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Why SPACs Could Leave Investors in the Cold

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The misalignments are severe.

SPAC sponsors say they are putting their reputation on the line, especially if they plan to repeat the process. This applies to series sponsors such as tech investor Chamath Palihapitiya, experienced banker Michael Klein and buyout specialist Alec Gores. In some cases, sponsors invest some of their own money in the business they are acquiring to better align their interests. But remember that often they have already received 20 percent of the business, so they are partially playing with house money.

SPAC sponsors also try to attract established brand investors to their launch, which gives legitimacy to the empty shell. For some of these investors, however, it’s all about financial engineering. They don’t have a unique interest in a SPAC as they have the ability to repay their investment plus interest for a modest but predictable rate of return, almost regardless of what happens to the acquisition. If the deal turns out to be a big winner, it’s a bonus.

What is unique is that the sponsor has no fiduciary duty towards the investors in the acquired company. Very few sponsors seek fairness opinions from third parties to confirm the price they are paying for an acquisition. And while mainstream investors increasingly pump additional funds into SPACs at the time of a merger, they typically do so at a lower cost than less-connected investors.

SPACs seek to differentiate themselves by nurturing their managers’ experience and the relationships with companies they may acquire. In most cases, however, the sponsor must use the money raised in a SPAC or be forced to return it within two years. This is an incentive to get a deal instead of getting the right deal at the right price and at the right time.

According to data service SPAC Research, there are currently more than 300 SPACs with a cash volume of around 100 billion US dollars seeking acquisitions. Since SPACs typically buy companies five times their size thanks to outside investment, that translates into potential purchasing power of about $ 500 billion.

“We have a massive problem with the imbalance between supply and demand. It’s inevitable, ”said Kawaja. “We know how it will end.”

None of this means that the traditional IPO process is better than the SPAC process. Both have advantages and disadvantages. It is possible for SPACs to become routine for certain types of companies to go public.

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Robert Dunfee