8.25.21 | Industry Insights
A Special Purpose Acquisition Company or SPAC is a publicly traded corporation with a two-year life span formed with the sole purpose of effecting a merger, or “combination,” with a privately held business to enable it to go public. SPACs are garnering a lot of attention lately in corporate boardrooms, on Wall Street, and in the media. Although SPACs have been around in various forms since the early 1990s, they have taken off in the United States during the past two years. More and more, SPACs are being considered for use in acquiring real estate and PropTech companies and taking them public. WeWork, the flexible office giant, is the latest real estate company to use a SPAC to go public. In the PropTech world, Latch – a keyless entry firm, SmartRent – a smart home automation company, and Opendoor – an online company for transacting in residential real estate are among the companies recently using a SPAC to go public. In 2019, 59 SPACs were created, with $13 billion invested; in 2020, 247 were created, with $80 billion invested; and in the first quarter of 2021 alone, 295 were created with $96 billion invested. And most interestingly, in 2020, SPACs accounted for more than 50% of newly publicly listed U.S. companies. When looking to take a company public, the use of a SPAC is regarded by some as a way to bypass the traditional and more cumbersome IPO process and attract more and a wider variety of investors, including institutional investors and private equity. Here are some important considerations when looking into SPACs.
What are the SPAC Advantages?
Perhaps most attractive is the fact that SPACs can be cheaper, faster, and easier to accomplish than a traditional IPO which can require, among other things, pre-marketing, advertising to underwriters, soliciting private bids, and a public statement. The process of a traditional IPO can often take nine to 12 months, with little certainty about the valuation and the amount of capital raised until the end of the process. In comparison, the entire SPAC process can take as little as three to five months, with the valuation set within the first month.
In addition, there is a tremendous amount of money right now in the public markets at a time when the number of public companies has gone down, which is an impetus for the stock exchange to push for more SPACs. Still further, there is an abundance of capital invested in private equity that would be open to the opportunities presented by SPACs. To add a further shine, the SEC has added some regulations to SPACs, which serve to improve investors’ confidence.
Moreover, investors recognize that public companies trade at higher multiples than private companies, adding further luster to the valuation of a SPAC. Also, business owners know that they lose some control with private equity, while a SPAC can provide investors with some influence in the business. And the cash raised in the SPAC process offers the security of liquidity.
For these reasons and more, SPACs have become very attractive and particularly to the real estate sector.
How Do Investors Participate in SPACs?
There are three avenues for investors:
- Sponsor Group: The SPAC process is initiated by the sponsors. They invest risk capital in the form of nonrefundable payments to bankers, lawyers, and accountants to cover operating expenses. If the sponsors fail to create a combination within two years, the SPAC must be dissolved, and all funds returned to the original investors. The sponsors lose not only their risk capital but also their significant investment of time. Typically, on a successful combination, sponsors earn shares in the combined corporation, often worth as much as 20% of the common equity in the SPAC for an investment of around 3% to 4% of proceeds of the IPO.
- SPAC IPO: Retail investors in a SPAC buy common stock combined with a warrant through an IPO prior to identifying the target company. A warrant gives the holder the right to buy more stock at a fixed price at a later date. Investment through a SPAC IPO offers the advantage to retail investors to either move forward with the deal or withdraw and receive their investment back with interest after the sponsor announces a deal with a target.
- Private Investment in Public Equity (PIPE): In the current market, sponsors are providing more certainty to various stakeholders in a SPAC deal by tapping various types of institutional investors (such as mutual funds, family offices, private equity firms, pension funds, and strategic investors) to invest alongside the SPAC in a PIPE or Private Investment in Public Equity. This additional funding source allows investors to buy shares in the company at the time of the merger. Sponsors use PIPEs to validate their investment analysis. PIPE investors commit capital and agree to be locked up for six months.
Behind the Glow – Potential Downsides
Exuberance does not guarantee an upside in a SPAC investment, and very often, the strength, reputation, or high public profile of the sponsor is what attracts investors to commit. Sometimes sports or entertainment celebrities are leveraged to bring in investors. The use of celebrities in itself does not necessarily indicate duplicity, but the question must be asked: What does this high-profile person bring to the table other than a recognizable name?
A SPAC IPO may not be as cheap as first imagined. There are the 2% underwriters’ fees plus a further 3.5% that hinges on the deal taking place. At 5.5%, it is still less than the approximately 7% typically charged for a traditional IPO. But, since shareholders frequently redeem their shares, this means that the SPAC ultimately retains a fraction of the IPO proceeds.
Another key issue is the overall performance of the SPAC. Some have delivered handsome returns, while others have not. It is up to the individual investor to take a hard look and match the projected results with their risk tolerance. SPACs do not offer a guarantee of success. You are putting your faith in the sponsor.
It’s in the Due Diligence
It’s clear that SPACs are another intriguing way into the market for investors. They have their charms and some dark patches beneath the glow. As with any investment, the more you know about the potential, the people, the prospects, and the projected performance, the wiser will be your decision. And just because the front person happens to be an expert at making three-pointers is not nearly sufficient in making an important financial decision. You need to dig much deeper.
This article is for general information purposes only and is not intended, and should not be construed, as legal or tax advice.
Berdon LLP New York Accountants