Fall from grace? SPACs

by Karolina Jaszczuk and Jacopo D’Angelo

In 2021, news were booming with mentions of SPACs, but was their appearance a recent phenomenon? Not at all. In this article we would like to bring forward the notion of Special Purpose Acquisition Companies and elaborate on their recent successes and shortfalls. Also recognised as “blank check companies” they don’t carry out commercial operations and their sole purpose is to raise capital by acquiring or merging with an already existing company. They are generally formed by investors or sponsors with extensive expertise of a particular business sector, to pursue deals in that area. However, the target is not ex-ante identified like in typical IPOs.

Despite them being in the spotlight last year, SPACs have been around for decades, dating back to 1993, according to Bloomberg’s data.

In the 90s, SPACs were characterised by helping small, underdeveloped companies to go public, while offering excessively favourable terms to their sponsors. As a result, they produced poor performance and led to hindered growth and damaged reputation. Looking at the track record of SPACs, people could have been hesitant to trust them again.

The first breaking point came in the 2000s when new regulatory changes gave structure to the evolution of SPACs and created a more attractive and sustainable investment vehicle.

The rise we have observed in 2020, that continued into 2021 stemmed from the unique conditions created by the COVID – 19 pandemic. Higher volatility levels made IPOs riskier, in consequence slowing down market activity. SPACs offered an alternative to traditional IPOs with the prospect of higher returns that came with some protection for investors, through the right of redemption.

2021 was a record year for SPAC IPOs and the market for de-SPAC transactions also remained strong. But how did SPACs performance change as the world adjusted to the pandemic?

2021 Market Overview

The first quarter of 2021 was dominated by SPACs, which accounted for 68.5% of all IPOs, compared to previous year’s 55.7% (Sara B. Potter, CFA, 2021). While the rush in IPO activity in the first quarter led to a proportionate increase in the number of mega-IPOs, which accounted for 4.7% of all, the dominance of SPACs has led to a surge in the share of IPOs raising $100-500 million.

One of the factors for SPACs growth in the United States was the decrease in the number of public companies over the last couple of decades, which dropped from its peak in 1990 at nearly 6000 to about 4000 in 2020. The US Federal Reserve has continued to pump extra cash into the market, even more so because of the pandemic, meaning SPACs offered a prospect of better returns according to Bloomberg.

We also cannot overlook the impact the private equity market had on SPACs. Over the duration of the pandemic, private equity firms stepped up to provide advice and capital to companies that suffered a tumble in sales. PE firms have shown growing interest to include more SPACs into their investment portfolios. This is because SPACs have several advantages over some traditional structures employed by PE and VC firms. These include having limited risk during the pre-acquisition phase, which provides the investor with security and return of liquidation in case the SPAC failures. Moreover, SPACs have greater liquidity and offer more leverage to investors over their initial investment by using warrants. In September 2020, for example, a big PE player – Apollo Global Management – registered a new SPAC with plans to raise over US$750 million, as reported by Michael Killourhy, in an Ogier article.

However, the second quarter of 2021 saw a big slump in SPAC activity with only 39 SPAC IPOs compared to 292 in the first quarter. The sharp decline also contributed to a drop in IPOs on US exchanges. The dampening effect could be traced to a growing number of lawsuits filed against SPACs by shareholders as more overhyped deals turned out to be flops. The jump from 5 to 15 class-action lawsuits from 2020 to the first half of 2021 caused uncertainty about the future of SPACs. While many of these suits could be dismissed in court, some have resulted in punishing settlements. In April, music streaming company Akazoo S.A. settled two security lawsuits for $35 million and the stock was delisted from the Nasdaq.

Another cause for growing hesitance from investors were the statements of the Securities and Exchange Commission’s (SEC) on projections and warrants. In April, the SEC issued two statements – one related to the accounting treatment of warrants and one related to liability risk – that have attracted considerable attention from SPACs and other stakeholders.

It was proposed that the warrants should be treated as a liability in the case of a reorganisation of the SPAC or tender or exchange offer with respect to the SPAC common stock. To add on, John Coates, the Acting Director of Corp Fin expressed his view that the perceived benefit and profit from de-SPAC transactions was exaggerated and potentially misleading.

After dipping to a one-year low, IPOs by SPACs rebounded slightly in the third quarter of 2021, raising $11.5 billion, up 41.9% from the $8.1 billion in the prior quarter but still down 73.3% compared to the third quarter of 2020 (Sara B. Potter, 2021). Q3 also saw a decrease in SPAC’s shares and warranties held by PIPE investors to 12%, falling from 17% in Q1. PIPE deals, short for Private Investments in Public Equity, refer to raising large amounts of money in a short period of time by offering shares of an already listed company to a group of accredited, private investors at a discounted price.

As the prices of post-SPAC companies became more volatile, and as the year wore on, more and more traded below the IPO price. Likewise PIPE deals trended lower. The tightening of the PIPE market posed new challenges to completing de-SPAC transactions.

2021 finished with 199 closed de-SPAC merger transactions, significantly more than the 64 in 2020 (Kevin M. Lacroix, 2022). As much as 95% of them involved PIPE transactions, with an average PIPE size of $316 million.

Despite the fact that the SPAC IPO market has rebounded considerably during the fourth quarter of 2021, the above mentioned changes in the SPAC market may decrease the number of successful de-SPAC transactions and present traditional IPOs as a more favourable option. While the market has shown resistance after it rebounded from the slowdown in the second quarter, we expect many market and regulatory challenges to continue throughout 2022.

SPACs vs Traditional IPOs

As established, SPACs serve as a vehicle for private companies to list on the public investment market. Despite the growing popularity of listing via SPACs, traditional IPOs remain the most common method for private companies to offer their shares on the public market through new stock issuance. Therefore, in an age where the value of SPACs is becoming increasingly uncertain, their advantageous aspects with respect to traditional IPOs must be evaluated.

The most significant factor that renders SPACs a strong means of listing publicly is their ability to reduce risk and minimise the timeframe of the IPO. As Matt Levine from Bloomberg writes, a “SPAC merger has one really good feature for the target company, which is that, when you sign the merger agreement, you know you’re going public, and you know the price.” However, SPACs have a noteworthy attribute: Investors are able to withdraw from the deal once a target for the proposed merger is identified. The withdrawal entails the SPAC repurchasing the shares at a rate equal to the IPO price less a pro-rata rate of taxes paid, or plus a pro-rata share of any positive interest received on the balance of the escrow account. Therefore, this unique feature casts doubts on whether SPACs actually encounter greater deal certainty than traditional IPOs.

In a study conducted by Michael Klausner, Michael Ohlrogge, and Emily Ruan, they found that the mean rate of redemption for SPACs was 58%, and a median rate of 73% with one in four SPACs having redemptions of over 95%. These significant figures highlight the fact that advocates’ claims that SPACs provide increased deal certainty, although valid in the context of specific instances, may not accurately represent the general trend. Furthermore, a Financial Times article mentions the case of biopharmaceutical start-up eFFECTOR Therapeutics which was expected to merge with Locus Walk Acquisition, a SPAC that had raised $175 Million. However, the funds were almost entirely eradicated when 97% of shareholders redeemed, leaving solely $5.2m (FT). Despite eFFECTOR ultimately getting saved by a $60 million private investment, it can be seen that SPACs do indeed fail, due to shareholders’ ability to redeem shares. Therefore, the question of whether SPACs actually provide increased deal certainty compared to a traditional IPO is under contention. Ascribing superior abilities in listing publicly to SPACs appears increasingly dubious.

Besides the uncertainty in SPACs’ ability to ensure deal certainty, there is also another pressing factor that can highlight potential drawbacks. This is whether SPACs actually provide significant returns on investment in the periods following the merger. According to the Annual Private Equity Report conducted by Bain & Company in 2021, Brian Kmet, Mike McKay, and Thomas Olsen found that “of the 121 SPAC mergers [they] studied, more than 60% have lagged the S&P 500 since their merger dates, with 50% trading down post-merger”. Furthermore, an ETF (ticker: SPAK) tracking various SPACs has returned -47.29% compared to the 12.30% of the S&P 500 (across the year 13 Feb 2021 – 13 Feb 2022). After even a quick glance at these values, it is clear that post-merger SPACs are generally underperforming the market by a significant margin. Highlighting that despite the SPAC boom, the results haven’t yielded significant returns to investors. However, this must not be misinterpreted as signifying that all SPACs are poor investments. In an interview with Forbes Matthew Kennedy, senior IPO strategist at Renaissance Capital states that “on an individual basis…we’ve definitely seen very competent, experienced SPAC sponsors find the good companies.” Therefore, despite the overall performance of SPACs post-merger being subpar, this is not discrediting all SPACs. However, it pushes investors to be more selective when investing. Potentially resulting in companies opting to go public via a traditional IPO instead.

*Performance of SPAC ETF compared to S&P 500*

Expectations for 2022

2021 was a stellar year for SPAC deals with over 600 completed deals in the United States alone. Despite this, 2022 will be a challenging year for SPACs as the market’s faith in them will be challenged. In an interview with CNBC, Chris Senyek, senior equity research analyst at Wolfe research claimed “The SPAC bubble is bursting” and mentioned that this is the product of SPAC shares’ high volatility, caused by their highly speculative nature. Furthermore, research conducted by Bloomberg shows that the number of failed SPAC mergers has spiked in Q4 of 2021 and Q1 of 2022 with the latter being 3 times higher than the value of Q4 in 2020.

Despite this seemingly hopeless trend, the Wall Street Journal consulted various experts on their opinions on the future of SPACs. The general consensus was that the market volatility seen in 2020 and 2021 is largely due to SPACs being a relatively new concept and that they will stabilise in time. Ivana Naumovska, an assistant professor at Instead mentioned that the SPAC market is starting to correct and shift towards an equilibrium, where the selection of targets will be more evidence-based rather than speculative. She expects that as the market stabilises and the number of SPAC deals decreases, the quality of these deals and returns on investment will increase. Moreover, founder of SPACInsider Kristi Marvin commented that SPACs’ biggest advantage is their ability to evolve. Therefore, it is expected that the structure of SPACs should grow and mature in accordance with the market, potentially allowing them to gain a future edge on traditional IPOs which have not changed much since being first implemented.

Ultimately, After facing a steady decline in 2021 and greatly underperforming the rest of the market, SPACs remain a topic of uncertainty, as experts claim they are yet to mature and stabilise before becoming a reliable and profitable method of listing publicly. However, when only considering 2022, it is unlikely that the SPAC market will reach this equilibrium in such a limited timeframe. Especially since, Julian Klymochko, CEO of Accelerate Financial Technologies, mentions that leveraged buyouts – now common practice in private equity – took 40 years to become the default allocation in an institutional portfolio. Therefore, although Klymochko mentions that the SPAC market will probably take a shorter timeframe to become default practice, we are unlikely to see any significant change as early as 2022.

Authors: Karolina Jaszczuk, Jacopo D’Angelo

Editor: Jakob Müller

List of Sources:

Photo by Ralph Mayhew on Unsplash

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