February 25, 2021

SPACs: The More Costly Route to the Public Market?

Earlier this week, electric vehicle startup Lucid Motors agreed to go public through a $24 billion SPAC merger.  The deal is one of the largest SPAC transactions ever, and is another example of the ongoing SPAC boom.  But is a SPAC deal the best way for a unicorn to access the public markets?  A recent study suggests that, at least from a cost perspective, the answer is usually “no.”

The study found that found SPAC mergers are a much more costly route to the public market than a traditional IPO. This Andrew Abramowitz blog summarizes the study’s conclusions. Here’s an excerpt:

The investment community has been abuzz recently about an academic paper, summarized here, that found the costs of going public via SPAC merger to be much higher on average than doing so via a traditional IPO. For my non-finance professionals out there, the most concise way I can put it is that the typical SPAC structure is designed to favor the initial sponsors and initial investors, over investors who buy shares in the open market after the SPAC’s IPO and the target company shareholders. This is because of two concepts present in most SPACs but not in most other contexts: the promote and warrants.

A promote is a form of compensation for the management team that forms the SPAC, brings it public and finds an acquisition target. Generally, this sponsor team gets, for nominal cost, 20% of the post-IPO shares of the company. Ultimately, these shares dilute the ownership of the SPAC investors and of the target company’s shareholders, post-merger, in a way that doesn’t occur in a traditional IPO.

Additionally, in most SPACs, the IPO is done as a sale of units, comprised of regular shares and warrants to purchase additional shares. The warrants (which are like stock options for those unfamiliar with the term) have an exercise price somewhat higher than the IPO price. The warrants are essentially a free add-on for the SPAC IPO investor. They can elect to have the company redeem their shares in advance of the merger and get their invested money back, but they still can keep the warrant and cash in if the stock pops.

Andy points out that the issuance of shares upon exercise of the warrants dilutes other holders in a way that wouldn’t happen in an IPO.  In contrast to the sponsor’s promote, an exercise of the warrant for cash would provide additional funding to the company, but funding provided by the exercise of an in-the-money warrant would come at a deeply discounted price compared to the market.

John Jenkins