A Special Purpose Acquisition Company (“SPAC”) is a type of shell company that is an increasingly common method used by firms to become publicly traded. This is the continuation of our three-part series meant to provide a comprehensive overview of the U.S. SPAC boom that may quickly spread into a global phenomenon. This part of the series will provide a brief history of SPAC evolution from the 1980s to present as well as a discussion on what factors drive SPAC issuances. View the first part of our series for a primer on SPACs and a detailed look at their structure. The third and final part of the series will delve into how SPACs have performed over time and who may be the winners and losers in the SPAC world.

A Brief History of SPACs

SPAC literature often separates the evolution of SPAC’s into three phases. Phase 1 follows the initial wave of SPAC IPOs that occurred following fall-out from the Penny-Stock scandals of the 1980s and includes SPAC IPOs occurring between 1993 and 1996. Phase 2 covers the reintroduction of SPAC IPOs beginning in 2003 and extending through the financial crisis in 2008. The final phase, Phase 3, covers the period following the Great Recession starting in 2009. Much of the academic literature on SPACs is relatively dated, as the real SPAC boom did not truly take-off until 2019. Therefore, it could be seen that future literature includes a fourth phase in the evolution of SPACs that encompasses the boom of 2020 to present. These phases are discussed in more detail below.

PHASE 1: 1993 – 1996 & PENNY STOCKS FRAUD SCANDALS

As discussed in Part 1 of our series, a SPAC is a blank check or cash-shell entity whose sole purpose is to take a privately operating firm public within a specified period. The SPAC itself does not have any operations. Historically, there was a negative connotation with the term blank check companies. Specifically, the 1980’s were plagued by fraudulent blank check companies, primarily in the penny stock market. Penny socks refer to the common stock of a small publicly listed company that trades below a specific threshold. In the U.S., the threshold for a penny stock is generally considered to be companies that trade below $5/share.[1] At the time, there was a lack of regulation on these types of entities, contributing to the lack of transparency of these deals for prospective investors. By one estimate, investors were losing approximately $2 billion a year on penny stock schemes.[2]

In the 1990s, following several high-profile fraudulent penny stock schemes, the SEC adopted the Penny Stock Reform Act of 1990, Securities Exchange Act of 1934 Rule 3a51-1 (adopted in 1992), and Securities Act of 1933 Rule 419 (adopted in 1992). This placed restrictions on how blank check companies could raise capital, and sought to increase transparency, improve shareholder rights, and motivate the shell company sponsors to act in the economic interests of the general shareholders. These regulations paved the way for the creation of SPACs. While these regulations applied to penny stock companies it did not apply to shell companies of larger size, such as SPACs (which must be larger than $5 million to exempt them from the SEC penny stock regulations). In fact, SPACs were created to follow many of the provisions set up under Rule 419 to minimize the chance that the SEC would expand the regulations to include all blank check companies, not just penny stocks.[3]

During the first Phase of SPAC issuances, SPAC were restricted to the Over-the-Counter (“OTC”) market, and could not list on a stock exchange. The first SPAC was issued in 1993, however, due to regulatory scrutiny on blank check companies in general, there were only 14 SPAC IPOs completed between 1993 and 1996.[4] SPACs were largely non-existent in the market during the second half of the 1990s. These SPACs are often left out of articles discussing SPACs, and many studies exclude these from SPAC analysis.  

PHASE 2: 2003 – 2008

Although SPACs were not booming in the late 1990s, internet-related companies were. The dot-com boom (AKA dot-com bubble or tech bubble) occurred in the U.S. from approximately 1994 to 2000 and was marked by a period of excessive market speculation by investors in tech related investments. As with most bubbles, the dot-com bubble burst in March 2000, leading to the dot-com economic recession. During this period, the Nasdaq reached an all-time-high of 5,132.52 on March 10, 2000 before losing approximately 75% of its value by October 2002.[5]

Following the dot-com crash, the use of SPACs returned (See Exhibit 1). Private companies were looking for cheaper alternatives to the traditional IPO process, utilizing reverse mergers to become publicly listed. As discussed in Part 1 of our Series, merging with a SPAC provided a readymade investor base and eliminated some of the barriers to public markets. For example, investment banks often prefer larger, less levered (i.e., smaller debt burden) firms with strong revenues. By merging with a SPAC, the private firms avoided some of the pitfalls associated with a traditional IPO process.

However, at the start of Phase 2, SPACs were still limited to the OTC market. This changed in 2005 when the American Stock Exchange (“AMEX”) allowed SPACs to list on its exchange. In 2008, both the New York Stock Exchange (“NYSE”) and the Nasdaq followed in AMEX’s footsteps, helping bolster the acceptance of SPACs in the market. There were 161 SPAC IPOs conducted between 2003 and 2008, with most of them listing on exchanges rather than OTC.[6] These IPOs raised more than $22 billion and represented more than 13% of total IPO issuances during this time.[7]

Although investors were increasingly warming to SPACs, regulators were not. In 2005, the SEC increased regulation on SPACs via enhanced disclosure requirements. Specifically, the SEC required that the private operating company set to merge with the SPAC provide the same level of firm disclosures as any firm going through the traditional IPO process, thereby eliminating one of the benefits of going public via SPACs.[8]

PHASE 3: 2010 – PRESENT

In 2009, during the Great Recession, only 1 SPAC IPO was completed, compared to a prior all-time-high of 66 SPAC IPOs in 2007. However, SPACs started to gain again in 2010. There were several regulations that came into effect during the Phase 3 period that may have increased the appeal of SPACs for investors and firms.

The “tender offer regulation” is one such regulation. Under this, SPACS could choose to abandon the proxy vote previously needed to complete the De-SPAC process in favor for a tender offer.[9] 57th Street Acquisition Company was the first SPAC to use a tender offer instead of a proxy vote, with an IPO date of November 16, 2009.[10] SPAC shareholders who did not wish to convert their shares over to the newly merged entity could redeem their shares via the tender offer mechanism. In the case of 57th Street Acquisition Company, the tender offer allowed for up to 88% of the SPAC’s common stock to be redeemed. The tender offer option increased the certainty that SPAC sponsors could complete a merger transaction in the window allotted (typically 24 months), decreasing the odds that the SPAC would be dissolved and liquidated.

Additionally, the JOBS Act was enacted in 2012. The primary purpose of the JOBS Act was to make it both easier and less expensive for young firms (defined as emerging growth) to go public via the traditional IPO process by reducing financial and reporting requirements.  However, SPAC firms also undergo a traditional IPO process prior to conducting a target search for acquisition. As a result, these SPAC firms could classify themselves as an emerging growth firm and take advantage of the benefits of the JOBS Act.

Furthermore, prior to 2010, SPAC proxy votes to approve a proposed merger were tied to an investors decision to redeem shares in the SPAC. As mentioned in Part 1 of our Series, these two conditions were separated, and investors could vote in favor of the merger separately from the decision to redeem their shares instead of gaining ownership of the merged entity. Like the tender offer regulation, separating these votes increased the likelihood that SPAC sponsors could complete the De-SPAC process in the allotted timeframe, reducing the likelihood of SPAC liquidation.

Since 2010, the number of SPAC IPOs and the average size of these deals have increased (See Exhibit 2). Although there was an increase in the SPAC activity during Phase 3, until 2020 SPAC IPOs made up 40% or less of the total number of IPOs per year and less than 20% of total proceeds raised. Historically, it appears that most private firms preferred the traditional IPO process to the SPAC process (See Exhibit 3) .

HISTORIC SPAC MARKET: 2020 – PRESENT

In 2020, the SPAC market took off. There were 248 SPAC IPOs that raised approximately $83.3 billion.[11] This represented 55% of total IPOs and 46% of proceeds raised. This is the first time in SPAC history that SPAC IPOs were more common than traditional IPOs. The hot market continues to burn in 2021, with 306 SPAC IPOs raising approximately $98.4 billion as of April 8, 2021 (See Exhibit 4).[12] This reflects 79% of total IPOs year-to-date and 70% of raised proceeds. The Wall Street Journal (“WSJ”) notes that there is an average of five new SPACs launched each business day.[13] Because of the structure of SPACs, nearly all the proceeds are on hand ready to be deployed to complete De-SPAC transactions (i.e., merge with a private operating firm). This means, at present, there are billions of dollars seeking to strike gold through a proposed merger.

That capital is being deployed at a rapid rate. There have been an increasing number of SPAC mergers completed (i.e., the De-SPAC transaction), generating billions in value (See Exhibit 5). The largest De-SPAC transaction in the U.S. to date occurred in January 2021 when Gores Holdings IV Inc., a SPAC, approved a merger with United Wholesale Mortgage, sporting a valuation of approximately $16 billion.[14] However this record was recently overthrown. On April 13, 2021, Grab Holdings Inc., a Singapore-based ride-hailing, digital-wallet, and food-delivery group, announced that it would go public on the Nasdaq exchange through the merger with Altimeter Growth Corp., a SPAC sponsored by Altimeter Capital (a California based firm).[15]  

The announced deal places a $39.6 billion valuation on the entity, more than 2x the prior De-SPAC record.

As discussed earlier in the Series, the exact target of a SPAC is unknown at the time of the SPAC IPO. However, many SPACs outline target industries in their prospectuses. Currently, many SPACs are seeking deals in booming sectors such as technology, industrial manufacturing (e.g., electric vehicles and space tourism), and healthcare (See Exhibits 6 & 7).

However, this exponential growth in SPAC activity has not escaped the attention of regulators. Top SEC officials are warning that SPACs may face increased scrutiny under the Biden administration.[16] On April 6, 2021, the acting director of the SEC’s Corporation Finance division stated that there are “some significant and yet undiscovered issues” with SPACs, specifically regarding the fact that SPAC transactions bypass some of the traditional IPO investor safeguards while offering potential disproportionate rewards for SPAC sponsors relative to other SPAC investors. These comments followed the SEC’s March 31st release of a statement reminding SPAC sponsors of their regulatory obligations and restrictions.[17] We will discuss the performance of SPACs in more detail in Part 3 of our Should SPACs be Back series, providing insights on financial outcomes associated with SPAC activity.

SPAC in the Limelight

As discussed in Part 1 of the series, SPAC sponsors oversee founding and managing SPACs. Typically, the sponsors have a track record of financial success, or experience within a specific industry. In the earlier phases of SPAC evolution, these SPAC sponsors were primarily made up of experienced and well-known investors. For example, Tom Hicks, a prominent Texas private equity investor launched a successful SPAC in 2007 and a second in 2010 that traded in the OTC market while Steve Woznick, co-founder of Apple, took a SPAC public in 2006. Other well-known businessmen included Joseph Perella and Ronald Perelman. While these names may have been well-known in the financial world, they were far from household names.

In the current SPAC boom, there is a wave of celebrities jumping on board the SPAC trend. For example, in December 2020, Serena Williams joined the management team and board of Berry Sternlicht’s SPAC – Jaws Spitfire Acquisition.[18] Ms. Williams is not the only sports celebrity to jump on the SPAC bandwagon. Others, including Shaquille O’Neal, Odell Beckham Jr., Colin Kaepernick, and Naomi Osaka, have all invested or advised in recent SPACs.[19] In fact, there has been an increase in the number of sports-related SPACs formed over the last two years (See Exhibit 8).

The celebrity rush does not stop with sports stars – Ciara Wilson, Jay-Z, and even former House Speaker Paul Ryan have also participated in SPACs.[20] The New York Times noted that these celebrities are often brought on as “strategic advisers,” meant to help promote and raise investor attention rather than to make financial decisions.[21] The recent increase in celebrity involvement even led the SEC to issue warnings to investors not to be lured into a SPAC investment solely because of its celebrity ties. In its March 10, 2021 Investor Alert the SEC noted, “[Celebrity involvement in a SPAC does not mean that the investment in a particular SPAC or SPACs generally is appropriate for all investors.  Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss.  It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.” [22] The SEC went on to call out the distinct risks of SPACs compared to traditional IPOs, highlighting the SPAC sponsors conflicts of interest that misalign their economic interest with those of the other SPAC shareholders.

What Drives SPAC Activity?

MARKET VOLATILITY

There have been several waves in SPAC activity, with the current wave being the largest in SPAC history. Due to the limited number of SPAC issuances prior to 2020, there is limited literature investigating what drives SPAC activity. However, recent working papers point to a negative relationship between SPAC volume, volatile markets, and time-varying risk aversion (See Exhibit 9).[23] The authors attribute this relationship to the fact that risk-averse investors are less willing to participate in SPAC IPOs during times of volatile markets due, in part, to the lack of transparency and performance history of the SPAC entities. The opaqueness of SPAC entities is magnified in periods of general market uncertainty, reducing investor willingness to invest in SPACs.

In a counterpoint, other research indicates that private operating firms may prefer to go public via a SPAC transaction as opposed to conducting their own traditional IPO during periods of weak IPO activity and volatile markets.[24] Academic literature shows that market timing is key to a successful IPO. A critical component in timing the market for issuance is the volatility of the market.[25] Research finds that the chance of IPO success is significantly decreased during periods of high market volatility. One study found that the frequency of IPOs decreases by 13% and proceeds raised decrease by 21% during periods of above-average market volatility.[26] Volatile markets may reduce the liquidity available in the market, making it more difficult for firms to raise capital via traditional IPOs.

In contrast, SPAC’s already have capital raised from their own IPOs, giving them access to liquidity the private operating firms desire. Additionally, SPAC acquisition values are locked in and negotiated prior to the closing of the deal, providing the operating firm with a guaranteed price, and removing the uncertainty of market conditions associated with trying to time the market with an IPO. As a result, from the private operating firm perspective, SPAC transactions may be more attractive to traditional IPOs during periods of market volatility or decreased liquidity. Supporting this, academic studies have found a strong positive relationship between market volatility and SPAC activity, with more SPAC activity occurring in periods of higher market volatility.[27] Thus, it appears private operating firms may seek to go public via a SPAC transaction as opposed to conducting their own traditional IPO in the face of liquidity constraints in a volatile market.

MARKET SENTIMENT

While an increase in market volatility appears to be associated with lower SPAC activity, market sentiment appears to have a positive correlation to SPAC activity. Market sentiment is a measure of the overall attitude of investors towards a specific financial asset or market. Recent research finds that periods of higher equity market sentiment (i.e., when investors are bullish or positive on equity markets) are associated with greater SPAC activity (See Exhibit 10).[28] According to the authors, traditional IPOs are less risky than SPAC IPOs, making the latter more attractive to yield-seeking investors. There are more yield-seeking investors in the equity markets when market sentiment is high (i.e., in a bullish market when prices are rising). As a result, SPAC activity is higher in periods of increased market sentiment, when there are more yield-seeking investors who may have a larger appetite for SPAC IPOs.

COST OF DEBT

Prior to the most recent SPAC boom, the cost of debt was reported to have a moderately strong inverse relationship with the number of SPAC transactions.[29] In other words, periods associated with lower interest rates appear to be correlated with a greater number of SPAC transactions (See Exhibit 11). While SPAC IPOs raise capital to be used to complete an acquisition, SPACs are not limited to financing an acquisition solely with the IPO proceeds. In some cases, SPACs also raise debt to help fund a future acquisition. To the extent SPACs utilize debt to help finance acquisitions, it is more beneficial to do so in an environment with low interest rates as opposed to high. Consequently, during the present boom, interest rates in the U.S. have been at historic lows.

PRIVATE OPERATING FIRM CHARACTERISTICS

As discussed in Part 1 of our series, the ultimate purpose of a SPAC is to take a private operating firm public via a SPAC transaction (AKA the De-SPACing process).  To be successful, there needs to be sufficient supply of private operating firms that will agree to a SPAC acquisition. As discussed briefly in Part 1 of the series, from the private operating firm perspective there are advantages to going public via SPAC transaction as opposed to conducting a traditional IPO. Some of these include a faster execution (e.g., 3-6 months vs. 12 – 18 months), lower associated costs and fees, access to experienced professionals through SPAC sponsors, and a guaranteed or known transaction price.[30]

Another benefit to private operating firms is the reduced scrutiny surrounding financial projections or forecasts under a SPAC transaction compared with a traditional IPO. In the traditional IPO process, the firm must provide historical financial records to potential investors and face significant liability risks associated with any projections about future earnings (AKA financial projections, forecasts, or forward-looking statements).[31] As a result, firms must be very cautious with how any forward-looking statements are presented to investors in a traditional IPO. However, a SPAC transaction is a merger, and is subject to a lighter level of scrutiny when it comes to financial projections. Specifically, under merger regulations, there are limited consequences should the firm’s projections not materialize in the future.[32] As a result, firms often circulate lofty financial projections and forecasts to investors. These projections may present the firm in a rosier light to SPAC investors, thus increasing the likelihood of an approved merger and possibly providing the firm with a higher perceived valuation.[33]

While these are advantages to any firm, they are particularly useful to firms with limited access to capital markets. Such firms tend to be smaller in size or those considered to be of lower quality. In fact, extant literature finds that firms targeted by SPACs tend to be firms that are smaller and of lower quality than those who conduct traditional IPOs.[34] Specifically, firms that are SPAC targets generally have weak growth opportunities and have greater leverage (i.e., higher debt load). Additionally, research indicates that SPAC targets are typically on the smaller side, where the costs associated with a traditional IPO may be a larger barrier to entry. KPMG provided insights that most SPAC-targeted operating firms have less than $500 million in revenue and a majority are not profitable (i.e., non-positive net income) at the time of SPAC acquisition.[35]

Summary

SPAC’s have evolved significantly since their inception, in part due to increased SEC regulation and scrutiny. Along with this evolution, we have also experienced a surge in SPAC activity. SPAC IPOs are occurring at a record pace with SPAC sponsors jumping beyond experienced finance professionals and into the world of sport and entertainment celebrities. The recent boom has led many to speculate that we are experiencing a SPAC bubble.[36] In fact, one survey found that 38% of readers believed that SPACs are in a bubble right now, the second highest rated probable asset bubble (See Exhibit 12). As the SPAC surge continues, there are an increasing number of critics raising concerns about SPACs and highlighting their, on average, less than stellar performance. In our final entry in our Should SPACs be Back series we discuss the financial performance of SPACs and provide insights on who appear to be the winners and losers in the SPAC world.

Sources

[1] Penny Stock - Definition, Characteristics, and Risk Factors (corporatefinanceinstitute.com)

[2] Not Guilty by Association: Why the Taint of Their "Blank Check" Predecessors Should Not Stunt the Growth of Modern Special Purpose Acquisition Companies (bc.edu)

[3] To learn more about the differences between penny stocks and SPACs, see e.g., Murray, J. S. (2014). The Regulation and Pricing of Special Purpose Acquisition Corporation IPOs. Available at SSRN 1746530; Floros, Ioannis V., and Travis R.A. Sapp, 2011, Shell games: On the value of shell companies, Journal of Corporate Finance 17, 850-867.

[4] Murray, J. S. (2014). The Regulation and Pricing of Special Purpose Acquisition Corporation IPOs. Available at SSRN 1746530.

[5] The Dotcom Bubble Crash Was 20 Years Ago Today—Could it Happen Again? (newsweek.com)

[6] Going public via special purpose acquisition companies: Frogs do not turn into princes (unisg.ch)

[7] Kolb, J., & Tykvova, T. (2016). Going public via special purpose acquisition companies: Frogs do not turn into princes. Journal of Corporate Finance, 40, 80-96.

[8] Not Guilty by Association: Why the Taint of Their "Blank Check" Predecessors Should Not Stunt the Growth of Modern Special Purpose Acquisition Companies (bc.edu)

[9] “A tender offer is a proposal that an investor makes to the shareholders of a publicly traded company. The offer is to tender, or sell, their shares for a specific price at a predetermined time.” Tender Offer - Definition, How It Works and Regulations (corporatefinanceinstitute.com)

[10] Going public via special purpose acquisition companies: Frogs do not turn into princes (unisg.ch)

[11] SPAC Analytics - Home

[12] SPAC Analytics - Home

[13] When SPACs Attack! A New Force Is Invading Wall Street. - WSJ

[14] United Wholesale Mortgage Goes Public in Biggest SPAC Deal Ever - WSJ

[15] Grab to Go Public in Record-Breaking SPAC Merger - WSJ

[16] SEC Official Warns on Growth of Blank-Check Firms - WSJ

[17] SEC.gov | Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies

[18] Mr. Sternlicht is the founder and CEO of Starwood Capital, and this marked his second launched SPAC. Serena Williams Joins SPAC Led By Barry Sternlicht – Sportico.com

[19] Sports Stars Think They Got Game in SPAC Arena - WSJ

[20] OK, What’s a SPAC? - The New York Times (nytimes.com)

[21] OK, What’s a SPAC? - The New York Times (nytimes.com)

[22] SEC.gov | Celebrity Involvement with SPACs – Investor Alert

[23] Blomkvist, M., & Vulanovic, M. (2020). SPAC IPO waves. Economics Letters, 197, 109645

[24] Kolb, J., & Tykvova, T. (2016). Going public via special purpose acquisition companies: Frogs do not turn into princes. Journal of Corporate Finance, 40, 80-96.

[25] “Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security.” See, Volatility Definition (investopedia.com)

[26] Schill, M.J., (2004). Sailing in rough water: market volatility and corporate finance. Journal of Corporate Finance, 10, 659–681.

[27] See e.g., Kolb, J., & Tykvova, T. (2016). Going public via special purpose acquisition companies: Frogs do not turn into princes. Journal of Corporate Finance, 40, 80-96. For example, in 2008 (during the Great Recession), SPACs made up 36% of all IPO activity, compared to only 6% in 2006.

[28] Bai, J., Ma, A., & Zheng, M. (2020). Reaching for Yield in the Going-Public Market: Evidence from SPACs. Available at SSRN.

[29] Kolb, J., & Tykvova, T. (2016). Going public via special purpose acquisition companies: Frogs do not turn into princes. Journal of Corporate Finance, 40, 80-96.

[30] Why so many companies are choosing SPACs over IPOs (kpmg.us). In a traditional IPO, the ultimately price received for issuing shares depends on market conditions at the time of listing. As a result, market timing of an IPO is a major factor in proceeds raised. In contrast, when acquired by a SPAC the price of the acquisition is negotiated price to the transaction closing, which locks in a known price.

[31] Why SPACs Could Leave Investors in the Cold - The New York Times (nytimes.com)

[32] Under U.S. law, “with mergers, plaintiffs have the burden of proof to show that managers knowingly made false statements, rather than merely having had bad luck, if the company fails to meet the projections.” See Gahng et al. (2021) from above.

[33] See Gahng, Minmo and Ritter, Jay R. and Zhang, Donghang, SPACs (January 29, 2021). Available at SSRN: https://ssrn.com/abstract=3775847 or http://dx.doi.org/10.2139/ssrn.3775847 . At present, these forecasts and projections are protected from U.S. lawsuits with a ‘safe harbor’ provision for mergers. This allows private firms to skirt the restrictions associated with an IPO while presenting possibly inflated projections in their investor presentations.

[34] See e.g., Datar, V., Emm, E., Ince, U., (2012). Going public through the back door: a comparative analysis of SPACs and IPOs. Bank. Finance Rev. 4, 17–36.; Kolb, J., & Tykvova, T. (2016). Going public via special purpose acquisition companies: Frogs do not turn into princes. Journal of Corporate Finance, 40, 80-96.

[35] Why so many companies are choosing SPACs over IPOs (kpmg.us)

[36] A bubble is when there is a sustained rise in the price of an asset or asset class above what its “normal” value. Price Bubble - Definition, Historical Examples, and Causes (corporatefinanceinstitute.com)

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