The latest hype on the stock markets revolves around these four letters: SPAC. Triggered in the USA (where else), the trend is now reaching Europe. Despite the growing popularity, there is often confusion about the pros and cons of SPACs. The concept is not new, so why is it suddenly in the spotlight? High time to take a closer look at the booming exchange vehicle.

In the U.S., the market is already huge. Everyone from NBA star Shaquille O'Neal to hedge fund star William Ackman is in the process of setting up their own SPAC. Self-made billionaire Richard Branson got the wave going in 2019 with his Virgin Galactic space company.

Then last year, the boom was unruly: With 247 SPAC IPOs, the number more than tripled in one year with six times the volume.

2020 was a strong year for traditional IPOs - and an even stronger one for SPAC IPOs:  

Source: Dealogic, Goldman Sachs Global Investment Research

This year, the steep development continues and I could mention even more numbers that show the hype.

But what is a SPAC anyway?

The abbreviation SPAC stands for Special Purpose Acquisition Company. The company initially has no business operations, but still raises capital through an IPO. Once the company is listed on the stock exchange, the SPAC seeks out an existing company to merge with.

So a shell company goes public, which then fills its empty shell. SPAC has 2 years to identify a suitable company that is not yet listed and complete the merger. If it does not succeed within those 24 months, the money is repaid.

The process can be understood as a "reverse IPO": While in a classic IPO an existing company is looking for money, the SPAC already has the necessary money but is still looking for the company.    

Why do companies decide to go this route and not go public on their own?

For one thing, they save time and money. The entire process of an IPO usually drags on for many months, if not years. The regulatory requirements and disclosures are extremely burdensome and costly. In the case of an IPO via a SPAC, on the one hand there are fewer regulatory hurdles, on the other hand the management of the SPAC takes care of the process and the company can be listed on the stock exchange after a few months. Since the two parties agree on a valuation in the process, there is also certainty about the price they will receive. This is a great advantage for companies, especially in highly volatile markets, as they are not dependent on the current mood on the market.    

The stock market vehicle is particularly suitable for mature start-ups looking for new capital. For them, it also has the advantage that they do not have to deal with several financiers, but only with the managers of SPAC. Compared to private equity, it also brings the advantage that the founders give up less control, as they usually continue to hold a significant stake in the company.

What advantages do SPACs offer investors?

SPACs offer retail investors the opportunity to invest in private companies that have not previously been publicly traded. Initially, investors can bet on the manager of the SPAC, hoping that a suitable company will be found within the prescribed 24 months. If this is not the case, investors do not suffer a total loss, but the SPAC is liquidated and the invested money is paid back.

However, an investment in SPACs offers enough risks anyway.

We probably all followed the rise and especially the fall of such a company last year at Nikola. By March 2020, SPAC VertoIQ was looking for a promising startup to acquire and finally found it in Nikola. With high expectations and hopes of being part of building a new Tesla, investors pounced on the shares. The price shot up from $12 to $80 in a matter of days, and no one wanted to miss out on the hype.

If we look at the price today, we see that a share is once again trading at just under $16. So what happened in the meantime?

Investors' trust was gambled away with fake reports about hydrogen truck journeys and simply false statements. At the latest since Hindenburg Research published a comprehensive report on the truck startup's fraud, investors jumped ship. Trevor Milton, Nikola's founder, went on the counterattack, again accusing Hindenburg Research of market manipulation.

The turmoil and accusations continue to weigh heavily on the company. No one knows if investor confidence will ever be regained or if, despite the enthusiasm in the sector, the share price will continue to fall. In any case, the market capitalization of $6.5 billion is still sporting with hardly any sales and a lot of unanswered questions.  

So what does the Nikola case show?

There are no guarantees for the quality of the companies bought out. In contrast to the classic IPO, there are far fewer obligations regarding finances. This brings the aforementioned advantage that companies can be brought to the trading floor much faster. However, it can also attract companies that are in urgent need of capital and are in a bad, perhaps even desperate, economic situation.

What does the German market look like?

In February, a SPAC launched in Germany for the first time in over 10 years. Tech investor Klaus Hommels raised 275 million euros from major investors and went public on the Frankfurt Stock Exchange a few weeks ago.

Hommels is one of Europe's best-known and most successful startup investors. He has shown a good hand several times in the past and has invested early in Spotify, Facebook and Revolut, among others. With Lakestar Spac I, Hommels is on the lookout for a promising tech company in Europe.

As a target company, Hommels could choose a startup that is already part of the portfolio of Lakestar's venture capital fund. These include GetYourGuide, and Glovo, for example. So it is open to speculation which company will ultimately be taken over, the only certainty is that it will be valued at at least 750 million euros. Thanks to his many years of experience, Hommels is definitely strongly networked and could definitely strengthen the European tech sector.

Is there an abundance of SPACs?

While we are far away from an overabundance of SPACs in Europe, things are quite different in the US. So many new SPACs have launched there in recent months that there may be more SPACs than companies eligible for acquisition. Although the money raised is repaid after two years without an acquisition target, this may tempt managers to handily identify a suitable company shortly before the obligation expires and make extreme compromises.

The current hype of the Spacs illustrates above all the hunt of investors to find additional returns wherever they can. In doing so, they don't hesitate to put more money even where they normally wouldn't. It is a reflection of the excess liquidity that currently exists in the markets and therefore fits the picture of current conditions.  

For mature startups, SPACs can certainly be a valid alternative to private equity and a traditional IPO. However, investors should definitely always look closely at the acquired companies and be aware that the success of the SPAC stands and falls primarily with the competence of the management.