A Primer on SPACs
A basic introduction to Wall St's latest trend & quick thoughts on its relevance for and longevity in Europe.
If you follow startup or financial news, you likely came across SPACs recently. If you haven’t, you’ll soon start noticing the name - even if it seems we might have passed their peak.
I’m getting a lot of questions from founders & friends about what they are, whether they’re relevant to Europe & if they’re here to stay, so I thought I’d write a quick primer about them!
So what’s a SPAC?
SPAC stands for Special Purpose Acquisition Company - a fancy word for what is commonly referred to as “blank cheque” companies. SPACs are “pots of money”, companies listed on stock exchanges with the sole purpose of making an investment in or acquiring a private company. In addition to the cash injection, the acquired company becomes publicly traded after the SPAC’s investment. This process is known as de-SPACing.
Who’s raising SPACs?
Cynics might ask who isn’t raising a SPAC these days. In the US, the trend brought “sponsors” - as investors raising SPACs are called - from all corners. They ranged from Tier-1 private equity firms to sport stars.
In the first 6 weeks of 2021, SPACs raised half as much money as through all of 2020, which was already a record year. Funds like Apollo, Oaktree & TPG represented most of the money raised by SPACs but some also featured sponsors like Shaquille O’Neal & Alex Rodriguez.
In Europe, the SPACs that are currently listed or the ones that have been announced are led by seasoned investors like Klaus Hommels of Lakestar, entrepreneurs like Xavier Niel or financiers like Matthieu Pigasse or Jean-Pierre Mustier.
Why are SPACs interesting?
The SPAC is a “three-faced” product. It needs to be interesting to (1) investors, who are trusting sponsors with their money, (2) companies looking for financing and (3) sponsors negotiating the deals.
Investors like SPACs because they present fairly little risk. Once a target is identified & confirmed by the sponsor, the investment is put up to a vote & investors can decide to get their money back, usually with interest. In today’s low rate environment, this means the opportunity cost is fairly low.
On the upside, if investors like the target, they can exercise the free “warrants” (options to buy additional stock at a certain price) which are given in exchange for being an initial backer of the SPAC. This option is an opportunity for investors to deploy more money in a company they are excited by.
Companies can be drawn to SPACs for a few reasons. SPACs can be interesting sources of late-stage growth capital, in markets like Europe where local growth funds are still fairly uncommon. Moreover, given the vehicles are already traded on public exchanges, SPACs are an attractive solution for firms looking to provide liquidity to their founders, employees and shareholders - with a faster, more certain & sometimes cheaper process than a traditional IPO.
“Sponsor economics” or the way in which sponsors are compensated for raising the money and investing in a target company, are at the heart of the debate over SPACs. Bill Ackman, the founder of Pershing Square, a famous New York hedge fund whose Tontine Holdings is the largest SPAC ever raised, once described SPACs as “a compensation scheme masquerading as an asset class.”
Default terms granted sponsors with “founder shares” once the investment was completed which amounted to 20% of the stock bought by the SPAC. The problem is that because these default terms aren’t tied to performance, there is sometimes an incentive to get a deal done at all costs within the investment period (2 years). This can lead to investing in bad companies, or at absurdly high prices. Compensation schemes have evolved however, and “staggered” payouts, distributed progressively based on the returns of the investment, now guarantee stronger alignment between sponsors & investors.
Why are SPACs a good product for the European ecosystem?
As I mentioned earlier, late-stage growth capital is still fairly rare locally in Europe. Traditional private equity firms like KKR or Blackstone have developed growth/tech focus funds, and many US funds like Coatue, Tiger or TPG are increasingly active in the region but there is still a lack of local players - SPACs offer a way to remedy this gap.
Liquidity is also scarce, which slows down the ecosystem’s velocity as a whole - a crucial aspect of its health, as Balthazar wrote recently. The European secondary market is still underdeveloped, tech-focused buyouts are rarer, few corporates have the balance sheet & know-how to pursue substantial acquisitions of technology startups and local institutional investors seem to be less receptive to IPOs.
SPAC sponsors can add a layer of trust for institutional investors, reassure founders about their long-term support and ultimately bring to the public markets founder-led companies for whom US-listings wouldn’t make much sense (like Doctolib or Babylon Health).
Are SPACs here to stay?
I think so, but (1) short term, the pace will continue to slow down as investors wait to see how currently listed SPACs play out, (2) mid-term, precipitated deals will tarnish the global perception of SPACs, which will (3) cause an increase in the average quality of sponsors and (4) prompt the emergence of “SPAC platforms” like the one built by Chamath Palihapitiya’s Social Capital.
I’d love to hear your views on SPACs & thoughts on where the trend is headed!
Want to be a part of our Family? Join our next batch, starting in September 💖