This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA
A SPAC is a so-called Special Purpose Acquisition Company. Although they have been around since the early 1990’s, they have become very popular in the past year.
In 2016 there was only 5 SPAC’s completed. In 2020 there were 65 completed and 13 transactions pending. In the first HALF of 2021 there were 61 completed and 153 transactions pending. Talk about growth! (1)
A SPAC is also known as a ‘blank-check company.’ A SPAC is formed by the founders; they raise capital through an Initial Public Offering (IPO). This company has no current business operations. Then the company goes out to merge with an existing private operating company. This is why they are called a blank-check company. Investors put funds in, not exactly knowing what the investment will be. They invest based on the reputation and experience of the founder. Depending on how the offering documents are written, a SPAC must generally complete a merger within 18-24 months of their IPO. For the existing private operating company, the route to becoming a public company in the past was an IPO. Shares are created, underwritten by investment bankers and sold to the Public. The SPAC is clearly a non-traditional IPO.
The Show Must Go On
There is no shortage of celebrities sponsoring SPAC’s these days. Here is a very short list of them;
- Shaquille O’Neal
- Alex Rodriguez
- Serena Williams
- Patrick Mahomes
- Jay-Z
- Paul Ryan
- Peter Thiel
- Richard Branson
And the list goes on and on. Are some of these folk’s astute business people? You bet. Exhibit A is Peter Thiel, one of the founders of PayPal (PYPL) and Palantier Technology (PLTR). He has a Roth IRA with over $5 billion in it. Yes, that’s with a B. Are they all seasoned business professionals? Not so much. Even the SEC issued a warning in early 2021 not to invest in a SPAC simply because there is a celebrity involved. (2)
Why the sudden surge in SPAC’s? Did someone mention money? I thought so. The sponsors of the SPAC get the so-called ‘promote.’ The ‘promote’ is that sponsors get their shares for nearly free. They own 20% of the company and the investors own 80%. The investors get to pay the fair market value for their shares. The sponsors acquire their 20% at a significant discount. For example, one sponsor of Gores Holdings IV, Inc. paid $25,000 for his shares. Once they closed the deal on the target company, these shares will be valued at $80 million. (3) That’s a pretty good rate of return, right? Additionally, they get to purchase warrants when the company closes on the purchase of the private operating company. These warrants give them the right to purchase additional shares if they would like.
Perhaps SPAC shouldn’t stand for Special Purpose Acquisition Company. Maybe it should stand for – Stop, Please Analyze (this) Company!
It is Déjà vu all Over Again
Yes, that’s a Yogi Berra quote. Aren’t all of his quotes just awesome? It is just a flashback to the 1980’s when Limited Partnerships were all the rage. Real Estate, Oil and Gas, Wind farms and Commercial Airplanes were just some of the industries that promoters targeted for Limited Partnership investments. The promoters of the Partnership would be the General Partners and they would manage the investment. The investors would put the money in and they would limit their liability by being Limited Partners. Well, that was the plan. The exchange was that the General Partners would bring experience and get the cash to invest. The Limited Partners would give the cash and get an experience. Boy did they ever. Just like the current SPAC’s, the Limited Partnerships were lightly regulated. Additionally, many of the General Partners and their marketing team would make the best timeshare salesman blush. They could really sell. Oh, and the fat brokerage commissions that were paid also offered a great incentive to sell these ‘investments.’
In addition to the exorbitant fees many of the promoters charged, most of these investments were illiquid and were tax motivated. On some deals you could get up to a $4 write off for every $1 invested. Who wouldn’t want that! Alas, even Congress saw this and did something about it (who knew) and passed the Tax Reform Act of 1986 limiting these deductions. This was the beginning of the end for these structures.
Locally, in the late 1980’s, we had the Colonial Realty scandal. They used the Limited Partnership structure and invested in real estate locally. When they were done, two of the promoters went to jail, one committed suicide and they left over 6,000 investors with losses of over $350 million. Ouch. (4)
Billionaire Hedge Fund Manager, William Ackman, CEO of Pershing Square Capital Management has done a 180 degree turn with his SPAC. In June of 2020 his SPAC, Pershing Square Tontine Holdings, LTD filed for a $4 Billion Blank-Check Company IPO. Now he is looking to pay back the investors in this SPAC. The deal with the proposed target company did not go through and he does not think he can get another deal done within the two-year window. Oh, yeah, there is also an investor lawsuit alleging the SPAC violated securities laws, never a good thing. In July, 2022 Mr. Ackman announced he was closing the SPAC because he was “unable to consummate a transaction that both meets our investment criteria and is executable.” (5)
Then there’s the lawsuit against the founder of Nikola (NKLA), Trevor Milton. In July, 2021 he was indicted on securities-fraud charges. This also, is not a good thing. U.S. prosecutors added a new wire fraud charge to him in June 2022. (6)
Additionally, the IPOX SPAC index is down 65% from its February, 2021 high. (7) Doesn’t all of this make you wonder, do you think there will be other lawsuits filed against other SPAC’s soon?
Lessons Learned
- Don’t invest just because there is a celebrity involved.
- Don’t invest where the outcome is generated from income tax savings.
- Don’t invest (too much) into illiquid investments you can’t control.
Warren Buffet, CEO of Berkshire Hathaway said, “Risk comes from not knowing what you are doing.” He also said, “Never invest in a business you cannot understand.”
Both seem appropriate here, right?
- CB INSIGHTS – July 14, 2021
- CNBC.com – March 10, 2021
- Bloomberg.com – September 24, 2020
- Hartford Courant – April 20, 2014
- CNN Business – July 12, 2022
- Reuters.com – June 22,2022
- Bloomberg.com – April 1, 2022
Any opinions are those of Thomas Scanlon and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results.