC validates the target company that is looking to go public. 

We are currently in a SPAC market bubble. This is caused by the confluence of so many SPACs being created at one time relative to the number of targets available—not to mention that many SPAC owners have never operated in these markets. 

Where SPACs Are Headed

There were so many SPACs launched between the beginning of 2020 and the end of April that we are now in a SPAC-saturated field. Hundreds of SPACs are chasing private companies that may or may not be going public. These companies may choose to go public via SPAC in lieu of late-stage fundraising, or instead of a regular underwritten IPO (because you don’t have to provide as much information, which is convenient for developing businesses). Companies that aren’t as mature may want to take this route because it is easier and more forecasting is allowed.

To forecast going forward, we will probably see a few SPACs launched each month between now and the end of the year, but not at the same pace as earlier this year. Investor appetite has really gone down. Investors will discriminate and become increasingly selective about which deals they choose—and for good reason. SPACs were trading on par during the first quarter of this year—now they are primarily trading below par. This has a trickle effect on the market.

The field needs to clear out a lot more before new SPACs are created. Think about how many publicly traded companies are out there right now (over 4,000 in the US) and the number of companies with a market cap at one billion dollars (roughly 2,000). If you do the math, it simply doesn’t make sense. A lot of these SPACs won’t find deals because of the limited number of billion-dollar companies. They will have to give the money back, and those people probably won’t return to the markets again. Then, more seasoned companies worth these valuations will close deals.

If your market cap is less than one billion, it is difficult to get the attention of institutional investors. I felt this pain—my company’s market cap was 2.5 billion, and we still struggled to get investors’ attention because there wasn’t enough float in the stock. You must possess a deep or broad understanding of how the equity capital markets operate. No matter your domain expertise in a particular industry, it is equally important that you have equity capital markets experience—some argue that this is more important than domain expertise.

Even though SPACs are a hot topic and a lot of major names are investing, it doesn’t mean you should too. In fact, The Securities and Exchange Commission previously warned against investing in deals simply because they are backed by public figures, urging investors to think twice before jumping in. Shares of deals with seasoned leaders tend to outperform those without by a wide margin during one-month, three-month, six-month, and one-year periods after the mergers close, according to Wolfe Research. One year out, SPACs with experienced operators averaged a 73% rally, whereas those lacking an industry veteran suffered a 14% loss on average. 

Don’t let the appeal of celebrity compel you to overlook the risks of SPACs. They have the potential for great success, but you need to have the know-how both in the investment domain and in terms of the business and its goals.

Read more for additional insights from Mark E. Watson III