The SPAC mania bubble may have burst under pressure from the Securities and Exchange Commission, which issued new guidance that could classify SPAC — special purpose acquisition company — warrants as liabilities instead of equity instruments.
Sometimes called “blank-check companies,” SPACs go public as cash shells with sponsors later identifying an operating business to merge with. A “celebrity” or another notable person aka sponsor, raises capital by taking the SPAC public in an IPO. This SPAC then uses proceeds from the IPO and a large stock issuance to acquire a private company, making it public. The private company ends up controlling the entire entity, according to Brian DeChesare, the founder of Mergers & Inquisitions and Breaking Into Wall Street — companies that help people break into investment banking and private equity.
SPACs are alternatives to traditional IPOs and can be faster, but they’re less transparent and unlike IPOs, the sponsor gets a 20 percent stake. And there’s much less regulatory scrutiny, DeChesare said in a March 1 YouTube video. The “sponsor” invests almost nothing in exchange for this 20 percent and could walk away with tens of millions of dollars even if the SPAC performs badly, while normal investors lose everything.
In April, there have been 10 SPAC deals so far, according to data from SPAC Research, CNBC reported. In March 2021, by comparison, there were more than 100 new SPAC deals for a record-breaking first quarter.
The slowdown came after the SEC issued accounting guidance that would classify SPAC warrants as liabilities instead of equity instruments. If it becomes law, pending and existing SPACs will have to recalculate their financials in 10-Ks and 10-Qs for the value of warrants each quarter, and that will be expensive.
“This is going to cost these companies a lot of money to evaluate and value those warrants each quarter rather than just at the start of the SPAC,” said Anthony DeCandido, partner at RSM LLP, in a CNBC interview. “Many of these groups lack the sophistication internally to do this themselves.”
Along with proposed new SEC regulations, retail investors may be having second thoughts about SPACs. Retail SPAC buying slowed from $120 million per week net purchase at the beginning of 2021 to single digits in April, according to Bank of America client flows.
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“With an IPO, you know what you’re getting, and you have the company’s audited financial statements, risk factors, and existing shareholder information. SPACs are a sign of a bubble ripe for a correction,” DeChesare said.
SPACs have not performed well by and large. The ones that launched in 2019 and 2020 have mean returns of negative 12.3 percent and negative 34.9 percent over 6 and 12 months following merger announcements.
“If you want to get rich with SPACs, you should be a celebrity, or at least have a large following on Instagram,” DeChesare said. “A more accurate abbreviation for SPAC is SCAM … that’s what they are to most normal investors and normal companies.”