The Rise and Fall of SPACs: A Comprehensive Analysis

Key Takeaways

• A SPAC, or a special purpose acquisition company, is a publicly listed company designed to acquire or merge with private companies, thus taking them public.
• SPACs raise capital through an IPO and use these funds to search for a target company. Once the transaction is finalized, the SPAC takes the company public through a reverse merger in a process known as de-SPACing.
• While SPACs enable private companies to go public more efficiently, they historically underperform and see risks from features like misaligned incentives.
• Over the last few years, the SEC has intensified its scrutiny of SPACs, instituting new rules that enhance investor protections while hindering SPACs’ trademark efficiency.

The financial world often resembles a rollercoaster, with trends that rocket to popularity before plunging into disfavor. One of the most intriguing financial phenomena in recent years has been the rise and fall of SPACs, or special purpose acquisition companies.

After a recent surge in 2020, SPACs have since cratered due to poor performance and regulatory scrutiny.

In this article, we delve into what has happened to SPACs: their history, how they work, their advantages and risks, and the evolving regulatory landscape.

What is a SPAC?

A SPAC, or a special purpose acquisition company, is a publicly listed company designed to acquire or merge with promising private companies, thus taking them public in lieu of them launching an initial public offering (IPO).

In this way, SPACs provide private companies an alternative to the traditional IPO process, which is a more expensive and time-consuming route to public markets.

Evolution & Explosion of SPACs

SPACs emerged in the 1980s as a way to bring companies in speculative industries, like oil and gas exploration, to public markets. They briefly fell out of favor during the dot-com years in response to the booming IPO market before staging a comeback from the early 2000s until the 2008 financial crisis.

Starting in 2019, SPACs exploded in popularity, which reached a fever pitch in 2021. In 2019, 59 SPACs were created, with $13 billion invested. In 2020, 247 were created, with $80 billion invested – more than four times the volume of the previous year. In fact, SPACs made up more than 50% of new publicly listed U.S. companies that year. The peak came in 2021 with 613 SPAC listings that raised $145 billion – a 91% increase from the previous year.

However, by 2022, enthusiasm waned significantly due to increased regulatory scrutiny, rising interest rates, and changing investor sentiment. Both the number of SPACs and the amount of capital raised have dropped significantly since.

How SPACs Work

SPACs are usually created by investors or sponsors with expertise in an industry in which they want to acquire promising companies. SPACs are often referred to as “blank check companies” because they don’t identify a predetermined acquisition target before they raise capital from investors.

SPACs raise capital through an initial public offering (IPO) in order to acquire or merge with a private company. After the IPO, the SPAC places the funds into a trust account until an acquisition is finalized. It then uses them to search for and acquire a target company.

Once the SPAC and target company agree to terms, the SPAC will publicly announce the target to investors and may embark on a road show to validate the valuation and raise additional capital through PIPE, or private investment in public equity.

Once the transaction is finalized, the SPAC takes the company public through a reverse merger in a process known as de-SPACing. The combined entity then begins trading under a new stock symbol.

SPACs must complete this process within a certain time frame, typically two years, or else they must liquidate and return funds to public investors.

SPACs vs. IPOs: Advantages and Risks

How exactly do SPACs compare to IPOs? SPACs’ main advantage boils down to efficiency as well as enhanced control. Their greatest disadvantage lies in their riskiness, which permeates their performance and reputation.

Advantages

• Fast Market Entry: While traditional IPOs take 12 to 18 months, SPAC mergers typically close within 3 to 6 months. This expedited market entry enables private companies to access public funding sooner.
• Less Expensive: SPACs are often less expensive than IPOs because of their efficiency. They also tend to spend less on services like marketing, legal fees, and financial consulting.
• Lighter Regulatory Scrutiny: Since SPACs are shell companies with no operations, the regulatory process is relatively straightforward, whereas the IPO process entails rigorous due diligence involving the scrutiny of a company’s finances and liabilities. However, the regulatory scrutiny of SPACs has heightened as we’ll explore below.
• Better IPO Pricing: Companies that go public via SPAC can negotiate IPO pricing before the transaction is finalized and may be able to set a premium price due to the limited time window. On the other hand, companies that go public via IPO are at the whim of market conditions, which may be volatile.
• Additional Capital: As mentioned above, SPAC sponsors have the option to raise additional funding through debt or PIPE (private investment in public equity).

Risks

• Potential Failure: Unlike an IPO, there’s a chance a SPAC fails to find an acquisition target. In fact, according to the data, this risk is high. In 2022, Pitchbook reported that nearly 800 out of the 1,288 SPACs created since 2020 were still searching for deals, putting them at risk of liquidation.
• Underperformance: De-SPAC companies have historically performed poorly. Mergers completed in 2021 and 2022 lost an average of 67% and 59% of their value compared to their de-SPAC prices. They also often experience significant price fluctuations post-merger, leading to uncertainty for investors.
• Misaligned Incentives: SPAC sponsors typically receive a generous 20% equity stake, which may incentivize them to hastily finalize a deal even if it’s not in the best interest of investors since they’ll profit regardless of whether the company’s stock price tumbles.
• Shareholder Dilution: As mentioned, SPAC sponsors usually own a 20% stake through founder shares as well as warrants to purchase more shares. They may even receive additional shares if they hit an agreed-upon target within a certain time frame which could dilute shares further.

Feature	SPAC	IPOs
Timeline	3-6 months	12-18 months
Cost	Less costly	More expensive
IPO Price	Negotiable and potential for premium price	Subject to market conditions
Regulatory Scrutiny	Lighter but this is changing	Heavier
Performance	Historically poor	Various but better on average
Shareholder Dilution	Higher	Lower

Regulation of SPACs

The recent rise of SPACs attracted significant attention from regulatory bodies, most notably the SEC. By the peak of SPAC mania in 2021, the SEC had intensified its scrutiny, leading to extended review periods for SPAC filings. In 2024, the SEC reinforced its regulatory framework to mirror the rules applied to traditional IPOs in order to enhance investor protections.

SPACs must now transparently disclose all material assumptions and bases that underline their financial projections to avoid optimistic forward-looking statements that previously left retail investors vulnerable to exaggerated promises. As part of this, SPACs no longer benefit from the safe-harbor protections for forward-looking statements under the Private Securities Litigation Reform Act.

SPACs must also supply additional information about the target company to investors so they can make more informed voting and investment decisions. They must also provide comprehensive information regarding conflicts of interest, sponsor compensation, and potential dilution risks to give investors clear insights into the deal structure.

Finally, the target company involved in a de-SPAC transaction must sign off on the registration statement, assuming liability for disclosure accuracy as an added layer of accountability.

These regulatory changes have importantly heightened investor protections, but they have also dimmed the traditional appeal of SPACs, which are known for their efficiency.

Summary

SPACs provided an innovative alternative to traditional IPOs, but their rapid rise in recent years was followed by an equally dramatic fall.

While they still offer a viable path to public markets, increased regulatory oversight, market volatility, and historical underperformance mean investors and companies must approach SPACs with caution. However, regulatory evolution may result in fewer, but potentially stronger, SPAC offerings as sponsors adapt to the changing landscape.

The coming years will determine whether SPACs can adapt into a sustainable long-term financing vehicle or remain a short-lived financial trend.