Special Purpose Acquisition Companies (SPACs) have a long history of setting records, so it’s not surprising that 2021 saw a record number of IPOs driven by SPACs.
SPACs had previously raised $83.4 billion in Initial Public Offerings (IPOs) in 2020, but by March of 2021, they had surpassed this number, climbing to $95.7 billion by the close of the first quarter.
Financial controllers may find themselves called upon to explain these record-breaking trends to senior management. Today, we’ll help you understand the ups and downs of SPACs, and what their popularity means for the financial industry.
What are SPACs?
The purpose of a SPAC is straightforward: It acquires a target company with the expectation of having the target company’s shares issued and traded publicly, which partly explains why SPACs are so popular for IPOs.
Typically, a SPAC is formed by investors who have some background in a particular industry, so the acquisitions associated with SPACs are not random mergers.
You may have heard SPACs referred to as “blank check companies.” This name comes from the fact that when a SPAC is created, it does not publicly disclose the identity of the target investment. In other words, IPO investors are investing in a company without knowing where their investment ultimately lies.
The SPAC is first listed publicly through a traditional IPO, though the listing requirements are reduced since they are a “blank check company.” After raising capital, the money is kept in a trust and used to acquire a target company.
SPAC Performance for 2021
Admittedly, SPAC performance for 2021 has not been consistent, but the popularity of this approach can hardly be denied.
In March of 2021, a record number of 109 SPACs were issued, dropping to only 13 the following month, a number that did not rebound until October. However, during the first quarter of 2021, $95.7 billion was earned from SPACs used in IPOs.
What’s behind this fluctuating popularity? The reason, say experts, is that during this time, financial personnel were struggling to work out accounting and regulatory principles, which resulted in a backlog of SPACs. Once these issues were worked out, SPACs returned to popularity, with 57 SPACs trading in October.
If 2021 is any indication, these trends will likely continue into 2022, making SPACs a new fixture for the world of investors.
Why are SPACs so Popular?
These recent trends raise an important question: Why are SPACs so popular? What advantages do they offer companies and their investors? We can highlight three reasons why companies rely on SPACs for their initial public offerings:
1. Greater Certainty
Stock market volatility translates into a lot of uncertainty for companies and prospective investors. When a company decides to go public, it can be challenging to find the right price at which to make its Wall Street debut.
Price yourself too low, and you could undervalue your company considerably. Go too high, and you could alienate potential investors.
SPAC mergers eliminate a great deal of this uncertainty since target companies can negotiate their stock price with the SPAC sponsor. This approach allows a target company to effectively “lock-in” a market price, which protects against volatility in the market as a whole.
2. Faster Access to Working Capital
Companies that merge with a SPAC will have faster access to working capital. If present trends continue, small to mid-sized companies will have an expanding pool of SPACs to choose from, granting them access to funds that can be used for investing in their companies so they can continue expanding.
This setup also makes SPACs an ideal choice for companies that want access to this capital but aren’t necessarily ready for a traditional IPO. SPACs can help these smaller companies grow without the risks associated with going public.
3. Flexible Terms
The process of merging with another company allows room for negotiation. The exact terms of a merger are largely determined by the companies themselves, which grants considerable flexibility in setting terms to the contract that can add additional value (or debt!) as a result of the merger.
This flexibility also means that a target company’s board of directors is subject to negotiation. The SPAC may set terms that would enable them to shape the way their target company is governed, and the target company may be willing to accept these terms for the right financial incentive.
The Need for Negotiators
What does this mean for financial controllers and CFOs? The increasing popularity of SPACs as a vehicle for IPOs will mean it will be more important than ever to properly negotiate for the optimal arrangement.
Financial personnel will play a role in this negotiation process by evaluating the acquisition’s financial terms and forecasting how such a merger would impact their company long term.
For now, SPACs appear to be here to stay, presenting another opportunity for those in finance to help shape the future of American industry.
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