Musical Chairs: Is a SPAC Right for Me?

Move over FAANG and IPO; there’s a new acronym that has taken Wall Street by storm. The SPAC frenzy is at fever pitch comparable to only the likes of Bitcoin mania, with the mega-rich from all walks piling in, hoping to bank millions of dollars in profits by simply being associated with a SPAC of their own. With deal flow surging, SPACs are turning into a bit of a lottery ticket and every one of them is not a winner, no matter if Chamath Palihapitiya is behind it or Ciara has sung about it. Here’s what you need to know.

Know What Your Buying

There is actually a bit of an eerie comparison between Bitcoin and SPACs insomuch that many retailer investors have purchased the cryptocurrency with minimal understanding of what it even is. The same can be said for a SPAC, a shortening of “special purpose acquisition company” in Wall Street nomenclature. As it happens, the recent spike in popularity is undergirded by another popular Wall Street acronym, FOMO (fear of missing out).

Ah, but blindly chasing a running stock or surging SPAC is more often than not a recipe for financial disaster. Remember, there were FOMO-blinded people actually buying GameStop at $480 amid the infamous Reddit rally in January before the stock crashed back to $40.

In all reality, to say SPACs are “new” is a mischaracterization. They’ve actually been around for about 30 years, although they generally were considered niche (and sometimes shady) ways to raise capital. The Securities and Exchange Commission has increased regulations on SPACs, which has helped fuel adoption and popularity.

A SPAC is simply a blank check public company created solely for the purpose of acquiring an operating private company in a reverse merger deal that makes the private company public as the surviving entity. The way it works is the SPAC is assembled and listed through a traditional IPO (initial public offering, which include road shows and a mountain of regulatory filings), raising cash from the IPO for the purpose of buying a company (or companies), although it is against the rules for the SPAC to disclose beforehand what company it plans to acquire.

The SPAC typically has two years to find and acquire a company or else it has to return the capital — earning interest in a trust — to its investors, with the initial sponsors losing any money put into the deal. Furthermore, investors can exercise a redemption right, which gives them their money back (pro rata value in trust) with a “no” vote on any proposed acquisition.

Until an acquisition is made, the SPAC owns nothing and effectively does nothing except look for an acquisition. Private companies looking to go public are attracted to the idea of a SPAC deal because it represents a far quicker, less byzantine pathway to becoming publicly listed than a traditional IPO.

For instance, whereas the IPO process can take 2–3 years from start to finish, a SPAC can be completed in just 2–3 months. Companies can save considerable time to reach the public domain, where valuations are higher and capital is generally easier to obtain than in the private sector.

While certainly faster, the economics of the SPAC route are cloudier. For starters, the SPAC can pass on its original IPO costs to the company in addition to any acquisition fees and expenses. While costing the company less outwardly, someone still has to pay the piper, which is usually done by investors, constraining the upside and begging the question of sustainability of the model.

Perhaps the most appetizing part for starting the SPAC is what is called the “promote,” a nominal amount of money for founder’s shares that become convertible into common shares of the acquired company. These rewards can be extremely lucrative, as generally a promote consists of shares worth 25% of the SPAC’s IPO proceeds.

Initial sponsors can realize exorbitant returns in a short period of time from the promote, as billionaire Alec Gores did by turning $25,000 into about $80 million in a couple months when a $16 billion deal was struck for United Wholesale.

Against this backdrop, it shouldn’t be any surprise why so many people are looking to get in the game to capitalize on the promote payday.

SPAC Hysteria

In May 2017, TPG Pace Energy Holdings became the first SPAC to trade on the NYSE. For the next three years, the SPAC climate was lukewarm at best, until the floodgates opened last year to the tune of 248 SPAC IPOs raising $83.3 billion. That’s going to seem like a trivial amount at the current rate of deal flow. According to, there have been 189 SPAC IPOs in 2021 already (as of Feb. 28) that have raised nearly $60 billion.

The blistering pace of SPAC listings spearheaded a record-setting start to a year for IPOs. More than 200 companies IPO’d in January, raising an all-time best $63 billion worldwide. That’s more than 5x the amount raised in IPOs in January 2020.

This is certainly cause for pause to wonder if the market is reaching terminal velocity. This pace cannot be sustained. It should also have investors questioning the quality and frothy valuations of all of these companies joining the public space. It’s arguable that a bubble is forming, one that hearkens feelings of the internet bubble where everyone and their brother had a way-overvalued website.

Has the Shark Been Jumped?

Face it; it is one thing to turn money over to a professional money manager that is going to stay in his or her lane to identify an acquisition target. Companies like Bill Ackman and his Pershing Square Tontine Holdings or Goldman Sachs Acquisition Holdings Corp. are examples of SPACs being managed by seasoned financial vets.

It is a different story when celebrities are being put as the face of a SPAC. CNBC’s Mad Money host Jim Cramer recently posited that SPACs have “jumped the shark,” a reference to a “Happy Days” TV episode that has come to mean utilizing far-reaching events for novelty value and a decline in quality.

The New York Times this month noted that “anyone who’s anyone” now has a SPAC. If that doesn’t throw up a red flag, nothing does. Just a sampling of the list of household names in the SPAC business today include Shaquille O’Neal, Steph Curry, Serena Williams, Alex Rodriquez, Ciara, (former House Speaker) Paul Ryan, Larry Kudlow, Colin Kaepernick and Billy Beane (of “Moneyball” fame).

The personal success of the aforementioned is absolutely undeniable, but that doesn’t necessarily qualify them to run a SPAC. In effect, it is more of a play on celebrity status to attract retail investors with a hefty payday potential dangling from the lucrative promote.

Not Risk Free

The SEC requires a long and onerous IPO process for a reason: transparency. The years-long process is designed to protect investors while the company coming public is intensely vetted by institutions and other professional investors, as well as regulators. That tedious process is foregone in a SPAC, replaced by the due diligence of the SPAC management team.

Unquestionably the hottest thing on Wall Street, SPACs still carry risk, particularly for retail traders that aren’t first in the know.

There is no guarantee a deal will ever get done, nor is there that everything will come up aces. Upstart EV truck maker Nikola was a red-hot SPAC play about a year ago, running up near $100 per share. Perhaps owing to a lack of transparency with regards to a deal with General Motors, shares have been dusted up, falling to under $20 currently.

In the aptly-titled “A Sober Look at SPACs,” Michael Klausner (Stanford University), Michael Ohlrogge (NYU), and Emily Ruan (Stanford University) took a deep dive into the SPAC process and economics for the first 47 SPAC mergers in 2020. In a nutshell, the study authors found that SPACS have many fundamental flaws, including three different types of embedded dilution that are a weight SPAC shareholders bear. The study also showed that post-merger share prices drop on average one-third or more.

Stay Smart

Even in an investing environment that is becoming increasingly self-directed, it is best to leave management of retirement money to the pros. Those insisting on self-direction would be best served to align with money managers with a proven track record and to spend considerable time truly understanding the nuances SPACs while keeping up with quantitative data on post-merger returns.

It is all too easy as a retail trader to get wrapped up in momentum and hype, exactly like what is happening with SPACs. Indeed, with 2 or 3 new opportunities coming public every day, there will be plenty of winners as sponsors work hard to find great private companies to bring public. There will also be plenty of losers.

SPACs are just the latest game of musical chairs on Wall Street and no one wants to get caught standing when the music stops.

By Maria Chernaya, Investment Advisor

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