What’s the deal with SPACs?

Hong Kong’s “Superman” tycoon recently takes advantage of the SPAC craze, selling at least three of Horizons Ventures’ fintech units to unnamed buyers. what’s the deal with SPACs?

SPAC IPOs in the United States collected a record $31 billion through 78 transactions between January 1, 2020 and August 21, 2020, officially outpacing conventional IPOs during the summer months. 1 According to Thomson Reuters, which had access to a March 1 study from financial markets data firm Refinitiv, there were 70 SPAC mergers globally in January and February 2021—six times the sum in the same timeframe last year—with the total value of February transactions hitting an all-time high of $108.6 billion.

What Are SPACs and How Do They Work?

A SPAC is a company that goes public through an initial public offering (IPO) but does not have a functioning business. It’s a kind of “blank check business,” or one that’s still in the early stages of development and operates with the aim of combining or acquiring another company.

Why SPACS?

Since it is more versatile and less burdensome than going public with an initial public offering, private businesses are eager to be purchased by SPACs (IPO).

The reaction of the capital markets to new public offerings varies depending on the state of the economy and the risk appetite of investors. A reverse merger enables a private corporation to become public after the IPO window has closed because a SPAC is already public.

SPAC acquisitions are also appealing to private companies because their founders and other big shareholders can sell a larger portion of their stock in a reverse merger than they can in an IPO.

SPACs have sparked a lot of curiosity, which is understandable. Sponsors gain access to capital through a mechanism that is quicker than a typical IPO, gives them more flexibility in completing acquisitions, and leaves them with a potentially lucrative 20% stake in the SPAC’s equity. Target businesses can go public without losing leverage, as would be the case in a straight M&A deal. And retail investors see an opportunity to engage in a buyout, which is typically reserved for sophisticated private equity or venture capital investors.

Price pressure on the target business is increasing.

Where we are concerned is that, as the amount of money raised by SPACs increases exponentially and the time to make an acquisition shrinks, SPAC sponsors can feel pressured to make deals at unreasonable valuations.

Before it must liquidate and return its capital to investors, each SPAC has a 24-month window to complete a deal.

If the demand for deals outnumbers the supply of high-quality acquisition targets, investors will suffer losses.

SPAC investors may want to consider the following questions when evaluating an acquisition target:

• Is the target company well-established and profitable?
• If not, does it have a realistic plan in place and is it on track to meet its objectives?
• Will the company’s success necessitate significant investments in technology, expertise, or other resources?
• How accomplished is the management team, and will they remain with the company after the SPAC’s acquisition?
• Is there a long-term competitive advantage, such as a patent or cutting-edge technology, that gives the target company “a large and long-lasting moat,” as Warren Buffet puts it when evaluating an investment?

The SPAC framework is an effective capital-raising tool that benefits sponsors, company executives, and investors alike. However, investors should not underestimate how difficult it is to value a SPAC or its assigned objective. When assessing a SPAC investment, “fear of losing out” on the SPAC boom is no substitute for sound judgment.