Investors in SPACs Need to Know the
Real Deal
If they still want to buy, so be it.
By Editorial Board
February 11, 2021, 1:00 PM GMT
They’re lucrative for Wall Street. For their investors, not
so much.
It’s hard to believe anyone would pay $10 for $7 worth of a company’s shares. Yet that’s roughly what
a lot of investors have been doing, by participating in a financial innovation
known as a special purpose acquisition company, or SPAC.
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.
To contact the senior editor responsible for Bloomberg
Opinion’s editorials: David Shipley at davidshipley@bloomberg.net .
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