How 4 letters destroyed billion$ | Preview

Disclaimer: Personal observations. Not professional advice of any kind.

At least 21 firms that went public by merging with special purpose acquisition companies, or SPACs, went bankrupt this year, according to data compiled by Bloomberg. Measured from their peak market capitalizations, the insolvencies bookend the loss of more than $46 billion of total equity value. – Bloomberg, December 2023

Many of the world’s largest companies are publicly-listed, meaning that their shares are traded openly on stock markets. Ownership of Apple, the most valuable company globally, is traded on the NASDAQ, a stock exchange in the US.

Companies must choose to ‘go public’. This means selling shares to the public to raise money, increase share liquidity and enhance popularity. Increased share liquidity means shareholders will be able to buy and sell the company’s shares more easily and at better prices.

However, there are also downsides to going public, like expensive regulatory processes to comply with, ownership dilution and increased public scrutiny. Multibillion-dollar corporations like Huawei and IKEA have remained privately-owned.

Most companies have gone public via an initial public offering (IPO), where investment bankers, lawyers and accountants are hired for various functions like valuing, marketing and selling the company’s shares, ensuring compliance with legal requirements, and verifying financial statements.

A purportedly cheaper and quicker alternative to an IPO is going public through a special purpose acquisition company (SPAC).

A SPAC starts off as a shell company. Shell companies are registered companies that usually hold no assets, or just cash–they don’t operate any actual business. Many SPAC shell companies are registered in Delaware, USA or the Cayman Islands due to favourable tax and regulatory treatments.

The reason why the SPAC is a shell company is because its ultimate purpose is to buy a target business, and take it public.

The individual or team that creates and manages the SPAC is called the sponsor. The sponsor pays the lawyers, accountants and bankers with their own money. This money is known as risk capital because if the SPAC fails, they lose their cash.

The sponsor will usually have mergers and acquisitions (M&A) expertise (e.g., buying and selling companies), which allows them to navigate the process of raising funds and buying the target company. Apart from technical expertise, the sponsor’s track record is important to attract investors.

Apart from the sponsor, SPAC teams are legally required to have at least three independent board directors, which the sponsor will usually source from their network. These directors will either have M&A/investing expertise and/or business expertise in the industry of the company the sponsor wants to purchase.

For example, the now-defunct SPAC financially backed by private equity firm KKR and fronted by Glenn Murphy, the former lululemon Chairman, aimed to ‘merge with an established consumer brand’. At one point, there were rumours they would merge with PetSmart, a chain of pet superstores.

Some SPACs have a clear target in mind. Many don’t.

Instead, these SPACs focus on trying to convince business owners in a specific industry (e.g., food and beverage) to go public via their SPAC. In these scenarios, it is beneficial to have business experts in a particular field to be more attractive to the businesses. For example, It will be easier to find and get a tech company to partner with your SPAC if one of your directors used to be a bigwig at Google.

Some larger SPACs may even have advisors, used by sponsors to build their brand to compete for investors’ money.

Advisors participate in the SPAC unofficially either by advising on specific elements, like new key hires before the company goes public, or just by having their name associated with the SPAC, for publicity reasons. An example of the latter is Shaq (the basketball star).

If you haven’t noticed already, a SPAC’s success is largely derived from the reputation of its team, because sponsors will be raising money on a promise of returns to investors, as opposed to regular company fundraising where investors buy a piece of a real business.