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SPAC Costs Are ‘Far Higher’ Than Previously Realized, Study Finds

When blank-check companies merge with a target, share prices drop, according to a new paper.

The costs of going public via a special-purpose acquisition company are both “opaque and far higher” than previously recognized, new research shows.  

SPAC shares tend to drop by one third or more of their value in the year following a merger, with investors bearing the brunt of the costs, according to a paper published on December 3.  

The research comes amid a renaissance for blank-check companies: In 2020 alone, the vehicles have raised as much cash in their IPOs as they did over the preceding decade, per the paper, which was written by Michael Klausner from the Stanford Law School and Michael Ohlrogge from the New York University School of Law. 

“SPAC benefits are greatly overstated,” Ohlrogge said by phone Thursday. “People say SPACs offer great deal and price certainty. The reality is very different than that.” 

SPACs are investment vehicles designed to merge with a private company, effectively taking them public. They are required to execute a transaction within two years of formation.

The SPAC sponsor — usually an investment firm or famous investor — forms the company, takes it public, then buys a block of shares and warrants. These cover the costs of setting up the SPAC and finding a merger target, the paper said.  

When a SPAC does go public, it charges $10 per unit, which includes a share, warrant, and sometimes a right to a fraction of a share, the paper said. The proceeds are placed in Treasury notes, while investors await a merger.  

SPACs have garnered a reputation for having more certain terms than IPOs, as the merger agreement sets the price or share exchange ratio before the closing of the deal. This is compared with IPOs, which are priced the day before the company goes public.     

This doesn’t account for changes made to SPAC merger agreements, as sponsors negotiate with investors following the deal announcement to make sure there’s enough cash for the transaction to take place, according to the paper. 

“Price certainty is at best achieved only after a final merger agreement is reached, which may be only a few weeks prior to the merger,” the paper said.    

Even after the final merger agreement is reached, there’s still price uncertainty. At that time, investors are allowed to redeem their shares for the purchase price, plus interest. The target company does not know how many redemptions there will be until roughly a day before the deal closes, the paper said.  

“It's just like an IPO; you don’t know what the price is going to be until the day before the listing,” Ohlrogge said.    

[II Deep Dive: Egregious Founder Shares. Free Money for Hedge Funds. A Cluster***k of Competing Interests. Welcome to the Great 2020 SPAC Boom.]

The average redemption rate among the 47 SPACs that Klausner and Ohlrogge analyzed was 58 percent, according to the paper. For investors, redemptions are worth it: the average annualized return for investors in those 47 SPACs is 11.6 percent, the paper said. 

This, though, comes at the remaining shareholders’ expense. To replace the money lost, 77 percent of the SPACs raised more money at the time of their mergers, primarily through third-party investors.  

These redemptions, along with the sponsor’s block of shares and warrants, the cost of underwriting, and the warrants and rights that still exist, dilute the value of the remaining shareholders’ investments, the paper said.  

“If the SPAC merger generates enough surplus to fill the hole created by this dilution, then the target and the SPAC shareholders can come out ahead — although the dilution is still present as a cost,” according to the research.  

So far, according to Ohlrogge, the research has been well received by investors.“I was expecting much more pushback; we really haven’t got much,” he said.

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