ComplianceSeptember 01, 2021

CT Expert Insights: SPACs Explained

You may hear the investment term SPAC recently, and for good reason. SPACs (Special Purpose Acquisition Companies) have been around for decades, but their popularity has skyrocketed over the past year. In this edition of Expert Insights, CT Corporation’s Senior Director, Amit Rajvanshy, explains what you need to know about SPACs.

Learn what a SPAC is, how it’s formed, what the upsides are of investing in a SPAC (such as faster time to market than an IPO), and the potential downsides (such as less time for due diligence). You’ll also hear how the pandemic influenced the historic rise in the use of SPACs and why the interest in SPACs may be tapering off somewhat.

Transcripts

Greg Corombos: Hi, I'm Greg Corombos. My guest in this edition of Expert Insights is Amit Rajvanshy. He is a Senior Director at CT Corporation. And today we're going to be talking about SPACs, what they are, why they're important and what you need to know about them. So, Amit, thank you very much for being with us.

Amit Rajvanshy: Pleasure, Greg.

GC: Well, for starters, give us an overview. What exactly is a SPAC?

AR: Greg, a SPAC really stands for Special Purpose Acquisition Company. It's also known as a blank check company, or even a poor man's private equity fund, but it's a very simple straightforward concept. In fact, the idea started back almost 30 years ago, back in early 1990s, when a Wall Street investment bank, GKN Securities, actually invented this concept.

So what SPAC is essentially is an investment vehicle. Typically, a professional investor, or even a business figure, you know, think of Bill Ackman, Sir Richard Branson, celebrities like those are even, you know, pop culture celebrities, athletes like Serena Williams, Shaquille O'Neal, Jay Z, some of these big names, they come together and form a shell company. This state when they form the shell company, this SPAC the special purpose acquisition company, really has no commercial operation. It's just an idea. It makes no products, it does not sell anything. But at that time, these celebrity promoters have a SPAC, they approach retail investors, you know, we have public markets, and then using their celebrity appeal, they seek public investments into the SPAC vehicle.

So, retail investors like you and I could invest maybe $10, ticket size stocks or warrants in this SPACs pool of capital. And the collection could be anywhere from 300 million to billions of dollars that are, you know, collected by the SPAC instrument. And now once the SPAC has been funded, there is money to invest. These celebrity promoters have a two-year time window to go and invest these funds. And investments really are in acquisition.

So, they take this money, and they screen private businesses, which may not be public yet. And then they acquire them using this SPAC’s funded capital. So, then what happens it's a reverse merger, that private business, it could be a pizza shop, it could be a medical instruments company, whatever, even you know, taxi services companies, they now become a publicly listed company through this SPAC mechanism. So that's all really it is. It's a, you know, private equity investment concept, but available to the public markets.

GC: Let's flesh it out just a little bit more. Can you give us a few examples, first of all the private companies that recently went public by merging with SPACs?

AR: Yeah, absolutely. A lot of them in fact, Virgin Galactic, which was the space flight company recently in the news, that was a reverse merger via SPAC. They went public. DraftKings, quite popular here in a sports contest and betting company that has gone public via SPACs. There is a real estate company called Open Door. WeWork. WeWork was a lot in the press, you know, in fact, it had shelved its initial IPO, and then it went public via the SPAC route. So that was interesting. And even Grab. Grab is a Southeast Asia's Uber, it's a, you know, a ride-hailing services company, it went public through a SPAC merger, and that was billions of dollars, I think $30 or $40 billion worth of SPAC is what grabbed bandwidth. So these are some known famous examples, but many, many more examples of businesses in all sectors going public.

GC: It's fascinating to look at some of the ideas and issues and concepts that are getting a lot of attention these days as a result of where we are in our society and, in the wake of the pandemic right now, it's not surprising that some of those places are going public and going strong. But how is it, Amit, that a SPAC is a faster path to public markets, than perhaps a more traditional approach?

AR: See, the traditional Initial Public Offering process is generally very arduous, because there is a lot of regulations and governance and control from the Securities and Exchange Commission. So typically, if you look at an IPO, a company has to be in operation, ideally, profit-making and you know, a viable, thriving business before a company typically goes through an IPO and gets listed on the public markets.

But that process becomes long. And there are a lot of regulatory hurdles that have to be cleared. So SPACs generally alleviate some of these burdens because they promote a faster and less expensive path, actually. So, SPAC acquisition can actually be closed in a few months. And you know, compare and contrast that with a typical IPO, that could take generally up to six months, even longer just for the paperwork.

So, SPACs really are, you know, a faster way to clear the regulatory hurdles, and get the clearances first, because remember, there is no underlying business to be audited and verified, just an idea. So, again, even the regulators don't have too much compliance burden to verify. So yeah, it's a faster process to go through that process.

GC: So, speed is obviously an asset, an upside for folks wanting to go that route. What other reasons have you've come across as to why SPACs are so popular right now?

AR: Actually, as I said, SPACs have been around for 30 years. It's only in the last, I would say 18 months or so that SPACs have become extremely popular. And initially before, like, in the 2020s, in fact, before the COVID pandemic, SPACs were usually the last resort, actually, for small companies who had trouble raising funds. But SPACs became very, very popular because of extreme market volatility that we all saw in the pandemic last year. The stock markets were extremely choppy, especially at the start of the pandemic, the first half, so a lot of companies actually chose to postpone their traditional IPOs. And there are chances that the market volatility could spoil their stock, you know, in public debut.

So that is why on one hand, those companies that there were not many IPOs hitting the markets. And on the other hand, because of the Federal Reserve's easy money policy, there were a lot of low-interest rates, capital waiting to be deployed. So, there was money, but there weren't too many new IPOs to chase. So that was the perfect opportunity for SPACs to emerge on the horizon as an attractive investment instrument so that it's just timing that, you know, all the market dynamics that led to so much popularity in SPACs that we have seen in the last 18 months or so.

GC: So really a perfect storm of conditions over the past year to year and a half to give SPACs the momentum they have right now. Now we're into the second half of 2021. Of course, do you see this growth continuing in the months ahead?

AR: Yes. See SPACs have had a very strong growth in the last 18 months. In fact, year to date, June, they have raised almost $117 billion through public capital new activity, but activity is slowing down. See, Greg, there are two parts to it. One is raising the capital and the second is deploying that capital.

So yes, raising the capital, i.e. new IPO issues will slow down. So, we will see, you know, some slowdown in new SPAC issuances over the second half of the year, again, remember with comparing to an off the charts growth rate. So it may appear slower, relatively, but they will continue.

But what is critical is that a lot of funds have been accumulated in the last 18 months that are still waiting to be deployed. So, the M&A activity, which is the long tail of these investments, will continue very strong in the second half of this year. So, all in all, we are going to continue to see a lot of strong growth in both capital raising and investment, not just in the second half of 2021, but also maybe into 2022. And even beyond, who knows.

GC: We're talking with Amit Rajvanshy. He's a Senior Director at CT Corporation, and we're talking about the concept known as SPAC, Special Purpose Acquisition Companies, and why they're so popular and attractive right now. So, we've talked a lot about the upsides, but let's talk about some of the risks that come with investing in SPACs. What do folks need to know on that front?

AR: As a retail investor, I think, needs to be aware that there are some structural defects or limitations, I should say, in the construct of SPAC itself that a retail investor should be aware of.

So, to start with one, there is a strong possibility of equity dilution, because what happens is that all these celebrity promoters or the business figures are floating the SPAC, they tend to charge what is promote equity, and that will be almost up to 20% of the fund, sometimes that's raised. And that could be issued to founders at a very nominal value. So, in some sense, there is upfront loading of returns that celebrities take regardless of the outcome of the of the investment. So that kind of comes out of the returns of the investor. That's one.

Two, the SPAC sponsors generally have to find a workable acquisition within two years, otherwise, they have to return the funds back to the public. Maybe three years at max. So, the time constraint sometimes becomes a disincentive. And the promoters can negotiate in less than, you know, best acquisition been for their investors. So that time pressure sometimes leads to issues.

And then due diligence of the SPAC process is also not as rigorous as a traditional IPO. Again, that's an advantage but a disadvantage, it is faster, but again, it's not as rigorous. So, a lot of times SPACs, you know, end up bringing a lot of early stage, much riskier companies to the public market through acquisitions, which then exposes the ultimate investors, the retail investors to that. So, no wonder the actual returns that SPACs had generated up until this this new era, you know, COVID, 2020, and before that, the average returns are much lower. But hopefully now I think with a little more regulatory oversight that we are seeing, we may see better returns for SPAC investors. All in all, I think retail investors should make an informed judicious decision of investing their capital in SPACs.

GC: And, finally, on that, we always like to make sure we do as much due diligence in these conversations as possible. What SPAC compliance considerations should folks know about?

AR: So, again, regulatory compliance professionals, whether they're law firms, internal corporate legal departments, accountants, there are, I would say there are two buckets or two segments of compliance considerations.

One is a whole set of rules that come with the SEC enforcement. So, there are capital market controls, and Securities and Exchange Commission that has enforcement and compliance tools, which are essentially related with the IP or the public offering. But before that, and regardless of that, I should say, there is a whole set of legal entity compliance burden that SPACs have to carry and law firms and legal entity professionals have to discharge that, which could include a setting up a legal entity, the formation itself, the appointment of a Registered Agent, just keeping the SPAC in good standing.

Because, again, a small mistake of not keeping the SPAC in good standing could actually have significant repercussions in a short timeframe. So, making sure the annual reports are filed on time. And once the mergers and acquisitions have been completed, all the follow up paperwork required with merger filings, etc., has to be also completed.

So, the traditional burden of keeping, maintaining, forming, and even dissolving a legal entity are very, very critical. And, given the public market exposure, it becomes even more sensitive to ensure that the compliance burden is professionally discharged.

GC: And CT Corporation can help with that correct?

AR: Yes. Yes, we have a full suite of services around from the birth and conception all the way to the end. In fact, we're the market leader in this space providing these services. So absolutely, you should reach out to one of our professionals who can advise you, help you, along the entire journey wherever you are on the entity compliance side.

GC: Fascinating to watch and better understand these developing trends. Amit thank you very, very much for being with us. today.

AR: Greg, thank you so much. It's been a pleasure.

GC: Amit Rajvanshy is a senior director at CT Corporation. I'm Greg Corombos and for more information on this topic, please call CT at 844-787-7782 or visit ctcorporation.com.

Related article:

The rise of the SPAC 

photo of Amit Rajvanshy
Senior Director, Strategy Development
Amit Rajvanshy is a Senior Director at CT, responsible for strategy development.  He tracks market developments that impact CT’s customers and products. He is a former strategy and M&A consultant from KPMG.