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Special Purpose Acquisition Companies (SPACs)

April 1, 2021 | Commentary

  • Special Purpose Acquisition Companies (SPACs) are a legal device where a proxy company with no business or revenues goes public in a simple Initial Public Offering (IPO) promising to find a merger candidate among private companies using the capital the SPAC raises.   Once the merger occurs, the private company becomes a public one.
  • SPACs have exploded in activity over the last two years, contributing to a reversal of a two decade decline in the number of public companies. Proponents say this is because SPACs offer private companies an easier path to becoming public without having to follow all the regulatory steps in a traditional IPO.
  • Another reason for the growth in SPACs is the highly attractive compensation the SPAC sponsors receive once a merger is completed.  This pay is highly dilutive to the SPAC owners. The sophisticated institutional investors in SPACs understand this and typically exit their positions between the time a merger is announced and when it is completed. Less informed public investors who are hoping to jump onto the next hot new public company are the typical buyers of these soon to be diluted positions.
  • Academic research is already emerging showing how poorly SPACs perform on average in the year after the merger.  This is in part due to meaningful misalignment of incentives between the SPAC shareholders and sponsors.  Investors seeking access to attractive new companies are probably better off taking their chances to buy after the merged company becomes public rather than face the certain, significant dilution that comes from most SPACs.
  • The spirit of clear disclosure and transparency of financial information in IPOs long embedded in SEC rules is being skirted by the SPAC process.  Investors buying SPAC shares after the merger announcement do not have access to key financial information with which to make an informed decision.  If a pattern emerges of weak companies being sold at too rich prices, the SEC may want to tighten SPAC activity to protect the public.

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