There is no denying that SPACs are trending and will continue to thrive (as of January 31, 2022, there are already 23 SPACs, and to put this number in perspective, only 59 were created in 2019). But as with any business transaction, it is important to consider the big picture and gain as much knowledge as possible to make informed decisions.
SPACs provide several significant benefits, but they may also present setbacks. Here are some pros and cons that interest SPAC stakeholders.
- Faster route for private companies to go public (a SPAC merger usually takes place between 3 to 6 months, while the IPO route can take 12 to 24 months).
- Risk-free opportunity for investors (in case of opt-out option, i.e. when they decide to withdraw their investment, they receive back their capital and the accrued interest).
- High profit for the sponsors, incentivized to create a high-quality business combination for the investors. Let’s make an example: a SPAC IPO offers 20 million shares to investors at $10 per unit. Sponsors, in case of successful business combination, got 20% of additional shares, equivalent to 4 million shares.
- The success of the SPAC depends on the strength of the sponsors, who are often supported by individuals with a strong reputation and a high public profile, so there is a risk that people will participate in SPACs just because they are drawn in by famous names. Sponsors must also present an effective negotiation, appealing to both investors and the target company, as the latter may be speaking to more than one SPAC in the initial process. Therefore, the target has a significant leverage as sponsors could lose everything if the deal is not successful.
- Time constraints in the choice of the target company can lead to a not carefully scrutinized selection just to close an agreement. In fact, sponsors are incentivized to complete the transaction since even a bad business combination for investors is preferred by the sponsors over the liquidation of the SPAC.
- Performance may fall far short of expectations. If many investors decide to redeem their shares, sponsors may be forced to resort to the Private Investment in Public Equity (PIPE) process to make up the difference.
Some SPACs may underperform, while others will achieve better results. But SPACs are here to stay, and they are becoming the preferred method for private companies to go public.
Although SPACs have improved since their first appearance in the 80s, further regulatory and market changes are undoubtably on the way, hence the need to be constantly informed with the latest SPAC news.