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Preventing SPACtacular disasters

The harsh reality is that less than 10 per cent of SPAC offerings since 2015 have produced positive returns, writes Royal Park Partners' John Clark.

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Rewind to a year ago, and conversations within the fintech industry had a strong focus on SPACs. 2020 saw over 80 billion raised via SPAC deals in the US alone. Its flexible deal structure and simplified process made them an attractive option for taking a company public, and many jumped on board.

Even in Q1 2021, many were focusing on ‘SPAC mania’ coming to the UK. As the wider conversation on keeping London’s fintech scene competitive in the global market continues, ensuring companies chose to list their SPAC deals in the UK has become essential. However, in the last few months, the tone towards SPACs has changed.

In July, the US DOJ brought criminal charges against Nikola founder, Trevor Milton for abuses to the SPAC process. The charges sent a warning shot to those banking on the SPAC boom. These concerns were confounded when data from Dow Jones revealed $75 billion has been wiped off the value of start-ups who went public via SPAC.

SPACs offer a number of advantages to companies, speed, control and for founders, a certainty of close, but the easy journey provided by SPACs has comes with many bumps. For both investors and companies looking to go public, a smooth ride is essential. Going forward, companies, SPACs and investors need to be watchful they’re doing what they can to prevent a SPAC disaster.

The investor view

Critics of the SPAC process often point to the large payouts received by SPAC sponsors as a warning sign. Sponsors are often given a large percentage of equity before a merger, meaning that there is a certain level of incentive to merge with any mediocre company in order to receive a large payday.

This large payday isn’t the only thing to worry investors. Compared to a traditional IPO, SPACs do not benefit from statutory safe harbour protections regarding forward-looking statements. Ideally, these statements allow a company to increase its value by talking about its future trajectory vs historical and current trading performance. However, in some instances, despite no demonstrable return, these forward-looking financials have acted as a smokescreen to hype up a SPAC target’s investment potential.

So where does this leave investors? Between forward-looking financials and a large payout incentive for sponsors, it looks like all the risk is on the investor side. The harsh reality is that less than 10 per cent of SPAC offerings since 2015 have produced positive returns. This is the lens investors should view these deals. They’re not a sure bet, and they’re not easy money. Investors need to protect themselves against losses by doing their due diligence, avoiding the hype, and taking a critical eye to forward-looking financials.

The SPAC side view

It’s not all investors. Companies and teams behind SPAC mergers need to be far more transparent and demonstrate to potential investors that they have performed their due diligence. It’s easy to talk about due diligence, but there are easy to spot red flags for both the SPAC, and the company being acquired.

One of the biggest warning signs, is when a SPAC sponsor refuses to give up their promote, which can create serious dilution to investors post-merger. Next, is the amount of cash the company and/or investors are taking off the table; the more equity that is rolled the better the optics in the market. Another way to gauge a SPAC team is by the warrant structure of the SPAC. Each warrant share should be on the lower end of a 1:1 and 1:5 ratio as this lowers dilution post-merger and signals the quality level of the SPAC team.

For SPACs looking to acquire a company, the rules are different. The key question for all SPACs should be ‘How will this deal float in the public market?’ In particular, can they gather enough PIPE investors to ensure SPAC shareholders vote on the deal? If the answer is yes, the market sentiment can be quite positive as can the proceeds for the SPAC. If the answer is no, the deal should be avoided or restructured so that investors aren’t left in the lurk.

Although SPACs still have to play by the rules, there are fewer restrictions than other vehicles going public. As a result, investors, companies and SPACs need to lead on protecting themselves. By doing this, all parties involved can ensure they continue to be a beneficial part of the financial services framework.

The views and opinions expressed are not necessarily those of AltFi.

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