What is a SPAC?

THE INVESTMENT boom in special-purpose acquisition companies (SPACs), a controversial species of shell business, keeps scaling new heights. On April 13th a new record was set when Grab, South-East Asia’s answer to Uber that provides ride-sharing, food-delivery and digital-payment services, agreed to merge with a SPAC founded by Altimeter, an American investment manager, in a deal that values Grab at around $40bn. This grants Grab a shortcut onto the Nasdaq and is the latest in a string of such deals (Lucid, a maker of electric cars, provides another notable example).

Last year in America roughly 250 special-purpose vehicles were launched, raising $83bn. The pace has quickened since. Shell companies holding $100bn or more could well acquire companies worth $500bn, within two years. In a sign of frothiness, SPAC sponsors include an eclectic mix of businesspeople, sports stars and even the son of Martin Luther King junior. Retail investors, too, are piling in: they accounted for 46% of trading in SPACs on Bank of America’s platform in January, as opposed to 30% the month before. Now, the mania is spreading to Europe, where Amsterdam is the hotbed of activity, but debate has begun in London about how to make its listing rules more welcoming. SPACs’ critics highlight dangers for uninitiated investors. So how do SPACs work; what underlies their sudden popularity; and what are the risks?

First, the basics. A SPAC’s raison d'être is to provide another firm with a quick and easy way to list on the stockmarket. Its lifecycle begins when a group of investors float a shell company on public markets, creating a pot of cash that can be invested in a real business looking to raise capital and go public. In the next phase of life, the blank-cheque concern seeks out an unlisted target company and proposes to merge with it. Targets are usually late-stage (that is, fairly mature) private companies whose owners and venture-capital backers want to cash out. Sponsors may have industries in mind from the outset.

Generally SPACs’ bosses must strike a deal within at most two years of birth or return cash to investors and sink into oblivion. In the event of a successful merger even more cash is usually raised from a handful of institutional investors, meaning the pot swells to around five times the size of the originally listed pile. This can then be spent by the newly public firm. The sponsor gets a portion of the merged firm’s shares and typically a seat on its board.

This may sound like a convoluted process. But SPACs provide would-be public companies with a swifter and easier route to market than a traditional initial public offering (IPO). Their popularity is inversely related to listing firms’ frustration with the traditional IPO route, with its long-winded (rigorous, SPACs’ critics would say) processes and high fees, about which tech types, especially, have long moaned. In a classic IPO, moreover, a company’s ultimate valuation is uncertain; firms merging with SPACs know how much capital they will raise. Adding to SPACs’ popularity, they promise rich pickings to their creators. Founders tend to get shares on the cheap, so can make decent returns even if a newly merged entity’s shares bomb. Early backers receive warrants (the right to buy shares at a given price in the future), which can dilute the returns of outside shareholders.

Such generous terms leave sceptics unconvinced. Some studies find that SPACs’ returns to investors are actually poorer than those of the wider market—and even those of companies that listed via a much-maligned traditional IPO. Neither are SPACs necessarily the cheap listing option some proponents claim. Underwriting fees are still incurred. The SPAC boom has a whiff of the bubble about it.

Yet, with the right design, SPACs could be a useful financial innovation, too. The price certainty and speed they bring to firms wanting to list improves choice, providing competition for Wall Street institutions. By opening up tech investing, SPACs could be a boon for retail investors and the wider economy. Those that combine with startups could give punters access to early-stage investment opportunities normally reserved for venture capitalists. Progress could be speeded up in areas including autonomous vehicles, biotech and quantum computing. Hapless retail investors may come a cropper as the market value of reverse-listed firms disappoints. But in the aggregate SPACs may yet prove their worth.