SPACs, or a special purpose acquisition company, has gained popularity and become one of the hottest trends for taking a company public compared to a traditional IPO. Around 250 companies were taken public in America through SPACs in 2020, raising 83 billion dollars. In the past 12 months, that number has soared to 120 billion. In this year alone, SPACs have raised more money than the first half of last year, showing its increasing popularity. The companies taken public through this method include Virgin Galactic (NYSE: SPCE), Nikola (NASDAQ: NKLA), and DraftKings (NASDAQ: DKNG).
So what is a SPAC? SPACs are essentially a company set up as a shell by investors to raise capital through an IPO to then buy out a privately held company, taking it public. In an IPO, bankers help a company sell its shares at an agreed price to the public. This is a long, arduous process that is finessed with a SPAC. In addition, in the IPO process, a lot of money is left on the table, going to everyone except for the actual company going public. Bankers underwriting the IPO typically underprice the shares by a huge amount to please their customers who are buying a sizable amount of shares in the IPO. They underprice the shares so much that the stock rockets up, on average, 20 percent on the IPO day. These “costs” don’t even include the fee paid, typically 5-7 percent of the capital raised. This adds up to 27 percent of the raised amount left on the table, a horrible IPO experience for the company. SPACs are able to skirt around this, saving the company millions of dollars.
SPACs are essentially reverse IPOs. In an IPO, a company is looking for money, while a SPAC is money looking for a company. The SPAC has the raised capital from their IPO, and is looking for a company to merge with. However, this brings the first majour disadvantage in a SPAC, which is that the investors are quite literally swinging in the dark. When investors buy the IPO of a SPAC, their money goes into an interest bearing trust, where it stays until the SPAC finds a private company to merge with. Once an acquisition is completed the SPAC’s investors can either swap their shares for shares of the merged company or get back their original investment plus interest from the trust. The investors do not know what company they will be buying into, showing the opportunity cost that they are taking. Another disadvantage of SPACs is that the founders of the SPAC keep 20 percent of the company, diluting the shares. Shareholders usually dislike this, as it reduces their ownership stake and typically reduces price. In addition, in a study done by Renaissance Capital, they found SPACs typically carry negative returns, with an average of -9 percent and a median of -29 percent since 2015, underperforming the benchmark S&P 500 by a considerable amount. Only 30 percent of all completed SPACs had positive returns.
However, SPACs are still important in making the process of taking companies public better, and could be useful for investors and companies. They provide another avenue for companies seeking to go public to go down, and provide the incentive to make the IPO process smoother, quicker, and cheaper. Even if some SPACs flop, the idea behind them is a welcome sight, and one that investors and companies buy into.