“It depends”, as my attorneys like to say.
Much has been said about SPACs – good and bad, especially during the pandemic when SPACs were at their peak – but like with almost any other financial endeavor, little has been said in the public sphere about their inner workings, which is crucial to understanding whether SPACs are making a comeback. I’ve been a consultant to at least a couple of SPAC entrepreneurs and have executed on +$300 million SPAC IPOs, so I have a deep understanding of what drives a successful capital raise in this industry – and what it takes to successfully close a business combination.
Launching a SPAC is easier than it looks. When you hear in the news that a sponsor raised x hundred million or even billion dollars, in a way they actually did – they had to come up with an investment thesis, prepare marketing material, put together a team, do a roadshow, etc. – but in reality, as far as raising capital goes, they had to come up with just enough money to cover a handful of expenses.
For one, they need to pay what we’ll call regulatory fees. They also need to pay an accounting firm to build their books and an auditing firm to audit them. Since this is a shell company that barely has any assets or liabilities, there is not much of a book to build or statements to audit, though. The sponsors also need to pay the exchange fees. They also need to pay for insurance for their directors & officers. And they also need to hire a law firm to help them draft the prospectus which is what the regulators ultimately need to give the sponsors the green light to trade in the public markets. They need to raise enough of what we’ll call working capital to cover the SPACs operating expenses once it goes public while they find a target for the business combination. And maybe a few other miscellaneous fees. All these mentioned add up to maybe a couple million dollars.
Then there are the underwriting fees, which is where the expenses start to add up a bit since they’re a percentage of the capital raised from public investors. This goes back to the roadshow and the hundred millions/billions mentioned earlier. The underwriters, an investment bank, have a network of institutional investors with very deep pockets and potentially an appetite for your SPAC. These underwriters set up a series of meetings, the roadshow, where you market your SPAC to these institutionals, and in exchange you pay the underwriters a fee for this service. Since these SPAC issuances are typically eight to ten figures, the underwriting fees can be quite hefty.
Finally, there is the over-funding of the trust account (the “Over-Funding”), which is one of the key structuring levers in SPACs. This is where one of the biggest factors of “it depends” comes into play. This is also where the infamous redemptions come into play. The Over-Funding is basically a percentage you are tacking on to the money the institutionals are giving you as an incentive for them to give you their money in the first place, so that if tomorrow you present to them a target they don’t like, they can still vote the transaction through and redeem their money with that added percentage on top — guaranteed.
In a zero-rate environment like the one we saw five years ago in the thick of the pandemic, if you as the sponsor offered an institutional 2.0% to 3.0%, that would be (and was) very attractive to them, as 2.0% is infinitely more than 0.0% – especially if it’s guaranteed over a 12- to 18-month horizon, which is the typical term for a SPAC – and especially since they also get the yield on the treasuries their money was put on while you looked for a target, plus the warrants which they get to keep either way so long as a business combination closes, etc. And for you as the sponsor, along with the other expenses mentioned before, you’d be looking at a low- to mid-seven figures range you’d actually have to raise. While still not insignificant, it’s also a fraction of the eight figures or more you’d end up raising in the public markets, and not that big of a hurdle if you are in an environment in which this is the hottest thing everyone wants to get in on. Also not that big of a risk either given the rich promotion you’d get for sponsoring this company.
Now that interest rates have gone up, sponsors on the other hand don’t have as much of an incentive to run a SPAC, as institutions would likely expect a larger spread on the Over-Funding – so more money the sponsors need to cough up and a smaller promotion.
With all this said, I want to go back to my question: are SPACs making a comeback? It depends, largely on which direction interest rates go and by how much. The Fed cut interest rates three times last year, so by that measure, we should start seeing more SPACs. On the other hand, their guidance has been a bit murkier recently, with some expecting that they might hold off on cutting rates for now and some even arguing that they might start increasing rates again. If the Fed adopts a more hawkish stance on rates going forward, then SPACs might not make a comeback anytime soon, so this also becomes a question of where we see inflation going over the next few years. More inflation, fewer SPACs; less inflation, more SPACs.
There are obviously other very important factors to consider when evaluating this question, such as the reputational damage SPACs sustained in the aftermath of the zero-rate days, or the assumption that there are enough companies out there that could be a good fit for a SPAC IPO, but hopefully this general framework provides high-level guidance on the future of these companies.