How SPACs Destroy Investor Wealth

Special-purpose acquisition companies (SPACs) should be illegal, according to Jeremy Grantham. Moreover, he says those structures are so speculative that investor enthusiasm for them is symptomatic of a pending collapse in equity prices.

Aside from Grantham, few observers have questioned the economic viability of SPACs, which have accounted for approximately half of the IPO volume in 2020.

That is why I was impressed when I read a recent study, A Sober Look at SPACs, by Michael Klausner of Stanford Law School and Michael Ohlrogge of the New York University School of Law. I also spoke with Ohlrogge last week to prepare this article.

Klausner and Ohlrogge exposed the central flaw in the SPAC structure. They also demonstrated that the performance of SPACs in the public markets has been unimpressive and that their purported benefits have been overstated or are nonexistent.

I will review their research. Because of the complexity of the SPAC structure, I will use an analogy to illustrate the destructive power they inflict on investors’ wealth.

I will conclude with an example of a properly structured SPAC that resolves the problems in the typical structure.

I will reference a recent SPAC whose target investments intersect with the financial planning profession (Lefteris, which targets “fin tech” investments) and those SPACs that target the acquisition of advisory practices.

What is a SPAC?

A SPAC is a corporation that raises money through a public offering to pursue a future acquisition. They are also known as “blank-check” companies because they raise funds before they identify the company they intend to acquire. A SPAC is led by a sponsor, and it has a board of directors and a management structure. Typically, the sponsor, board and management have worked together before in the industry they intend to target for an acquisition.

The IPO investors purchase shares at a standard price of $10, which also gives them rights and/or warrants that are usually exercisable at $11.50 per share. The sponsor receives 20% the post-IPO equity at essentially no cost. This is known as the “promote.” The sponsor typically also provides funding to the entity through the purchase of warrants exercisable at $11.50/share, often at a price of $1.00 to $1.50/share, which may approximate their fair market value.