Mac Clouse

A controversial investment vehicle garners new regulatory—and Hollywood—interest.

A recent episode of HBO’s “Billions” series begins with its characters—the owner and employees of a large hedge fund—discussing something called a SPAC. Oddly, their dialogue excludes a definition, leaving us, as viewers, wondering, Huh? What’s a SPAC?

SPAC is an acronym for a special purpose acquisition corporation, an entity with no business operations. It is formed to raise funds through public equity markets to acquire or merge with an existing company. SPACs are also called “blank check companies” because they often require a significant leap of faith by investors.

This aspect of SPACs is attracting attention outside of Hollywood. In late March, the U.S. Securities and Exchange Commission (SEC) proposed new regulations aimed at improving investor protections by requiring SPACs to make financial disclosures like those of traditional initial public offerings (IPOs). The SEC’s proposal has supporters and, interestingly, detractors who believe the agency is overreaching.

To help unravel the SPAC mystery, the Daniels Newsroom recently spoke with Mac Clouse, a professor in the Reiman School of Finance at the Daniels College of Business. Clouse’s primary teaching areas are corporate finance, microfinance and investment banking. Twice a year, he takes students to New York for the Organized Walk Down Wall Street course.

Give us an overview of SPACs.

The general purpose of a SPAC is to take a company public, but to do so in a way other than the traditional IPO process. By forming a SPAC, an entity or individual—called a sponsor—is essentially announcing its intention to raise money and buy a company. In some cases, the sponsor has a certain company in mind. In other cases, it doesn’t have a specific target and is asking for investors’ trust in offering ownership of the company they will eventually buy. This is why SPACs are called “blank check companies.”

What are the benefits of forming a SPAC versus filing for an IPO?

SPACs provide the benefit of avoiding the IPO process, which can be lengthy and expensive, and has significantly more regulatory requirements. IPOs require multiple regulatory filings, including a registration statement and a preliminary prospectus. Also required are extensive financial, organizational and operational disclosures, as well as detailed individual information on a company’s leadership and board. Since a SPAC may be purchasing an unknown company sometime in the future, there are no financials to disclose, so it skips many of the steps.

What would be a good analogy for describing a SPAC?

SPACs revolve roughly around the idea of someone approaching you and saying, “I have an idea for a company I might want to buy. If you invest money with me, I’ll find the company and then you’ll be part of the deal.”

In this respect, SPACs are akin to private equity investments. Private equity funds raise capital from qualified investors for the purpose of acquiring companies in a particular area or industry. However, being a qualified investor means having minimum requirements for income and net worth, which the funds are required to verify. SPACs essentially do the same thing, but they have no income or net worth requirements. You are simply buying a stock on an exchange.

What are the advantages of SPACs for sponsors?

Primarily, it’s fewer regulations—not having to meet the same disclosure requirements as IPOs. But it also provides the advantage of a much larger investor pool. Private equity companies can only do business with qualified investors, financial institutions, endowments, insurance companies and other investment companies. SPACs don’t have those limitations and can do business with anyone, which provides access to larger amount of capital.

Doesn’t the concept of SPACs and less disclosure raise regulatory concerns?

Yes. And that’s the question around SPACs: Is it okay to have less disclosure?

One of the SEC’s goals is to protect investors and make sure people are not getting taken for a ride. That’s why there are so many disclosure requirements for IPOs. Before I buy stock in an IPO, I have its filings and access to a lot of information about the company. I can build a lot of knowledge of what I’m getting into.

With a SPAC, at least at the outset, you’re investing in the sponsor’s ability to come up with a good deal for you. There is little that can be done beyond checking into the sponsor’s background and prior success. That’s the focus of the proposed SEC rules. Since SPACs are being used as an alternative to conducting an IPO, they believe investors deserve the protections of traditional IPOs.  

What are the regulatory and legal requirements of SPACs?

Currently, the most prominent requirement of SPACs is that they have a two-year window to invest the funds they’ve raised. At that point, If the funds have not been used for an acquisition, they must be returned to investors.

Outside of that, SPACs have all the requirements of other publicly traded companies under the Securities Exchange Act of 1934, including annual and quarterly financial reporting, material event reporting and proxy statements. They’re also subject to regulation under the Sarbanes-Oxley and Dodd-Frank Acts.

How are SPACs priced if there are no underlying assets that can help determine a valuation?

IPOs are generally priced relative to a company’s financial performance and fundamentals, which suggest it’s worth a certain price per share. That would be its estimated market value divided by the number of shares being issued. Prevailing market factors also play a role, but a company’s financials typically justify its offering price. If it’s set too high, the IPO won’t be successful.

SPACs are much more arbitrary because there may not be an acquisition candidate with underlying financials that would suggest a price. Instead, you’re just paying dollars to get in. As soon as the acquisition is made, the share price will reflect the performance and fundamentals of the acquired company, which could be higher or lower than the price you paid. But if a SPAC does have an acquisition candidate, the price could be based on that company’s financials.

In some instances, SPACs may be priced to raise a certain amount of money for an acquisition, say $200 million. If the SPAC sponsor were to issue, for example, 10 million shares, the SPAC would be priced at $20 per share.

The concept of SPACs is not new. What has prompted renewed interest in them?

That’s right. SPACs go back to the early 2000s, but they weren’t heavily used from the outset. Even in 2013, there was only about $1.4 billion invested in SPACs, which isn’t much in market terms. By 2020, that number increased to $83 billion and last year doubled to about $161 billion.

The renewed interest in SPACs tracks roughly with the growth and popularity of private equity and the desire for regular investors to have access to those deals. SPACs essentially provide the opportunity for individual investors—who are, indeed, the primary investors in SPACs versus institutional investors—to have access to private equity-types of investments without having to be qualified investors.

Are SPACs considered to be riskier investments than other public company investments?

They are. First, there are no guarantees as to what you’re getting into. You don’t always know which company they’re going to invest in, so you don’t have any performance or financials benchmarks. You are initially investing in the ability of a sponsor to identify a good acquisition target.

Have SPACs been successful?

There have been success and failures.

Burger King went public when it was purchased by a SPAC and the company has grown quite nicely. DraftKings, the sports betting company, also went public through a SPAC acquisition and remains a viable company. On the other hand, Goldman Sachs formed a healthcare SPAC in 2007 that was not successful. So, even strong belief in a sponsor—even one as strong as Goldman Sachs—is not a guarantee of success.