A New Frenzy About an Old Investment: What’s Special About SPACs?

Welcome to the March 2021 edition of our newsletter!  In this issue, we’ll examine the increase in companies going public via special purpose acquisition companies, and identify some risks involved for would-be investors.

When SPACs Attack: Differences Between SPAC Listings and Initial Public Offerings

Special purpose acquisition companies, or SPACs, have existed since the 1990s, but are gaining notoriety of late as they’re embraced by activist investors and celebrities alike.  This increased profile has made the entities, which can also act as “blank check” companies that do not have to initially define an acquisition target or investment objective, something about which much is known but perhaps less is understood.  Instead of filing a traditional initial public offering – or even a confidential version of such an offering — with a SPAC a privately held company that seeks to raise capital in public markets is acquired by a group of investors, who then can list the company or an exchange and raise capital via the offering of shares.

There are various rules governing “blank check” companies but not necessarily SPACs, most notably that an acquisition must be completed within 18 months after the agreement is signed; if no such deal is consummated the investors’ funds, held in escrow, must be returned to them.  Most SPACs can avoid this limitation via certain exemptions, although it must use at least 80 percent of funds raised for an acquisition, which must be completed within a slightly longer window of 24 months.  If these benchmarks are not met, a SPAC must dissolve and escrow funds are returned.

Unlike its IPO cousin, the underwriter of a SPC is not required to conduct due diligence on the investment or its leadership team.  Once an acquisition target is identified, a proxy is required to be sent to investors, and this is where such investors – even if they’re retired basketball stars – should do their due diligence.  What is the track record of the existing management?  Have they tried to raise capital before, for this company or others, and what were the results of those efforts?  What is the market for the company’s product, either in development or already on the market, and what is the regulatory landscape?  Have the executives of the target company – or the backers of the SPAC – faced any reputational concerns in the past?

Given that SPACs have most often been the domain of “penny stock” companies whose credibility can be a concern, investors are wise to ignore much of the current hype around the use of this vehicle to bring companies to public markets.  But if investors do decide to move forward with investing in a SPAC, it is largely left to them to do their own homework.