Over the last couple of years, Special Purpose Acquisition Companies (SPACs) have become all the rage. More were done in 2020 than ever before, and more were done in the first quarter of 2021 than all of 2020. The traditional IPO has been knocked off the top of the public liquidity hill, replaced by the “De-SPAC” transaction.
Before delving into what’s driving the SPAC boom, a brief overview of how SPACs work.
A SPAC is a company that is formed and goes public with no business plan other than to acquire some other business in the future. So, the SPAC itself in fact does an IPO, and then (only after the SPAC IPO) begins searching for a suitable private company to acquire (let’s call it TargetCo). The acquisition of TargetCo provides liquidity for TargetCo’s investors via exchanging their private shares of TargetCo stock for the publicly-traded shares of the SPAC.
Now, commentators have offered a variety of explanations for why the SPAC/De-SPAC dance is somehow superior to the IPO dance. Most of those explanations (cheaper and more efficient being the common theme) are ... well ... variously bogus. Or, more sympathetically, less than compelling.
The real reason SPACs are so attractive is a quirk in the securities laws. I don’t want to get too technical, and I’ll try and keep the inside baseball stuff to a minimum, but bear with me for a minute.
When a company does an IPO, it has to be very careful how it talks about its projected future performance in the documents filed with the SEC and given to prospective investors. Basically, the company will go out of its way to say those projections are not guaranteed, and those projections are likely to be more conservative than they might otherwise be. In the event those projections are seriously missed, though, there is a good chance the company will face a lawsuit alleging securities fraud. Such suits are expensive to litigate (even if they are ultimately won, rather than settled or lost), distracting to management, and bad for the company’s reputation in the markets.
Now, here’s the thing about SPACs: they don’t have any business other than acquiring some as-yet-unidentified business. So, there are no significant financial projections when a SPAC goes public: there is no basis for financial projections if you don’t even know what business you are going to be in. Instead, SPAC IPO disclosures will say something to the effect of “hey, aren’t we smart, savvy people; trust us with your capital and we’ll find a great business to acquire. And, if you don’t agree to that acquisition, you can opt out of the De-SPAC transaction and get a good part of your capital back.” There are no forward-looking business projections in the SPAC transaction – and thus no potential liability for not meeting them.
And that sets up a very clever sleight of hand. You see, when a public company (a SPAC in this case) acquires a private company, the “De-SPAC” transaction does not involve a sale of the private company’s stock to the public, which means that the regulations around liability for financial projections in an IPO do not apply. Which also means financial projections in De-SPAC transactions are often more ... aggressive than financial projections in IPOs.
If all of this sounds too good to be true (or bad, depending on your point of view), well, it will likely change in the coming months. Both Congress, and more to the point the SEC, are making noises about the De-SPAC financial projections ... loophole ... and talking about closing it sooner rather than later. If/when that happens, most commentators think that the SPAC bubble will deflate, if not burst. Which confirms, I think, that the other reasons offered for the SPAC boom are, as suggested, not very compelling. It really is mostly about the De-SPAC financial projections sleight of hand.