Is the ‘SPAC track’ the fast lane to growth… or the road to ruin?

Special Purpose Acquisition Companies, or blank cheque companies, are exchange listed companies whose sole assets are cash, a board, and a shareholder register of potential backers. That’s it. Their existence is not new: their popularity is.

Function varies by jurisdiction and mandate. In general, a SPAC will raise >US$150 million in cash via an IPO, often from US hedge fund backers, mandating a management team to acquire a company in a target industry. In exchange for US$10 cash (placed in trust), the investor receives a US$10 share (but in effect, an ‘at-the-money’ call option – the right to buy at par) with a warrant (another free option, to buy a new share at a higher price, often 15%). Management then has 18–24 months from IPO to conclude a deal or liquidate. On finalising a target and investment case, the merger is put to the SPAC shareholders for a vote. If the investor is not excited by the proposed transaction, they have the right not to participate and recall their cash but retain the warrant: it is this ‘free option’ warrant element that makes them attractive to investors. Simultaneously, financial, strategic or private equity investors may be introduced via a PIPE (“Private Investment in Public Equity”) to bring additional capital and stablise the shareholder base. 

The investor's perspective 

When presented with a proposed combination with a target (the “de-SPAC” process), shareholders have two choices: 1) request their money back (while retaining upside exposure) or 2) approving and holding shares in MergeCo. To approve this, the investor must be more excited about the potential transaction (owning shares and warrant), than merely having a small free option in the investment. To the professional investor, few opportunities are better than a free one: the onus is on management to produce a very compelling target and investment case, de-risked by the application of capital. 

The management's perspective 

Management (largely interchangeable with the Sponsor) will receive a large, free (or “sweat equity”) stake, typically 15–20%, in the resulting company. They are heavily incentivised to conclude a deal, as soon as is practical. With so little skin-in-the game, investors are wary: hence management’s credentials are critical and SPAC boards comprise starry names to dazzle investors and targets. To deliver on the business plan, the SPAC needs to persuade as many investors as possible to approve the transaction and keep their cash in the company.

When SPACs were rare, the SPAC could effectively conduct a reverse auction to find the most attractively priced target, but as the SPAC cohort grows faster than the universe of suitable candidates, and time limits tick closer, targets’ negotiating strength has increased; the auction process can even be reversed to put targets in the driving seat (this so-called “SPAC-off” will not be mourned by lexicographers when the frenzy passes).

From the target’s perspective

A SPAC is akin to Series D, E, and IPO in a single transaction. The merger swaps voting control for capital.  This is highly dilutive, given investors’ equity and management’s stake, and further dilution is triggered if it performs well (warrants and management incentives). But such heavy dilution may not exceed multiple rounds: and with funding de-risked, the organisational emphasis can be shifted from financing to execution.

The target receives a premium valuation, transformational capital, equity liquidity, a credible board, a shareholder base, early market profile and price certainty, delivered at low expense with high speed and certainty. It is compelling.  But for the intense dilution to be economically rational, the equity upside must be substantial. 

SPACs offer a procedural novelty, but ultimately the fundaments are unchanged: a clear investment case is needed to persuade prospective shareholders to convert. Targets must develop compelling business models to attract informed institutional capital who will fund future growth to share the returns. They enable an acceleration of business growth but they do not change good business structure. 

Europe’s conservative capital markets are sceptical of SPACs and their mixed record: European bankers are either wild-eyed in excitement, or eye-rolling in distaste. Amsterdam may see more listings but London’s rules are currently an impediment.

Following that bumper 2020, the trend has accelerated with 143 SPACs IPO’d in the USA between Jan 1 and Feb 17, 2021 averaging US$300 million of cash. This domestic saturation is channelling SPAC attention to Europe. In cleantech, Europe boasts a less overwhelming, solitary Amsterdam SPAC, and an unconvincing £1.3 million UK SPAC last December. More will follow, but right now a European SPAC is likely to be US-listed with US shareholders.

There is no limit on the type of business a SPAC may choose to target, but our interest is whether they suit clients. We identify four industry characteristics:

• Scale-ups: the business model has been de-risked, equity returns are strong and the final impediment to growth is access to capital; e.g., grid-scale and commercial and industrial (C&I) battery storage, like Stem Inc. 
• Emergent industries: when companies are competing for early dominance, scale will bring undisputed advantages (e.g., network effects) and a winner-takes-most industry outcome is likely such as the EV charging infrastructure space where EVgo and EVBox are two examples, delivery/coverage networks, two-sided digital marketplaces.
• Capital intensive industries: where high upfront investment is required to deliver returns, yet the venture risk is low and equity returns are high such as EV manufacturers Lucid, Xos, Arrival, Nikola or Gigafabs: Norwegian battery maker Freyr, for example. 
• Spin-outs: established high-growth businesses capable of accelerating growth without their parent companies’ capital constraints: energy storage system integrator Fluence and other large corporations’ new energy divisions would be (potential) examples of this. 

Some pre-commercial technologies may also receive SPAC investment (e.g., fusion power, CCS, hydrogen), but we see the characteristics above as the lowest risk starting point.

As ever, pitfalls lie in the detail of execution: how old is the SPAC? How many of the IPO investors will make their capital available? Will the credentialising key names remain engaged? How long-term are the hedge fund sponsors? Which PIPE investors will join the register and board, and why? Will the capital base bridge beyond the 12 month underperformance typical during the subsequent delivery phase? Will underperformance outweigh the purchase premium? Are US and European perspectives aligned? Over time, management often discovers that capital is not a commodity.

If you don’t meet two or three of the suitable criteria above, don’t waste time and resources engaging advisors. If you do, there is merit in qualified non-partisan advice to appraise a transaction in which so many parties get a ‘free lunch’ from your business (SPAC management, bankers, lawyers, warrant-holders).

The SPAC boom is widely expected to ‘end in tears’ – most booms do – and Nikola Corporation will not be the only cautionary tale. But SPACs are bountiful cash in search of opportunity and their accelerative function confers genuine advantages. Some cleantech companies will leapfrog competitors to dominate their vertical through SPAC mergers. In 2021 a new window has opened. Open windows are not without risk. But they have merit too. Be cautious, be critical, but be open-minded.

Cover Image: US energy storage systems and artificial intelligence controls platform provider Stem Inc is a prominent example of a company where the 'final impediment to growth is access to capital'. Image: Stem Inc.