Younger investors may think that special purpose acquisition companies (SPACs) are a new phenomenon that emerged a few years ago. But the reality is that these “blank check companies” were created back in the 1990s, and largely fell out of favor until seeing a resurgence post-COVID.
With both the IPO and M&A markets seeing a significant shift recently., dealmakers are well aware of the rapid rise and fall of this asset class from 2020 to 2023. In 2020, there were 248 SPAC IPOs in the U.S. that raised $83 billion, compared to just 59 in 2019. But most recently, the SPAC market cooled off considerably. SPACs IPOs in the first three quarters of 2022 raised a combined $12.78 billion, compared with $127.27 billion in the same period in 2021.
348 SPACs are set to expire in 2023, creating pressure for blank check companies to finalize business combinations. Until February 2023, 19 SPACs with over $5 billion in trust have already liquidated, compared to none at this point in 2022.
So, what can dealmakers learn from the SPAC boom and bust to avoid getting burned in the future?
Cheap money can lead to irrational valuations
The rapid rise of SPACs was concurrent with the inflating of several other asset classes, including cryptocurrencies and non-fungible tokens (NFTs). In retrospect, it’s clear that the flood of cheap money introduced to the market by the Federal Reserve (Fed) contributed to the rise of all these assets at the same time.
So, one clear lesson is that hype, excitement, and cheap money can lead to overvaluation and unrealistic expectations. Many SPACs were valued at multiple times their revenue, and some even before they had any revenue. When the market cooled off and investors started to scrutinize the underlying business fundamentals, many SPACs struggled to find attractive targets or to complete their mergers.
Similarly, dealmakers need to be careful not to get caught up in the excitement of a potential acquisition, and conduct proper due diligence to ensure that both parties involved in the deal have a good outcome. Just because a company has a hot product or technology doesn’t necessarily mean it’s worth the premium price tag.
Be sure that fundamentals match the narrative
Another lesson from the SPAC boom and bust is the importance of having strong underlying fundamentals in addition to a clear and compelling story. Many SPACs were initially successful because they had a compelling narrative that attracted investors.
For example, electric vehicle maker Lucid Motors raised $4.4 billion at an eye-watering $24 billion valuation through a SPAC merger by positioning itself as a competitor to Tesla and highlighting its cutting-edge technology. Similarly, DraftKings, which merged with a SPAC in 2020, was able to capitalize on the growing popularity of online sports betting.
Dealmakers can learn from these stories by ensuring that the companies they work with have strong fundamentals to go along with a compelling story. This means having a solid understanding of the company’s value proposition and positioning it in a way that differentiates it from competitors.
IPOs require significant due diligence for a reason
A significant factor behind the rise in SPACs in 2020 was the lack of public filings required to do a deal. Unlike an initial public offering (IPO), SPACs require far fewer disclosures from companies, since investors trust fund managers to merge with strong companies.
The eventual bust of many of these companies highlights the importance of transparency and credibility in investing. Some SPACs faced scrutiny over their management fees and the incentives of their sponsors. Additionally, there were concerns that some SPACs were not doing enough due diligence on their acquisition targets and were rushing to complete deals before their two-year deadline.
Dealmakers need to be transparent and honest with investors, and they need to demonstrate that they have a rigorous process for evaluating potential targets. This means conducting thorough due diligence on financials, management, and market positioning, and being upfront about any potential risks or challenges.
Have a clear and well-defined exit strategy
Finally, the SPAC boom and bust highlights the importance of having a clear and well-defined exit strategy. Many SPACs struggled to find attractive merger targets, and some had to resort to less-than-ideal deals to avoid liquidation. In some cases, investors in the SPAC suffered losses when the deal failed to materialize or the target company did not perform as expected.
Dealmakers need to have a clear plan for what happens if the acquisition does not go through, or if the target company does not perform as expected. This means having a well-defined liquidation process, as well as contingency plans for addressing unforeseen challenges or risks.
The SPAC boom and bust provides a number of valuable lessons for dealmakers. It highlights the importance of conducting thorough due diligence, ensuring fundamentals match narratives, being transparent and credible, and having a well-defined exit strategy.
By keeping these lessons in mind, dealmakers can increase their chances of success and avoid the pitfalls that tripped up many SPACs in the past.