The Real Deal On SPACS: Their Past And Future
Special-purpose acquisition companies, or SPACs, are publicly traded shell companies formed to pursue deals. A start-up is chosen and merges with SPAC and that company gets the SPAC’s spot on a stock exchange. It can then sell shares to the public. So far 71 deals were made with target companies in 2020 (15 of those companies had no revenue last year).
The difference between using a SPAC rather than a traditional IPO stems from a liability shield that Congress gave to public companies 25 years ago but didn’t apply to firms doing IPOs. The result: Startups going public through SPACs can make rosy projections about future results with less risk of facing lawsuits than they would if disclosing those figures in a traditional IPO.
“It’s a perfectly legal regulatory arbitrage,” said Joseph Grundfest, a law professor at Stanford University and former Securities and Exchange Commission commissioner.
Making such projections can help startups gain large valuations. Fisker Inc., went public via a SPAC in October and told investors it projected revenue of $13.2 billion in 2025. The company has yet to generate any revenue. It has used momentum to get to a valuation of more than $4 billion.
Both Nikola Corp. (had annual revenue of less than $500,000) and MultiPlan Corp. (both went public via a SPAC) have been accused of fraud by short sellers. MultiPlan has rejected the claims as baseless, but the company’s stock has fallen 28% since the report’s release. Nikola, despite the fraud allegations is up 90% year-to-date.
SPACs have a crucial feature to protect investors: Before one does a deal, its investors may redeem their shares for cash, collecting its IPO price, usually $10 a share, plus interest.
Critics worry the SPAC boom could end badly for smaller investors who don’t understand the risks. “These types of very speculative companies should not be sold to retail investors at such an early stage,” said Howard Schilit, head of accounting consulting firm Schilit Forensics.
"SPAC founders are very incentivized to do a deal,” said Matt Kennedy, a senior strategist at Renaissance Capital. “Investors shouldn’t rely on their due diligence.”
SPAC sponsors (those that raise the money) are given the sponsor promote or the ability to buy 20% of the company for just $25,000. This feature can be lucrative for a SPAC’s founders, handing them equity stakes worth millions of dollars while diluting the value of shares held by external investors. Amid such criticism, a few newer SPACs are tying their founders’ payoffs to the performance of the company’s stock in the years after the merger.
SPACs have a poor record of delivering returns. Of 107 that have gone public since 2015 and executed deals, the average return on their common stock has been a loss of 1.4%, according to Renaissance Capital, a research and investment-management firm. (vs 49% for those that went public via IPOs).
The average return on newer SPAC deals in 2020 has been 17%, Renaissance Capital says. (Based largely on DraftKings Inc. and Nikola)
The SEC reviews every merger filing that details the deal terms between a SPAC and its target company, the same way the SEC staff checks every IPO prospectus. But underwriters are cut out of the process mostly which makes one less set of eyes that can stop bad companies from accessing public markets.
SEC Chairman Jay Clayton has said SPACs might not be well understood by all investors. Speaking to CNBC in September, Mr. Clayton said the SEC was monitoring how blank-check companies disclose information, such as how their sponsors are compensated.