People have every right to give away their money. But the government — specifically, the Securities and Exchange Commission — ought to ensure that they have at least an inkling of what they’re doing.
SPACs have become a wildly popular way for people to get a piece of up-and-coming private companies that are about to be taken public. These vehicles say, in effect: Pay us $10, and we’ll find an exciting target to invest in — and if you don’t like our choice, we’ll give you your money back with interest. We’ll even throw in some warrants, which allow you to buy more shares at a discount if things go well. Sounds tempting.
To be sure, the enterprise benefits many of those involved. SPAC sponsors, who range from celebrities to titans of finance, typically get a share for every four shares bought by investors. Target companies get a relatively simple path to public ownership. Hedge funds get an arbitrage opportunity: By flipping or redeeming the shares, for example, they can obtain warrants for free. Investment banks collect fees for handling both stages of the process — the SPAC’s initial share offering and the subsequent merger that turns the target into a public company.
There’s also a big regulatory advantage: The structure skirts disclosure rules. Because the SPAC is little more than a bank account, it needs only a cursory initial public offering prospectus. And because the merger isn’t a traditional IPO, certain constraints don’t apply: The target company, for example, can make claims about future growth and profitability that might otherwise risk litigation.
Yet for those who actually buy into SPACs to invest in promising companies — including retail investors who purchase the shares on the open market — the cost can be exorbitant. Once the sponsors, hedge funds and bankers have taken their cuts, the remaining SPAC shareholders are left with a diluted stake. One analysis of 47 deals consummated between January 2019 and June 2020, for example, estimated that by the time of the merger with the target company, the typical SPAC retained less than $7 per share (compared with the $10 per share its initial investors paid).
Not so tempting when you put it like that. Yet since the beginning of 2020, SPACs have raised more than $100 billion, according to data compiled by Bloomberg. Are the prospects of the target companies really so great — and the skills of the SPAC sponsors so valuable — that people are willing to take a hit of more than 30% just to participate? Or has the combination of opacity and financial engineering blinded them to the actual costs?
There’s a good way to find out: Give investors better information about what they’re getting into. To that end, the SEC should require SPACs to provide prospective shareholders with estimates of the dilution they will experience in different scenarios — akin to the management-fee disclosure required of investment funds. Regulators should also insist that target companies adhere to regular IPO disclosure rules.
If the SPAC magic still proves so attractive that investors knowingly keep piling in, fine. They’ve been warned. If not, perhaps more sponsors will adopt structures designed to produce better outcomes — as at least one large sponsor has done. Shed light, then let the market decide.