The Great SPAC Scam: SPACs a Great Deal for Sponsors, but Not Others | Hacker News Reader

The Great SPAC Scam: SPACs a Great Deal for Sponsors, but Not Others

mergersandinquisitions.com

108 pointsrexreed55 comments

Right. You pay 20% of the company's value to avoid some legal fees and SEC scrutiny. And then there's an average net loss for investors.

What am I missing? Other than the sponsors, what are people getting out of it? Going "public" and selling shares on the public market without having to disclose anything first? This feels so bubble.

Gives late stage VCs a way to dump their fail whales on the public market and cash out before they fail.

Like so much of finance, it's about risk.

If you're a company owner: If you take your company public in an IPO, you have no idea what people will pay. With a SPAC you can discuss and negotiate and fix a price. That might be 100% shares or 100% cash. But you know you will end up with X percent of the shares and Y dollars once the deal is done so you can manage your risk.

If you're the SPAC, you are taking more risk. But you think you're getting the company cheaper than the market will value it. So you'll profit from the first day of trading.

Public companies (in theory) are better run and have easier access to capital. So the act of going public should increase company value and that adds motivation to both sides.

Using a sponsorship deal and charging investors for it is just advertising really. If the SPAC wastes money on it, that's the investors problem.

It doesn't seem much worse than buying on the first day of an IPO, when the well-connected investors have already bought their shares at the IPO price and enjoyed a "pop" to the price they're selling to you at.

In the typical structure of a blank-check SPAC, if you don't like the company they pick to acquire, you're supposed to be able to get your money back before the deal closes. I'd guess that the option isn't exercised all that often in practice, though.

In some cases, the advantage of a SPAC is that it has a senior management team that will take over the acquired company (not unlike a PE deal). For some investors, this makes the target company more attractive than it would have been going public on its own without a management team.

For those investing in public equities: I personally believe some SPACs are definitely worth it in the long run. SPACs suffering on the public markets are a great opportunity to make long-term investments if you are very, very careful and wait a bit longer than most to jump into the right companies.

From my experience, the strategic part is to wait until warrants expire. Most SPACs have very, very positive investor presentations that assume they will 10x or 100x in value over the next 5-10 years... Typically, SPAC sponsors get warrants to buy additional shares of the companies at a significantly lower price than those buying on public markets post merger... Knowing nothing else, you'll want to wait until these warrants expire as that's when things should stabilize.

... at least that's my strategy. Curious what others are doing.

I'm a small-time retail amateur and consider myself conservative with my portfolio (I stock-pick so that may be generous) so take this with a spoonful of salt. But to me, by buying in SPACs, or IPOs for that matter, one is trying to play VC's game. You're buying companies who have yet to prove their business model, who are likely far off from actual profitability - earnings before everything else (EBITDA) doesn't count - and whose valuations have a ton of future growth front-loaded. That may work if you have deep knowledge of a market, it's participants and how $X company fits in, but I suspect most people buying these young stocks don't have any particular knowledge of them. However with that in mind, the main issue to me is that one would be playing that game after actual VCs had the opportunities to play during private rounds.

When cash-burning start-ups raise money on public markets at nose-bleed capitalizations and laughable (non-binding) projections, it begs the questions (1) why it's present investors are unwilling to fund it internally at more reasonable private valuations and (2) if the price they are offering you to pitch in at, on the public market, is optimized for current shareholders or new ones. I'd suspect (1) is because they're either ready to off-load their risk or unwilling to burn/risk more of their own cash and (2) it's obviously at the company's and it's present shareholders advantage. Sometimes it works out great, you'd have done brilliantly by investing in a now thriving company when it went public, but IPOs/SPACs are offering sloppy seconds on speculative companies.

My style is more akin to buying proven cash-cows at reasonable-ish valuations so I'm probably not the target demographic anyway, but I mostly wouldn't consider buying any newly traded company until people who bought the initial offering are in pain. I'll miss out on lots of boats this way, but I'm at peace with that.

> My style is more akin to buying proven cash-cows at reasonable-ish valuations

if it was so proven, the current valuation would not fall far from the NPV via some sort of discount cashflow analysis. It's still possible to get a good deal, but just as difficult, as only an unexpected growth can give you the returns you want.

There were a few companies that I was waiting for to go public that ended up going the SPAC route around the time I didn't have extra capital to deploy at the time they went public. Now, I'm just glad I didn't. While I still intend to invest once the knife that is their valuations stops falling and starts to rebound on fundamentals, for now they still have a bit more to lose in their valuation to be in line with the rest of the market on your standard metrics eg. P/E.

I'm just not gutsy enough to short the stocks until then.

One thing I am now on the look out for is for short-term short squeezes before initial lockup periods expire.

Perhaps overly cynical but my take is that there’s little relationship between fundamentals and valuations of “exciting” public companies at the moment, and so acting on any grand theory about underlying value is acting in the face of an unfortunate reality: you could be right… and still lose money.

You can find example after example of company that is either vastly overvalued, or vastly undervalued, according to any reasonable measure. I have no confidence that I can effectively predict the stock price of one of these companies, and SPACs fit squarely into that category. If I was looking for high-risk high-reward, I’d rather take riskier bets on known quantities.

Is that why the most profitable companies are also the most valuable?

But the reverse does not hold true: plenty of the highest priced companies don't make a "profit", in the accounting sense. Such as Amazon.

That hasnt been true for years. Amazon has had a positive net income for quite a while. Their margin is small, but not negative.

Your warrant coverage thoughts are very on point, spacs if structured properly are very clever but the lack of transparency on warrants and notes is a problem for the asset class.

...and what's also interesting is how little innovation there is in SPACs. Tells you a lot about how stale/uninnovative the entire finance industry is.

Everyone has similar warrants, similar share structures, and even the $10-pre-merger price. AFAIK, there's no reason for all these consistencies beyond copying and pasting the original docs.

Anyway, I am tracking a lot of SPACs and waiting about 1-2 years before diving into some of the more promising ones. We'll see how it goes!

Doing the same.

Partially what also interests me is that the "quant data" is just emerging. Meaning you have a fully new set of key indicators, of facts to look out for when making sense about a possbile investment.

OTOH I agree that SPACs are equally useful for fraudsters: Exiting a failing business no professional investor wants to purchase. E.g.

[Trigger warning!] the conservative coffee brand "Black Rifle Coffee" is IPOing via a SPAC. I would be really surprised if their grandiose revenue projections materialized without their Trump-base which they have annihilated recently. [Trigger Ending]

But that's just one example out of many such SPAC companies, which will slash portfolios of retail investors. And in doing so tainting those SPACs with actual value and prospects.

Thorough study from a year ago for interested folk: https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-s...

Very interesting read, SPACs seems like a very bad deal in most cases. Also found this article which tells much the same story but with better graphics: https://financescp.net/2020/12/18/spac-mania-2020-no-free-lu...

I mean, I don’t think this is particularly worse than any other deal. Investment bankers, institutional investors, etc., effectively take a cut of every other deal so why should a SPAC be any different?

It’s a big cut, relatively speaking, but there’s also potentially a good amount of risk. And although lately it seems like there hasn’t been much risk in SPACs and the sponsors have been doing very well, investment bankers have been doing very well too!

From my adventures in finance, I notice that nobody really understand what the experience is like for the issuer.

All the perspectives are about the secondary market.

SPACs: great for issuers

Crypto: great for issuers

NFTs: great for issuers

IPOs: great for issuers

Direct Listings: decent for issuers

Bonds: AMAZING for issuers

Be an issuer. Concepts become a lot more obvious alot faster when you think "what do the issuers get out of this" and dive and dig to find out the answer. If you're reading Matt Levine's digestible breakdown, it's too late.

> Be an issuer

Great advice, if you've got a spare few tens of millions of dollars.

Depends on what you are issuing.

Either way, just remember its an option sometime after you cover your basic finances. It doesnt have to all be a larger stock portfolio to eventually make a downpayment on a 30-year mortgage. You might actually have enough capital to play the real game

Can you clarify what you mean by issuers in each of the examples above? And how exactly one becomes an issuer if this is even a practical matter?

The person/group that creates the project, and originally sells the asset.

One complication would be that in a SPAC that would be the SPAC sponsor, as well as the target company's founders or preferred investors.

It being a practical matter depends on how much capital you have.

So what's to stop a VC firm from juicing the returns they provide their own limited partners by simply standing up a series of SPACs which they in turn use IPO proceeds to acquire some of their own poorly performing companies that couldn't get acquired or go public on their own, while also enjoying the 20% "promote" that sponsors get?

Nothing. Everything is a contract, you just need to get someone to agree to it. The regulator just makes sure information is disclosed, the investor is the one that has to be discerning.

In prior market conditions, people were not agreeing to SPAC contracts. In these market conditions they are.

In theory, the answer is that reputational risk disincentivizes this behavior. In practice, markets these days are pumped so full of easy money in need of somewhere to go that that seems a fairly remote concern. As to "is this all a game"--while I don't think it's good for society that this is the way things are, the extremely wealthy have been playing finance on easy mode for a while now, and so far there's no sign of that stopping.

There is not supposed to be any prior relationship between the SPAC's sponsors and the company being acquired. I believe it violates SEC rules. So the VC shouldn't be able to set up SPACs specifically for acquiring their own companies.

It wouldn’t be the express purpose.

And yeah the SEC has input on the wording of the proposed target company vote. So they would eventually know.

But since VCs typically have single to low-double digit ownership of anything in their portfolio, it would probably pass muster just fine. Would just need to be disclosed.

I’ve seen SPAC investors approve buying newly formed companies, formed two months prior. So they’ll approve anything (except buzzfeed lol)

Why do you think bonds are an especially good deal for the issuer? Even more than SPACS? What kind of bonds are you referring to? Gov or Corp?

Both. But only for the credit worthy, which is determined by the market.

They all rely on new money from investors to pay back the old one. There is a word for that, but it doesn't matter.

The investors rely on assurances that their investment could be paid back from other sources.

In practice though they just use new debt from new investors to payoff the old one to old investors.

The remaining proceeds can and are used for anything with no transparency. But there doesn't need to be, as long as investors are paid back.

Credit markets are very misunderstood (Bonds, Credit, High Yield, Junk, Fixed income are basically synonyms, there are many subsections of this market and regional ones around the globe). People just think they're boring and don't take a second look.

> In practice though they just use new debt from new investors to payoff the old one to old investors.

One particularly interesting idea I've heard bandied about is to eliminate the rollover risk this represents by allowing the issue of perpetuities. Obviously repayment risk remains, as Evergrande currently reminds us.

So the issuer just pays interest forever until it happens to be paid off?

Similar to how a credit card is paid off? Or line of credit? That’s kind of interesting, crowd invested credit lines. Doable now, only by investing in a lending corporation, but not on the open market.

CREAM Finance’s Ironbank in the defi/open finance space is attempting something like that, where protocols get a credit limit and can borrow to finance their operations. Interest payments shared with investors.

> So the issuer just pays interest forever until it happens to be paid off?

Well, by definition perpetuities are never paid off. You could just buy your debt back on the open market though. I'm not a lawyer, so IDK if there's any interactions with "Dead hand" rules in the area based on a brief review of wikipedia[1], similar to 99 year leases or whatever motivated this potential disaster[2].

[1]: https://en.wikipedia.org/wiki/Rule_against_perpetuities [2]: https://www.latimes.com/business/story/2019-08-09/etf-spy-lo...

its instant money for the government that they pay a low rate on over a long period. OF COURSE its good for them!

Super dumb question: As far as I see, SPACs are usually smaller than the companies they acquire. What keeps a company from just paying out some profit to the founders, them setting up a SPAC themselves from that money, IPO it and then reverse merging the company?

Is it time to market? Conflict of interest? Are there limitations to the size difference?

I'm just thinking that since the "vehicle" seems to be useful, shouldn't there a race to the bottom be going on in terms of sponsor margins? As in essence, the value any of them provide seems to be pretty replaceable to me. Or what else do they bring to the table than an empty hull?

It’s not legal to have a target acquisition in mind when you start a SPAC

Tell that to Jay Sidhu and BankMobile/bmtx. Started his SPAC when the Flagship acquisition of BankMobile was failing. After never being able to dump the asset from Customers Bank, his son's SPAC purchased BankMobile.

It would be hilarious if it weren't so sad how preferential treatment from the SEC is. I wonder if they're just lazy or if there really just is a wall street nepotism club.

Kinda amazing how much trust people put into an institution with the bulk of their net worth that routinely ignores and enforces rules arbitrarily.

Or Patrick Orlando and Donald Trump, who reportedly discussed their SPAC merger months before Orlando sold shares to investors. But then, I think enforcing this no-contact law will be hard, i.e. difficult to prove unless regulators obtain explicit proof of a conversation between interested parties.

https://www.nytimes.com/2021/12/07/business/dealbook/trump-m...

I think there'll be major conflict of interest if a founder does that.

The closest thing I've observed to that scenario is Group Nine, a digital media company, which launched a SPAC that it planned to merge with another media company, then merge with itself.

Group Nine, however, recently merged itself (minus its SPAC) with a rival, Vox Media, and hasn't talked about the plans for the SPAC henceforth, but it's suspected that the combined Group Nine-Vox Media will merge with it.

https://techcrunch.com/2021/01/15/group-nines-spac-goes-publ...

https://www.vox.com/recode/2021/12/13/22833341/vox-media-gro...

Imagine an IPO for a company without any requirement to make money, follow conventional accounting standards, delivery any actual product. It's an open-ended but legalized form of money laundering and fraud.

Why isn't there a race to the bottom to shrink the sponsor cut from 20% to 5% or something? If being the sponsor is as protected and lucrative as suggested surely plenty of people would be willing to sponsor for less of a cut, which in turn would make the deal less of a bad deal for others?

Every deal is different, 80% of a share in a good company is worth a lot more than 95% of a share in a bad company. If it's an extremely marginal case then the sponsor shrinking their cut might be the difference between the retail investors pulling out or not, so in that case you might see it happen, but most of the time negotiating the acquisition and the PiPE is the hard part, and if you succeed at that then the deal is going to happen.

What defines "good" and "bad"? From the market perspective "good" would be defined by its medium to long-term return to the investor that holds for a long enough period to cover the short-term loss. Whereas "bad" would be an acquisition that has declining value over time, even if its short-term performance is acceptable.

I mean just in terms of value when the merger actually closes, the SPAC equivalent of the IPO price.

There is an abundance of capital chasing ever diminishing returns. I think it's at least somewhat likely there is little price elasticity on the sponsor cut and almost certainly a lot of retail investors who are irrational investing in these SPACs.

I'm confused.

This only applies to SPACs with a sponsor, and even then only when the sponsor takes a bigger cut than the profit from buying the firm and taking it public.

And even then, it seems like a stretch to call it a scam: if you buy an investment product because it sponsors someone you like, you're gonna pay accordingly. Nike or Coke Cola aren't a scam because they cost more and spend the money sponsoring celebs. Neither are these.

Are they worse value for money? Yes. But that's pretty obvious and people don't just look at cost/ingredients when they make their purchasing decisions. That's their right not a scam.

Which SPACs don't have a sponsor? In which SPACs do non-financial sponsors take less than 20% of the total company value? Would you invest in a company that has no defined product, service, or business model, and puts all their eggs into the basket of a private company that you might not have ever heard of, in a business relationship between the SPAC and acquired company that is never fully disclosed in which the share price is almost assured to drop at least 1/3 the day after trading and in which there is no long term evidence of value creation?

These companies aren't like Coca-Cola that started as a small business and then grew, delivering value along the way. There is no way for an investor to "look at the ingredients" of a SPAC at the time they invest in the SPAC before the merger.

Byrne Hobart noted recently that SPACs are interesting for spinouts, which matches their history as a vehicle designed to take something public that would have trouble in a traditional IPO process.

I’ve been worried the potential 2022 IPO of Quora will be a SPAC.

That site has unfortunately gone downhill. It used to be that Quora had real world experts to answer almost any question with excellent detail. In fact, scrolling through Quora looking at different answers on different topics was a major pastime for me, and I think many others.

However, Quora massively opened their user base (I suspect to justify VC funding) and the quality of answers suffered. Now, I dare not open my feed because it's full of political vitriol on a large scale.

Yeah, for me Quora really went downhill as well. I was a regular reader, also a contributor for things I knew about. Even went to a local meetup once.

At some point I realized that my feed just features opinions from Quora celebrities who are actually just some random people on the internet when you think about it. So I just stopped using it.

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