Several weeks ago, I read my fellow writer Max Ash’s article, “A SPAC-tacular Rise”, in The Commentator’s Business Section, in which he discussed one of the newer and more popular investments on Wall Street: the SPAC (Special Purpose Acquisition Company). For those who do not know what a SPAC is, Ash acutely summarized it in his article as follows:
“SPACs are essentially shell companies that have already gone public with no operating history that are created with the sole purpose of raising money to acquire another company (which otherwise would have gone public through an IPO). When investors pour money into a SPAC, they do not know what company said SPAC will be acquiring. The caveat: if the SPAC is unable to complete an acquisition within two years of its formation, all funds are returned to the investor(s). A traditional IPO is underwritten by a certain number of banks. When a private company wants to public through a SPAC, they are merging with an (already public) SPAC, essentially bypassing the usually drawn-out and expensive IPO process.”
Ash then raised several strong arguments in support of SPACs increased popularity, including the interest-gaining return that investors receive on their principle while the SPAC searches for a start-up in which to invest, as well as the option given to investors to withdraw their investment before the SPAC invests in their targeted private company.
Moreover, Ash raised two points to explain why private firms looking to go public might favor an SPAC over an IPO. “[ Firstly], If a company were to pursue a traditional IPO, like WeWork, the negotiations could be drawn-out, leading to investors questioning and critiquing the company’s business model... [and secondly,] going public through a traditional IPO introduces the possibility of an IPO ‘pop’ and the stock is vulnerable to full market risk, while a SPAC affords the comfort of price certainty much earlier in the process while limiting the risk from the volatility of the market.”
These points are valid and true, but it is precisely these points that, I believe, are room for concern.
The reason that an IPO requires thorough accounting auditing of the listing-company is that the rules and regulations that verify the financial performance of a private company are significantly less stringent than those that verify the figures of a public firm. Accounting of private companies is necessary for taxation, but the accuracy of their numbers are not checked as scrupulously as a public firm’s, and therefore are more prone to over-evaluation (“creative accounting”) that estimates the company at a much higher than it may truly be worth.
Once a firm goes public, investors are able to look at the company’s performance, both recorded and projected, and decide how much they believe the company is worth. As such, the most impartial and objective evaluation of the company occurs only once they go public. That is one of the reasons that the WeWork IPO never materialized. Bankers from WeWork’s underwriters looked at the firm’s numbers and simply could not justify to investors the price tag at which WeWork had evaluated themselves. The IPO is a way for a company to “go to market”, but it also allows the market to “screen” the company and determine for themselves its true worth. The only reason SPACs are not subject to the same scrupulous rules is because of a liability shield that Congress gave to public companies over two decades ago. According to that ruling, a public company (in this case, the SPAC — the listing-company is still private prior to actually listing) is allowed to make rosy projections about future results with little risk of lawsuits from angry investors. This allows for more “favorable” or “optimistic” projections for the future profits of public companies, projections which are based on expectations of future deals and not (as yet) real, tangible, verifiable results, than for private ones (which are held to stricter, more exacting standards). As a result, the SPAC acquisition “sidesteps” the scrutiny that would surround a private company going public via a typical IPO.
This also explains the “IPO-pop” that a listing company hopes for. When the firm actually comes to market, their “numbers” are available for all investors to see, and if investors are pleasantly surprised by what they consider to be the upward trajectory and momentum of the firm, they will purchase the stock, driving the stock price upwards, hence an “IPO-pop.” The converse, however, is that if investors are displeased with the firm’s figures, the stock price will drop, causing frustration and losses for the many private investors and employees who were sold or given stock prior to the IPO.
The importance of an IPO for investors is that the numbers of the now-public company are verified and audited by an accounting firm, and therefore can be confidently trusted. SPAC’s, on the other hand, can “hide” behind the screen of a public company, and therefore greatly obscure their true long-term value.
The other, more macroeconomic, argument against SPACs is that the SPAC-chase has become a sort of “wild-goose lottery chase” where investors finance the SPAC without initially knowing where their money will go. Yes, before the final acquisition, investors are able to withdraw their investments from a SPAC if they do not approve of the proposed acquisition, but the fact that investors are happier to leave their money in a SPAC instead of investing in public companies must lead us to worry about the lack of positive-NPV (Net Present Value) projects available on the market. If private, accredited investors have to go through “secret SPACs'” to achieve above-average returns, what does that tell us about the opportunities for growth available in the rest of the market? The lack of readily available positive-NPV projects essentially means that there is much less innovation, creativity and entrepreneurialism in our economy currently than there was in decades gone by. The nation that put man on the moon seems to be losing its innovative touch, its exploratory edge, and that will cause our economy to deflate in unexpected ways in the years to come. As proud Americans, who value this country as the land of opportunity, growth, innovation and development, that should worry us, and should spur the creative, entrepreneurial and problem-solving capabilities within our society. Perhaps it is no surprise that of the 71 SPAC-acquisitions completed so far in 2020, 15 purchased companies that had no revenue in 2019, and the average return on SPAC investors’ common stock has been a loss of 1.4%, according to research and investment management firm Renaissance Capital. These “shots in the dark” in which investors have financed somewhat blindly in SPAC’s instead of in public companies whose project earnings are more legitimate and trustworthy suggests a rather pessimistic outlook for the medium-long-term future where American investors may start to find economic less creativity, less technological innovation, and, ultimately less profit.
Photo Caption: The enigmatic nature of SPACs prevents investors from knowing what they truly are and often this elusive complexion bars the SPACs themselves from knowing their very own identity.
Photo Credit: Pixabay