The Economy Is Hot and So Are SPACs

During Berkshire Hathaway’s recent annual shareholder’s meeting, Warren Buffett recently declared the economy red hot.

“It’s almost a buying frenzy,” the Berkshire Hathaway Inc. chief executive officer said during the meeting. “People have money in their pocket, and they’re paying higher prices,” he said.

The red hot economy is also good news for SPACs and investors hoping to latch onto the surging economy. So it’s not just consumers with money burning a hole in their pockets, it’s also investors looking to cash in on the good times, and SPACs are the direct beneficiaries of all this.

After a record-breaking 2020, 2021 looks to be even bigger for SPACs. Why?

Because companies are looking to grow their businesses and piggyback on the booming economy turn more and more to SPACs as a quick and viable alternative for raising capital.

How Do They Work?

SPACs involve three principal parties:

  • Deal Makers/Sponsors.
  • Private Companies.
  • Investors.

Dealmakers launch SPACs to publicly sell bundled shares and warrants to the investing public – usually at $10/bundle. The goal of SPACs is to identify a private company for acquisition in an industry the deal makers are familiar with. Then, the private company is acquired through a reverse merger – making it a public company.

SPACs usually have 24 months to identify and complete an acquisition. Investors of the SPAC have a voice in selecting the acquisition company, and if any disapprove of the proposed acquisition, they can sell their shares on the market and keep their warrants.

Through the warrants, investors can retain some upside even if they opt-out of a deal. If the merger is successful, investors who opted out still have the opportunity to enjoy some upside.

The combination of shares and warrants appeal to investors looking to invest in a reasonably safe bet – the biggest risk being the opportunity cost of tying up their investment capital. At the same time, the SPAC identifies and acquires a private target.

Before 2020, SPACs, also known by their more common name, blank-check companies, had a reputation for being vehicles for fraud – used by boiler room operations as part of penny stock pump-and-dump schemes.

In 2020, however, SPACs went mainstream – raising a record amount of capital – with many prominent figures even getting in on the action and launching their own SPACs.

Prominent public figures Paul Ryan, the former speaker of the House of Representatives, and Gary Cohn, the former director of the National Economic Council, each launched their own SPACs. In addition, hedge-fund manager Bill Ackman raised a $4 billion SPAC, the largest ever.

The Companies that are using SPACs to go public are no longer obscure – with many already well-known brands. Last April, Draft Kings used a SPAC structure to go public – directly on the heels of Virgin Galactic, which went public in late 2019. Both have seen positive returns since.

Why Are SPACs Hot With Investors Now?

SPACs are hot with investors because they offer investors the prospect of above-market returns with some downside protection. The appeal of SPACs is the direct result of pandemic-fueled volatility in the markets that has stalled the traditional IPO market. At the same time, low interest rates and trillions of dollars in newly-printed money have lowered treasury yields.

As a result, SPACs have filled a niche for investors looking for the upside of IPOs with the downside protection of treasuries, thanks to the right of redemption.

For SPACs, there is no shortage of private acquisition targets with venture capital and private equity funds that have pumped money into private companies looking for an exit without an IPO. SPACs offer these private equity and venture-backed companies a streamlined path for going public without the cost and time of going public on their own.

SPACs are trending and benefiting from a perfect storm of a surging economy, volatile equity market, and low-yield treasuries – pushing investors to an asset with the potential for above-market returns with downside protection.

The timing is right for SPACs for all involved – deal makers, private companies, and investors.