Managing the potential risks of SPACs

Businesses must carefully consider the implications of going public, market veteran says

Managing the potential risks of SPACs

Risk Management News

By Gabriel Olano

Despite being around for decades, special purpose acquisition companies (SPACs) have recently gained significant popularity, not just in North America but globally. Over US$1 billion has been raised this year via six SPACs in emerging markets, including China and Israel.

A SPAC, also known as a blank check company, does not operate commercially and exists solely to raise capital through an initial public offering and acquiring an existing company, which will get the target entity listed on the stock market.

“The purpose of a SPAC is to facilitate a younger company going public with more certainty about timing and predictability of price and give them access to resources they wouldn’t have otherwise,” said Mark E. Watson III (pictured above), founder of Aquila Capital Partners and former CEO of Argo Insurance. “They help these companies go public while bypassing the time and expense of an IPO process, including filing an S-1 registration statement with the SEC. The SPAC helps the company enter the IPO process and access capital markets, even though they may not be quite as mature as a more seasoned publicly traded company. In theory, those who evaluate and select which companies will go public via SPAC believe they will be a good fit for the public markets. In a sense, a SPAC validates these companies.”

One major benefit of a SPAC, Watson said, is that it allows companies to go public faster. Traditional IPOs usually take around 18 months, but using a SPAC can help companies go public in as short as three to six months.

However, a SPAC is not a magic ticket to getting listed.

The SPAC method saw a surge in popularity in 2020, with a total of US$87.9 billion raised as of March, but the pace slowed in subsequent months.

“Actually, it looked more like it came to a screeching halt,” Watson said. “This is a viable go-to-market strategy that should not be ignored—but it should be approached with careful consideration.”

What are the main risks of SPACs?

According to Watson, the main risk of using a SPAC is not meeting investor expectations. Regulatory scrutiny also had a negative effect on interest.

“There was a huge investor appetite when SPACs made a wave at the end of 2020 and into 2021 – but we’ve seen this appetite wane in recent months,” Watson said. “In the spring of this year, the SEC started reviewing more SPACs, cooling investor interest.”

For the first quarter of 2021, an average of 89 SPACs was listed each month, according to data from Bespoke Investment Group. Since April, however, the monthly average has dropped to around 10.

“Investors are more hesitant now that the market bubble has popped,” Watson said. “Knowing the founders or managers of a company and knowing their growth strategy is an important first step in investing in the right company. One of the challenges companies have when thinking about going public is that they are not used to reporting. They have to change their framework and think more about the present versus the future. This can be challenging for investors looking for a good deal.”

In order to manage these risks, Watson said companies that wish to get listed must correctly evaluate if they are ready to report their financial results publicly.

“Identifying their level of readiness is a huge first step in managing any potential risks,” he said. “They also must consider the responsibilities involved with being a public company. Many private companies simply aren’t ready to be public registrants. There is an increased level of financial reporting that must be adhered to, including audited financial statements, as well as a correct estimation of the market they’re entering into and where that market is headed.”

According to Watson, there is an excess of supply in the SPAC market – there are more SPACs than there are companies that would use a SPAC to go public. Many businesses can either get listed on their own or are not mature enough to go public.

“While we will see many companies go public this year (the latest estimate is more than 100), they don't necessarily need to go public via SPAC and are more likely to take the traditional IPO route, which narrows the field even more for SPACs,” Watson said. “The SPAC sponsors are caught between a rock and a hard place—the companies that they could take public are capable of doing it on their own because the IPO window is open right now, or they are too nascent and don’t have the financial reporting capability to go public, or maybe their business model is not far enough along to provide public equity investors with some level of predictability.”

Thus, business leaders must carefully consider which listing route is the right one for their company, taking into account the company’s overall readiness.

“While SPACs can present a good opportunity to raise capital and create liquidity for sellers, this doesn’t mean they are the correct fit for everyone, and as the market evolves, the pace at which these mergers occur will continue slowing down in the near term,” Watson said.

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