As its name suggests, a Special Purpose Acquisition Company (SPAC) is a listed cash box that acquires a private company to take it public. At the time of its creation, the SPAC may state a broad purpose to source and acquire companies in a particular industry but the actual target is unknown when it lists. Initial investors place their trust in the promoter to find a ‘good’ target however they have an option to redeem their investment if the proposed target is unsatisfactory. The SPAC promoter has 2 years to find a suitable target or it liquidates. The promoter, for their part, in general receive 20% of the target company once acquired.
SPAC’s have been around for many years in various forms but they have become popular recently as a way for private companies to bypass the traditional IPO process in a post-Private Equity world. The traditional IPO process has historically underpriced companies going public by 27% on average leading to criticism that the process is run by Wall St for the benefit of Wall St. In 2020 and 2021, moreover, the degree of underpricing of IPO’s has been significantly more than that average where it is not uncommon for newly listed entities to double in price on listing day or more within a week.
Wall Street’s claim that a ‘successful IPO’ is one that delivers a stag-profit to favoured customers is at the core of the search for an alternative financing vehicle. Stags’ gains are subsidised by the pre-IPO shareholders (founders, angels, venture capitalists and private equity investors) since these stakeholders receive less than the opening day market price places on the company. For instance, an IPO which prices at $100 and raises, say, $100m in new capital, but then lists the next day at $127 per share delivers $27m to the new investors. This $27m is money that long-standing pre-IPO investors don’t receive despite bearing much greater risk.
Disgruntlement with the traditional IPO process gave rise to the market for private capital. ‘Private is the new Public’ enabled the likes of Spotify, Uber, AirBnB and a host of other new companies to grow much larger without accessing the public capital markets by drawing on pools of private capital entrusted to expert deal makers in the private equity and venture capital space. These private structures were successful in meeting capital demands but could not provide either pricing or liquidity to shareholders. This is an inescapable function of the public markets. Is there a way to achieve a public listing without having to suffer the underpricing of an IPO?
Enter the SPAC. To my mind the main difference between a SPAC and an IPO are the incentives for the promotors/lead managers. IPOs have an incentive to underprice whereas the SPAC promoter takes 20% of the target so that they have an incentive to overprice. Indeed, this seems to be the case with something like 60% of SPACs trading at a discount of 20% or more 6 months after completing their acquisition. Wall St points to these numbers as failures but pre-listing shareholders who sell early are smiling.
Of course the best result from a market efficiency standpoint is a listing mechanism that delivers a fair price at listing for existing shareholders without either subsidising Wall St or paying a large fee to a promoter. This mechanism is a ‘direct listing’ which simply takes a private company into a public market and lets risk-takers (real buyers and real sellers with real money) determine the market clearing price. This was Spotify’s approach and everybody except Wall St and the SPAC promoters were smiling.
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