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The Great SPAC Scam: SPACs a Great Deal for Sponsors, but Not Others

108 points by rexreed 5y ago

Animats 5y ago
Right. You pay 20% of the company's value to avoid some legal fees and SEC scrutiny. And then there's an average net loss for investors.
- rexreed 5y ago
  What am I missing? Other than the sponsors, what are people getting out of it? Going "public" and selling shares on the public market without having to disclose anything first? This feels so bubble.
  - m_ke 5y ago
    Gives late stage VCs a way to dump their fail whales on the public market and cash out before they fail.
  - pge 5y ago
    In some cases, the advantage of a SPAC is that it has a senior management team that will take over the acquired company (not unlike a PE deal). For some investors, this makes the target company more attractive than it would have been going public on its own without a management team.
  - c0balt 5y ago
  - fennecfoxen 5y ago
    In the typical structure of a blank-check SPAC, if you don't like the company they pick to acquire, you're supposed to be able to get your money back before the deal closes. I'd guess that the option isn't exercised all that often in practice, though.
  - lmm 5y ago
    It doesn't seem much worse than buying on the first day of an IPO, when the well-connected investors have already bought their shares at the IPO price and enjoyed a "pop" to the price they're selling to you at.
  - LatteLazy 5y ago
    Like so much of finance, it's about risk. If you're a company owner: If you take your company public in an IPO, you have no idea what people will pay. With a SPAC you can discuss and negotiate and fix a price. That might be 100% shares or 100% cash. But you know you will end up with X percent of the shares and Y dollars once the deal is done so you can manage your risk. If you're the SPAC, you are taking more risk. But you think you're getting the company cheaper than the market will value it. So you'll profit from the first day of trading. Public companies (in theory) are better run and have easier access to capital. So the act of going public should increase company value and that adds motivation to both sides. Using a sponsorship deal and charging investors for it is just advertising really. If the SPAC wastes money on it, that's the investors problem.
cl42 5y ago
For those investing in public equities: I personally believe some SPACs are definitely worth it in the long run. SPACs suffering on the public markets are a great opportunity to make long-term investments if you are very, very careful and wait a bit longer than most to jump into the right companies. From my experience, the strategic part is to wait until warrants expire. Most SPACs have very, very positive investor presentations that assume they will 10x or 100x in value over the next 5-10 years... Typically, SPAC sponsors get warrants to buy additional shares of the companies at a significantly lower price than those buying on public markets post merger... Knowing nothing else, you'll want to wait until these warrants expire as that's when things should stabilize. ... at least that's my strategy. Curious what others are doing.
- chews 5y ago
  Your warrant coverage thoughts are very on point, spacs if structured properly are very clever but the lack of transparency on warrants and notes is a problem for the asset class.
  - cl42 5y ago
    ...and what's also interesting is how little innovation there is in SPACs. Tells you a lot about how stale/uninnovative the entire finance industry is. Everyone has similar warrants, similar share structures, and even the $10-pre-merger price. AFAIK, there's no reason for all these consistencies beyond copying and pasting the original docs. Anyway, I am tracking a lot of SPACs and waiting about 1-2 years before diving into some of the more promising ones. We'll see how it goes!
- Fordec 5y ago
  There were a few companies that I was waiting for to go public that ended up going the SPAC route around the time I didn't have extra capital to deploy at the time they went public. Now, I'm just glad I didn't. While I still intend to invest once the knife that is their valuations stops falling and starts to rebound on fundamentals, for now they still have a bit more to lose in their valuation to be in line with the rest of the market on your standard metrics eg. P/E. I'm just not gutsy enough to short the stocks until then. One thing I am now on the look out for is for short-term short squeezes before initial lockup periods expire.
Glyptodon 5y ago
Why isn't there a race to the bottom to shrink the sponsor cut from 20% to 5% or something? If being the sponsor is as protected and lucrative as suggested surely plenty of people would be willing to sponsor for less of a cut, which in turn would make the deal less of a bad deal for others?
- b9a2cab5 5y ago
  There is an abundance of capital chasing ever diminishing returns. I think it's at least somewhat likely there is little price elasticity on the sponsor cut and almost certainly a lot of retail investors who are irrational investing in these SPACs.
- lmm 5y ago
  Every deal is different, 80% of a share in a good company is worth a lot more than 95% of a share in a bad company. If it's an extremely marginal case then the sponsor shrinking their cut might be the difference between the retail investors pulling out or not, so in that case you might see it happen, but most of the time negotiating the acquisition and the PiPE is the hard part, and if you succeed at that then the deal is going to happen.
  - rexreed 5y ago
    What defines "good" and "bad"? From the market perspective "good" would be defined by its medium to long-term return to the investor that holds for a long enough period to cover the short-term loss. Whereas "bad" would be an acquisition that has declining value over time, even if its short-term performance is acceptable.
    - lmm 5y ago
      I mean just in terms of value when the merger actually closes, the SPAC equivalent of the IPO price.
codezero 5y ago
I’ve been worried the potential 2022 IPO of Quora will be a SPAC.
- boeingUH60 5y ago
  That site has unfortunately gone downhill. It used to be that Quora had real world experts to answer almost any question with excellent detail. In fact, scrolling through Quora looking at different answers on different topics was a major pastime for me, and I think many others. However, Quora massively opened their user base (I suspect to justify VC funding) and the quality of answers suffered. Now, I dare not open my feed because it's full of political vitriol on a large scale.
  - jgilias 5y ago
    Yeah, for me Quora really went downhill as well. I was a regular reader, also a contributor for things I knew about. Even went to a local meetup once. At some point I realized that my feed just features opinions from Quora celebrities who are actually just some random people on the internet when you think about it. So I just stopped using it.
the_watcher 5y ago
Byrne Hobart noted recently that SPACs are interesting for spinouts, which matches their history as a vehicle designed to take something public that would have trouble in a traditional IPO process.
stillicidious 5y ago
Thorough study from a year ago for interested folk: https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/ https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-s...
- kennethh 5y ago
  Very interesting read, SPACs seems like a very bad deal in most cases. Also found this article which tells much the same story but with better graphics: https://financescp.net/2020/12/18/spac-mania-2020-no-free-lunch-at-wall-street/ https://financescp.net/2020/12/18/spac-mania-2020-no-free-lu...
vmception 5y ago
From my adventures in finance, I notice that nobody really understand what the experience is like for the issuer. All the perspectives are about the secondary market. SPACs: great for issuers Crypto: great for issuers NFTs: great for issuers IPOs: great for issuers Direct Listings: decent for issuers Bonds: AMAZING for issuers Be an issuer. Concepts become a lot more obvious alot faster when you think "what do the issuers get out of this" and dive and dig to find out the answer. If you're reading Matt Levine's digestible breakdown, it's too late.
- rexreed 5y ago
  Can you clarify what you mean by issuers in each of the examples above? And how exactly one becomes an issuer if this is even a practical matter?
  - vmception 5y ago
    The person/group that creates the project, and originally sells the asset. One complication would be that in a SPAC that would be the SPAC sponsor, as well as the target company's founders or preferred investors. It being a practical matter depends on how much capital you have.
    - rexreed 5y ago
      So what's to stop a VC firm from juicing the returns they provide their own limited partners by simply standing up a series of SPACs which they in turn use IPO proceeds to acquire some of their own poorly performing companies that couldn't get acquired or go public on their own, while also enjoying the 20% "promote" that sponsors get?
      - vmception 5y ago
        Nothing. Everything is a contract, you just need to get someone to agree to it. The regulator just makes sure information is disclosed, the investor is the one that has to be discerning. In prior market conditions, people were not agreeing to SPAC contracts. In these market conditions they are.
fisherjeff 5y ago
I mean, I don’t think this is particularly worse than any other deal. Investment bankers, institutional investors, etc., effectively take a cut of every other deal so why should a SPAC be any different? It’s a big cut, relatively speaking, but there’s also potentially a good amount of risk. And although lately it seems like there hasn’t been much risk in SPACs and the sponsors have been doing very well, investment bankers have been doing very well too!
endymi0n 5y ago
Super dumb question: As far as I see, SPACs are usually smaller than the companies they acquire. What keeps a company from just paying out some profit to the founders, them setting up a SPAC themselves from that money, IPO it and then reverse merging the company? Is it time to market? Conflict of interest? Are there limitations to the size difference? I'm just thinking that since the "vehicle" seems to be useful, shouldn't there a race to the bottom be going on in terms of sponsor margins? As in essence, the value any of them provide seems to be pretty replaceable to me. Or what else do they bring to the table than an empty hull?
- boeingUH60 5y ago
  I think there'll be major conflict of interest if a founder does that. The closest thing I've observed to that scenario is Group Nine, a digital media company, which launched a SPAC that it planned to merge with another media company, then merge with itself. Group Nine, however, recently merged itself (minus its SPAC) with a rival, Vox Media, and hasn't talked about the plans for the SPAC henceforth, but it's suspected that the combined Group Nine-Vox Media will merge with it. https://techcrunch.com/2021/01/15/group-nines-spac-goes-public/ https://techcrunch.com/2021/01/15/group-nines-spac-goes-publ... https://www.vox.com/recode/2021/12/13/22833341/vox-media-group-nine-deal-explained https://www.vox.com/recode/2021/12/13/22833341/vox-media-gro...
- robbiep 5y ago
  It’s not legal to have a target acquisition in mind when you start a SPAC
  - enduroman 5y ago
    Tell that to Jay Sidhu and BankMobile/bmtx. Started his SPAC when the Flagship acquisition of BankMobile was failing. After never being able to dump the asset from Customers Bank, his son's SPAC purchased BankMobile.
    - boeingUH60 5y ago
      Or Patrick Orlando and Donald Trump, who reportedly discussed their SPAC merger months before Orlando sold shares to investors. But then, I think enforcing this no-contact law will be hard, i.e. difficult to prove unless regulators obtain explicit proof of a conversation between interested parties. https://www.nytimes.com/2021/12/07/business/dealbook/trump-media-spac.html https://www.nytimes.com/2021/12/07/business/dealbook/trump-m...
LatteLazy 5y ago
I'm confused. This only applies to SPACs with a sponsor, and even then only when the sponsor takes a bigger cut than the profit from buying the firm and taking it public. And even then, it seems like a stretch to call it a scam: if you buy an investment product because it sponsors someone you like, you're gonna pay accordingly. Nike or Coke Cola aren't a scam because they cost more and spend the money sponsoring celebs. Neither are these. Are they worse value for money? Yes. But that's pretty obvious and people don't just look at cost/ingredients when they make their purchasing decisions. That's their right not a scam.
- rexreed 5y ago
  Which SPACs don't have a sponsor? In which SPACs do non-financial sponsors take less than 20% of the total company value? Would you invest in a company that has no defined product, service, or business model, and puts all their eggs into the basket of a private company that you might not have ever heard of, in a business relationship between the SPAC and acquired company that is never fully disclosed in which the share price is almost assured to drop at least 1/3 the day after trading and in which there is no long term evidence of value creation? These companies aren't like Coca-Cola that started as a small business and then grew, delivering value along the way. There is no way for an investor to "look at the ingredients" of a SPAC at the time they invest in the SPAC before the merger.

108 points by rexreed 5y ago

Right. You pay 20% of the company's value to avoid some legal fees and SEC scrutiny. And then there's an average net loss for investors.

rexreed 5y ago
What am I missing? Other than the sponsors, what are people getting out of it? Going "public" and selling shares on the public market without having to disclose anything first? This feels so bubble.
- m_ke 5y ago
  Gives late stage VCs a way to dump their fail whales on the public market and cash out before they fail.
- pge 5y ago
  In some cases, the advantage of a SPAC is that it has a senior management team that will take over the acquired company (not unlike a PE deal). For some investors, this makes the target company more attractive than it would have been going public on its own without a management team.
- c0balt 5y ago
- fennecfoxen 5y ago
  In the typical structure of a blank-check SPAC, if you don't like the company they pick to acquire, you're supposed to be able to get your money back before the deal closes. I'd guess that the option isn't exercised all that often in practice, though.
- lmm 5y ago
  It doesn't seem much worse than buying on the first day of an IPO, when the well-connected investors have already bought their shares at the IPO price and enjoyed a "pop" to the price they're selling to you at.
- LatteLazy 5y ago
  Like so much of finance, it's about risk. If you're a company owner: If you take your company public in an IPO, you have no idea what people will pay. With a SPAC you can discuss and negotiate and fix a price. That might be 100% shares or 100% cash. But you know you will end up with X percent of the shares and Y dollars once the deal is done so you can manage your risk. If you're the SPAC, you are taking more risk. But you think you're getting the company cheaper than the market will value it. So you'll profit from the first day of trading. Public companies (in theory) are better run and have easier access to capital. So the act of going public should increase company value and that adds motivation to both sides. Using a sponsorship deal and charging investors for it is just advertising really. If the SPAC wastes money on it, that's the investors problem.

cl42 5y ago

For those investing in public equities: I personally believe some SPACs are definitely worth it in the long run. SPACs suffering on the public markets are a great opportunity to make long-term investments if you are very, very careful and wait a bit longer than most to jump into the right companies. From my experience, the strategic part is to wait until warrants expire. Most SPACs have very, very positive investor presentations that assume they will 10x or 100x in value over the next 5-10 years... Typically, SPAC sponsors get warrants to buy additional shares of the companies at a significantly lower price than those buying on public markets post merger... Knowing nothing else, you'll want to wait until these warrants expire as that's when things should stabilize. ... at least that's my strategy. Curious what others are doing.

chews 5y ago
Your warrant coverage thoughts are very on point, spacs if structured properly are very clever but the lack of transparency on warrants and notes is a problem for the asset class.
- cl42 5y ago
  ...and what's also interesting is how little innovation there is in SPACs. Tells you a lot about how stale/uninnovative the entire finance industry is. Everyone has similar warrants, similar share structures, and even the $10-pre-merger price. AFAIK, there's no reason for all these consistencies beyond copying and pasting the original docs. Anyway, I am tracking a lot of SPACs and waiting about 1-2 years before diving into some of the more promising ones. We'll see how it goes!
Fordec 5y ago
There were a few companies that I was waiting for to go public that ended up going the SPAC route around the time I didn't have extra capital to deploy at the time they went public. Now, I'm just glad I didn't. While I still intend to invest once the knife that is their valuations stops falling and starts to rebound on fundamentals, for now they still have a bit more to lose in their valuation to be in line with the rest of the market on your standard metrics eg. P/E. I'm just not gutsy enough to short the stocks until then. One thing I am now on the look out for is for short-term short squeezes before initial lockup periods expire.

Glyptodon 5y ago

Why isn't there a race to the bottom to shrink the sponsor cut from 20% to 5% or something? If being the sponsor is as protected and lucrative as suggested surely plenty of people would be willing to sponsor for less of a cut, which in turn would make the deal less of a bad deal for others?

b9a2cab5 5y ago
There is an abundance of capital chasing ever diminishing returns. I think it's at least somewhat likely there is little price elasticity on the sponsor cut and almost certainly a lot of retail investors who are irrational investing in these SPACs.
lmm 5y ago
Every deal is different, 80% of a share in a good company is worth a lot more than 95% of a share in a bad company. If it's an extremely marginal case then the sponsor shrinking their cut might be the difference between the retail investors pulling out or not, so in that case you might see it happen, but most of the time negotiating the acquisition and the PiPE is the hard part, and if you succeed at that then the deal is going to happen.
- rexreed 5y ago
  What defines "good" and "bad"? From the market perspective "good" would be defined by its medium to long-term return to the investor that holds for a long enough period to cover the short-term loss. Whereas "bad" would be an acquisition that has declining value over time, even if its short-term performance is acceptable.
  - lmm 5y ago
    I mean just in terms of value when the merger actually closes, the SPAC equivalent of the IPO price.

codezero 5y ago

I’ve been worried the potential 2022 IPO of Quora will be a SPAC.

boeingUH60 5y ago
That site has unfortunately gone downhill. It used to be that Quora had real world experts to answer almost any question with excellent detail. In fact, scrolling through Quora looking at different answers on different topics was a major pastime for me, and I think many others. However, Quora massively opened their user base (I suspect to justify VC funding) and the quality of answers suffered. Now, I dare not open my feed because it's full of political vitriol on a large scale.
- jgilias 5y ago
  Yeah, for me Quora really went downhill as well. I was a regular reader, also a contributor for things I knew about. Even went to a local meetup once. At some point I realized that my feed just features opinions from Quora celebrities who are actually just some random people on the internet when you think about it. So I just stopped using it.

the_watcher 5y ago

Byrne Hobart noted recently that SPACs are interesting for spinouts, which matches their history as a vehicle designed to take something public that would have trouble in a traditional IPO process.

stillicidious 5y ago

Thorough study from a year ago for interested folk: https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/ https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-s...

kennethh 5y ago
Very interesting read, SPACs seems like a very bad deal in most cases. Also found this article which tells much the same story but with better graphics: https://financescp.net/2020/12/18/spac-mania-2020-no-free-lunch-at-wall-street/ https://financescp.net/2020/12/18/spac-mania-2020-no-free-lu...

vmception 5y ago

From my adventures in finance, I notice that nobody really understand what the experience is like for the issuer. All the perspectives are about the secondary market. SPACs: great for issuers Crypto: great for issuers NFTs: great for issuers IPOs: great for issuers Direct Listings: decent for issuers Bonds: AMAZING for issuers Be an issuer. Concepts become a lot more obvious alot faster when you think "what do the issuers get out of this" and dive and dig to find out the answer. If you're reading Matt Levine's digestible breakdown, it's too late.

rexreed 5y ago
Can you clarify what you mean by issuers in each of the examples above? And how exactly one becomes an issuer if this is even a practical matter?
- vmception 5y ago
  The person/group that creates the project, and originally sells the asset. One complication would be that in a SPAC that would be the SPAC sponsor, as well as the target company's founders or preferred investors. It being a practical matter depends on how much capital you have.
  - rexreed 5y ago
    So what's to stop a VC firm from juicing the returns they provide their own limited partners by simply standing up a series of SPACs which they in turn use IPO proceeds to acquire some of their own poorly performing companies that couldn't get acquired or go public on their own, while also enjoying the 20% "promote" that sponsors get?
    - vmception 5y ago
      Nothing. Everything is a contract, you just need to get someone to agree to it. The regulator just makes sure information is disclosed, the investor is the one that has to be discerning. In prior market conditions, people were not agreeing to SPAC contracts. In these market conditions they are.

fisherjeff 5y ago

I mean, I don’t think this is particularly worse than any other deal. Investment bankers, institutional investors, etc., effectively take a cut of every other deal so why should a SPAC be any different? It’s a big cut, relatively speaking, but there’s also potentially a good amount of risk. And although lately it seems like there hasn’t been much risk in SPACs and the sponsors have been doing very well, investment bankers have been doing very well too!

endymi0n 5y ago

Super dumb question: As far as I see, SPACs are usually smaller than the companies they acquire. What keeps a company from just paying out some profit to the founders, them setting up a SPAC themselves from that money, IPO it and then reverse merging the company? Is it time to market? Conflict of interest? Are there limitations to the size difference? I'm just thinking that since the "vehicle" seems to be useful, shouldn't there a race to the bottom be going on in terms of sponsor margins? As in essence, the value any of them provide seems to be pretty replaceable to me. Or what else do they bring to the table than an empty hull?

boeingUH60 5y ago
I think there'll be major conflict of interest if a founder does that. The closest thing I've observed to that scenario is Group Nine, a digital media company, which launched a SPAC that it planned to merge with another media company, then merge with itself. Group Nine, however, recently merged itself (minus its SPAC) with a rival, Vox Media, and hasn't talked about the plans for the SPAC henceforth, but it's suspected that the combined Group Nine-Vox Media will merge with it. https://techcrunch.com/2021/01/15/group-nines-spac-goes-public/ https://techcrunch.com/2021/01/15/group-nines-spac-goes-publ... https://www.vox.com/recode/2021/12/13/22833341/vox-media-group-nine-deal-explained https://www.vox.com/recode/2021/12/13/22833341/vox-media-gro...
robbiep 5y ago
It’s not legal to have a target acquisition in mind when you start a SPAC
- enduroman 5y ago
  Tell that to Jay Sidhu and BankMobile/bmtx. Started his SPAC when the Flagship acquisition of BankMobile was failing. After never being able to dump the asset from Customers Bank, his son's SPAC purchased BankMobile.
  - boeingUH60 5y ago
    Or Patrick Orlando and Donald Trump, who reportedly discussed their SPAC merger months before Orlando sold shares to investors. But then, I think enforcing this no-contact law will be hard, i.e. difficult to prove unless regulators obtain explicit proof of a conversation between interested parties. https://www.nytimes.com/2021/12/07/business/dealbook/trump-media-spac.html https://www.nytimes.com/2021/12/07/business/dealbook/trump-m...

LatteLazy 5y ago

I'm confused. This only applies to SPACs with a sponsor, and even then only when the sponsor takes a bigger cut than the profit from buying the firm and taking it public. And even then, it seems like a stretch to call it a scam: if you buy an investment product because it sponsors someone you like, you're gonna pay accordingly. Nike or Coke Cola aren't a scam because they cost more and spend the money sponsoring celebs. Neither are these. Are they worse value for money? Yes. But that's pretty obvious and people don't just look at cost/ingredients when they make their purchasing decisions. That's their right not a scam.

rexreed 5y ago
Which SPACs don't have a sponsor? In which SPACs do non-financial sponsors take less than 20% of the total company value? Would you invest in a company that has no defined product, service, or business model, and puts all their eggs into the basket of a private company that you might not have ever heard of, in a business relationship between the SPAC and acquired company that is never fully disclosed in which the share price is almost assured to drop at least 1/3 the day after trading and in which there is no long term evidence of value creation? These companies aren't like Coca-Cola that started as a small business and then grew, delivering value along the way. There is no way for an investor to "look at the ingredients" of a SPAC at the time they invest in the SPAC before the merger.