Introduction
Special Purpose Acquisition Companies (SPACs) experienced a surge in popularity, promising to bypass traditional IPO processes and rapidly bring companies to public markets. However, while some initially appeared promising, many SPAC mergers have underperformed significantly. This blog explores the concept of SPACs, their intended benefits, and why they’ve struggled to deliver sustainable value post-merger.
What Are SPACs and How Do They Work?
SPACs are shell companies created to merge with private firms, taking them public without going through a conventional IPO. Organizers raise funds from investors through an IPO, promising to acquire a private company within a set timeframe (usually 18-24 months). If no deal is secured, the funds are returned to investors. This route offers speed and flexibility, which was particularly attractive during periods of market volatility.
The Promised Benefits
SPACs emerged with several selling points:
Faster Market Entry: Compared to IPOs, SPACs can expedite the process of going public.
Greater Valuation Control: Companies have more room to negotiate valuations than through IPO roadshows.
Experienced Leadership: Many SPAC sponsors are industry veterans or prominent investors.
Lower Public Scrutiny: Since the process avoids some IPO disclosure requirements, companies face fewer pre-listing obligations.
These benefits sparked investor enthusiasm, but the outcomes have often been far less favorable.
The Reality: Poor Post-Merger Performance
A major challenge with SPACs has been the poor performance of merged companies in public markets. High-profile examples illustrate this downward trend:
23andMe: Since going public in 2021, 23andMe performed very poorly and it struggled to gain profitability. After merging with VG Acquisition Corp. with a stock price of $16.04 per share, its stock saw sharp declines as the company struggled to meet market expectations and fell to a low of 75 cents, a 95+% decline. It currently trades at about $5.00 per share.
MetroMile: The pay-per-mile insurance firm merged with INSU Acquisition Corp. II in February 2021 with a first day closing price of $18.00 per share. But it soon found itself underperforming. On March 30, 2021 (only about six weeks later), after announcing its 2020 financial results, the stock closed at $11.23. On May 17, 2021, it announced its financial results for Q1 of 2021, and the price fell further to $6.96. The share price ultimately fell to $2.25 by November 2021, when Lemonade, also an insurance company start-up, announced its plans to acquire MetroMile.
Other companies that have had similar drops: Clover Health, SoFi, ChargePoint Holdings and BarkBox, to name a few.
In most cases, SPAC mergers have resulted in significant losses for investors, with the majority of post-merger companies trading well below their initial $10 share price. Structural issues like unrealistic growth projections and weak fundamentals have been major contributors to this trend. Additionally, many of these companies lacked the operational readiness required for public markets, leading to underperformance soon after listing.
In reality, most post-merger SPACs have performed poorly. According to the Valuation Research Corporation, on average, mergers completed in 2021 and 2022 have lost 67% and 59% of their value relative to their offering price (typically $10). The De-SPAC Index, which measures the performance of SPAC mergers, fell almost 75% in 2022, after losing 45% in 2021.
Perhaps there actually is critical value in the traditional pre-IPO requirements like full vetting, lengthy disclosures and regulatory scrutiny. While time-consuming, expensive and even annoying for companies anxious to go public, those protections are there for very valid reasons.
Structural Challenges: Favoring Sponsors at the Expense of Investors
One of the key flaws in SPACs lies in their structure, which tends to favor sponsors more than public shareholders. Sponsors typically receive around 20% of the post-merger company’s shares as a “promote” fee, regardless of the stock’s future performance. This structure incentivizes completing a merger—even with suboptimal targets—over returning funds to investors.
Moreover, SPAC investors often receive warrants, allowing them to purchase shares at a discount post-merger. However, these warrants dilute the value of existing shares, negatively impacting long-term shareholders. Such dilution is one of the leading causes of stock price declines after mergers, as demonstrated by companies like SOC Telemed (94% plunge) and View Inc. (described in the press as perhaps the "SPAC-era's worst deal"), whose share values plummeted soon after their SPAC transactions were completed.
The Rise and Fall of SPACs
SPACs rose to prominence between 2020 and 2021 due to several factors:
Excess Liquidity and Market Optimism: Low interest rates encouraged speculative investments.
Retail Investor Engagement: Platforms like Robinhood facilitated access to SPAC shares for everyday investors, contributing to the speculative frenzy.
Media Hype: High-profile deals gave SPACs widespread attention, fueling excitement.
However, as economic conditions shifted and regulatory scrutiny increased, the SPAC market rapidly cooled. Rising interest rates, disappointing earnings from merged companies, and tighter SEC regulations contributed to the decline. By 2023, many SPACs were liquidated as sponsors struggled to find quality merger targets, leaving investors wary of further involvement.
Lessons Learned: A Cautious Future for SPACs
While SPACs offered a novel approach to accessing public markets, their structural flaws and tendency to overpromise have resulted in widespread disillusionment. For companies considering this route, preparing for the operational demands of public markets is critical. Similarly, investors must conduct due diligence, understanding the risks of dilution and misaligned incentives before engaging in SPAC investments.
SPACs remain a cautionary tale—a rapid rise, driven by enthusiasm and easy capital, followed by an equally rapid fall as reality set in. Investors and companies alike must approach them with a clear understanding of their risks and limitations to avoid becoming part of the next wave of financial disillusionment.
Supporting Quotes
Aswath Damodaran, Professor of Finance, NYU Stern: "SPACs represent an intriguing financial innovation, but too often they have become vehicles for speculative excess."
Warren Buffett, CEO of Berkshire Hathaway: "You don't find out who’s swimming naked until the tide goes out—and the tide has gone out for many SPACs."
Lora Dimitrova, Finance Professor, University of Exeter: "Sponsors' incentives often misalign with shareholders’ interests, encouraging deals that benefit the few at the expense of the many."
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