Special Purpose Acquisition Companies (SPACs): Meaning and Recent Developments
A Special Purpose Acquisition Company (SPAC) or a Special Purpose Vehicle (SPV) is a company that is formed with the motive to invest in other companies. It generally listed on a stock exchange to raise huge funds which are used to acquire other companies which are usually smaller private companies. At the time of raising funds, the company, in which the SPAC or SPV would invest in, may or may not be known. Read more about the working of a SPAC in my previous article here.
Much is talked about the SPAC boom. If we break it down for simpler understanding, the story of SPAC boom may sound something like this:
- With rise in PE investments during COVID and a general notion that everything is cheap now, retail investors are keen to invest not just in listed companies but in private companies too.
- However, retail investors do not have sufficient funds and connects to buy private company’s equity.
- SPACs provide an indirect route to retail investors to invest in private companies.
- Hence, the demand for SPACs increases and more SPACs are listed on the stock exchanges. Renowned names in the industry back the SPAC to attract retail investors.
- However, SPACs now face a difficulty to invest because of limited availability (limited supply) of high potential private companies in the market.
- Desperate to perform, SPACs pay unreasonably high premium to buy even the not-so-high potential private companies in the market.
- Large-scale players like Bill Ackman abandon big deals (his plan to acquire $4bn stake in Universal Music) that had thousands of hopeful eyes.
- Many SPAC deals in jeopardy because of “investor no-show” (example: $24bn Lucid Motors SPAC deal).
- Reports of misleading investors (the renowned investors who backed the SPAC at the time of listing) raise concerns surrounding the SPAC boom.
SPACs in the past have been seen as an easy way for scams simply because of the complexity of its structure and compensation schemes. Despite this statistic, SPACs are still on a rise. It is still too early to predict anything about this boom. But the SPACs are required to follow a cautious approach in their investments simply to avoid massive or large-scale failures 5 or 10 years down the line. Buying companies at high premium is not a new concept, but are all the companies worth the premium? If yes, then we are going to witness some glorious times ahead of us. If not, it’s going to be a problem. Why? Although one good company in the SPAC portfolio may compensate for the failure of other companies, the concept of failure of so many companies itself is worrisome and may fuel panic activity such as a panic sell-off which may get disastrous for a SPAC who is barely managing to survive on one or a few companies’ performance. Also, are we prepared to avoid yet other scams stemming from SPACs in the future? Multiple questions to think about!
As finance enthusiasts or retail investors, we must be aware and cautious about this SPAC boom as it may have trickle-down effect on the entire global economy leading to another crisis if not managed well now.
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