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SPACs: The Herpes of Autotech Fundraising – You can’t get rid of them

SPACs (Special Purpose Acquisition Companies) are a great alternative for some established companies with significant revenue and real earnings that would otherwise be qualified to do an IPO. However, those with little revenue or no earnings are subjecting themselves to the unpredictability of the public markets, frequently leaving the company’s founders little say-so over its future.

SPACs always sound like a good idea, and for Sponsors and PIPE funders, they sometimes offer nice rewards. But for founders and owners of startup technology companies, they can be disastrous. Once you’ve succumbed to the process, you just can’t get rid of the SPAC, and much like the way a social disease is usually contracted, a decision was made in the heat of the moment without actually considering the consequences. They both seemed like a good idea at the time.

After being acquired by a SPAC, many of these new unicorns can’t justify their public market valuations. No company is going to buy them for that price, so they are stuck with being public and frequently controlled by people they don’t know. Much like the ESOPs fad of the 1980s, SPACs are the shiny new things that will solve all of a company’s problems,[1] but they can create bigger problems that can’t be unwound.

Among the potential paths to the public markets for mobility companies, SPACs are rapidly gaining popularity. Newsfeeds are filled with reports about them and their high-profile acquisitions, and with celebrities like Alex Rodriguez involved in this trend, plenty of mobility business owners are wondering if a SPAC merger is the right route to raise money for their fledgling enterprise.

At first glance, SPACs can be a tempting option. They allow a company to bypass the traditional IPO and allow companies to go public faster. But SPACs are also full of downsides, and business owners who aren’t aware of these risks can find themselves with their business’ value diluted and their life’s work on a downward spiral. While SPACs can work for a select few founders in certain situations, the majority of SPAC mergers – particularly those in the autotech industry – pose a significant risk for losses of equity.

Understanding SPACs

SPACs, also called “blank check” companies, are shell corporations that raise money to be used for a future acquisition. That money is raised through an IPO, and the SPAC isn’t allowed to identify the acquisition company before raising those initial funds.[2] The SPAC’s entire existence and purpose are to raise the money necessary to acquire a business.

SPACs have become a popular option for transitioning private companies into publicly traded ones. Unlike a traditional IPO, in which a business grows and undergoes the IPO process to list its securities on an exchange, SPACs frequently don’t have an operating business with substantial assets, except for what is raised through the IPO.[3]

How SPACs Operate

SPACs are publicly traded and investors can buy shares upon the IPO, which are typically priced at $10 initially. Because the SPAC hasn’t announced or even found the business it plans to acquire at this stage, investors don’t know specifically what their real investment is.[4]

A SPAC is managed by sponsors, directors, officers, and affiliates, and this management team is responsible for identifying companies that the SPAC might acquire. A SPAC sponsor is typically compensated with 20% of the post-IPO equity.[5] While the management team works to identify potential companies to acquire, the IPO proceeds are held in an escrow account.[6]

SPAC investors can vote on potential acquisitions, and because they’ve invested before a company has been identified, it’s possible that the investors might not like the companies that the SPAC is poised to acquire. An acquisition will move forward if more than 50% of shareholders approve and if less than 20% of shareholders vote to liquidate their shares in the SPAC. If more than 20% of shareholders vote to liquidate their shares, then the SPAC’s escrow account is closed and funds are returned to the investors. [7]

SPACs have to complete an acquisition within a designated period, which is usually two years. If the SPAC fails to acquire a business, then the escrow account is closed and investors receive their money back.[8]

The Appeal of SPACs

Several situations have converged to drive the popularity of SPACs among both investors and business owners. The pandemic has resulted in increased market volatility levels, driving up the risk of IPOs and simultaneously slowing the market. As the U.S. Federal Reserve infused cash into the market, yields lowered.[9] These historically low interest rates have prompted investors to consider investing in the IPOs of SPACs. The appeal of a potential valuable acquisition means that some investors are willing to buy into a SPAC and wait for up to two years to see those potential – and hopefully big – returns.[10]

At the same time, venture capital and private equity funds were looking for exits in 2020 as SPAC growth accelerated. Some private equity firms sponsored SPACs, while others opted to sell to a SPAC for the benefits that it offered over a traditional IPO.[11]

Those benefits are many. SPACs provide a faster way for companies to go public, taking just three to four months to complete as compared to traditional IPOs, which can take two to three years. An acquisition by a SPAC also allows a company to negotiate its public offering terms, offering greater certainty of what the transaction will look like at closing. A SPAC that offers an experienced management team could also provide valuable leadership and guidance during and after a company goes public.[12]

High-profile investors and companies who have gotten involved with SPACs have also bolstered others’ interest and confidence in SPACs. Billionaires Richard Branson and Tilman Fertitta formed SPACs, and companies like Virgin Galactic, Opendoor, and DraftKings have taken their businesses public through merging with SPACs.[13] These large acquisitions have gained public attention and resulted in increased media coverage, driving overall awareness of SPACs and some of the success stories that can result.

All of these factors and situations have led to increased SPAC popularity, particularly during 2020.

The Current State of SPACs

At first glance, SPACs seem to be booming. In 2020, SPACs accounted for more than 55% of IPOs by volume. SPACs raised $83.4 billion in 2020, nearly $70 billion more than the $13.6 billion they raised in 2019.[14] SPAC mergers of 2019 through 2020 have outperformed mergers from 2016 to 2019, likely due to factors like the effects of the market volatility resulting from the pandemic.[15]

But examining SPACs’ performance post-merger tells a different story. SPAC acquisitions completed from 2015 to 2020 have underperformed post-merger, resulting in significant losses. Through September 2020, just 93 of the 313 SPAC IPOs since 2015 completed an acquisition. Those 93 SPACs experienced an average loss of -9.6% and a median return of -29.1%. In contrast, traditional IPOs have averaged a return of 37.2% since 2015.[16] This differential highlights just one of the many issues that come with SPACs.

The Cracks in SPACs

The potential issues with SPACs begin with the basics of how SPACs operate, and these flaws have significant implications for investors. Because they buy into SPACs before the acquisition target is identified, investors have no knowledge of what the operating company will be. Instead, investors are betting on the SPAC sponsor’s ability to identify a company that poses a promising investment opportunity. When that company is identified, investors might not like it and might not have chosen to invest in it on their own, though they maintain the option of not approving the acquisition.

A SPAC sponsor’s goal is to make an acquisition within two years, but the sponsor doesn’t necessarily have to find the best deal. A sponsor’s extra shares in the company act as incentive for the sponsor to find a good deal, but that doesn’t mean that a SPAC won’t overpay for an acquisition. SPAC sponsors aren’t required to do the same due diligence that occurs with IPOs, which can mean that investors don’t truly know the essential details of the acquisition.

If an acquisition isn’t made within two years, then the SPAC will be dissolved. While investors will receive their funds back, with interest, that money could have potentially been enjoying greater returns over that two-year period if it were invested in another company. Investors may be looking at lost opportunities when their money is tied up in a SPAC.

Even if an acquisition is made successfully, the stock can still fall below the $10 a share that the SPAC IPO investors paid, and these investors can lose money. Because SPAC sponsors acquire 20% of the post-IPO equity for very little, share value is already diluted. The chances of making significant profits from a SPAC investment are minimal and the risks are high. Unfortunately, those risks are even higher for some of the companies that turn to SPACs to take their companies public.

Why SPACs Aren’t Right for Most Autotech Companies

SPAC flaws don’t end with the investors, and an acquisition by a SPAC can cause disastrous effects for many companies. Smaller companies eager to go public and tempted by the apparent ease of a SPAC acquisition may enter this relationship without a complete understanding of the effects of an acquisition – and they can lose some or all of their companies in the process.

The issue starts with valuation and dilution. In the venture capital community, valuation doesn’t equal value. It’s common for tech companies to base their valuation on an idea for a product, long before that product is ever brought to market. A company might raise multiple rounds of funding for product development, with each round usually driving up its valuation. But until that company has established its contractors, manufactured its products or received SaaS revenue, its actual value is hard to determine.

For this reason, venture capital is a mismatch for the autotech industry, and most venture capitalists will admit this. The process of designing a concept, developing and refining the technology, and getting that product on an OEM’s vehicle that can be driven and sold takes about seven years. As a result, autotech companies often need to be funded for seven years before they’re able to generate income. Their timetables don’t match the those of the “rounds” and “raises” necessitated by the venture capital community.

SPACs are another form of venture capital, and being acquired by a SPAC is a tenuous situation, thanks to the dilution that is inherent in the SPAC structure. Value dilution occurs in three ways:

  • The SPAC sponsor is compensated with shares of 25% of the IPO proceeds or 20% of post-IPO equity.
  • SPACs allow IPO investors to redeem their shares for full price plus interest and still retain the rights to keep their warrants in the units for ongoing returns.
  • SPACs pay a merger underwriting fee that’s based on IPO proceeds even though most of those shares will be redeemed during the merger.[17]

Those three elements can lead to rapid value depreciation, and companies that opt for a SPAC merger can see their stock value fall. When that company has a valuation that is significantly greater than the company’s actual value, and without products or services yet on the market to generate income and replenish cash reserves, companies can see their share value fall until those shares are no longer worth the amount of money that’s in the bank.

Owning 40% of a publicly traded company valued at $2.5 billion seems to create a lot of wealth, but if that value falls to, say, $400 million because of the whims of the public market, then the company founder is left with a lot less wealth than he or she could have possibly received in a private transaction.

As shown in the chart below, many autotech SPACs have experienced tremendous swings in valuation (“Current” herein is as of April 12, 2021).

Did these companies experience any fundamental changes in their technology or operations that would warrant such multi-billion changes in valuation, or were these just results of the ever-changing fear and optimism of the public markets?

When SPACs Falter

Indeed, many autotech SPACs have experienced dramatic problems. Canoo has abandoned or scaled-back numerous strategies since its raise of $630 million. Romeo Power expects revenue for the year to be approximately $100 million less than projected. Lordstown Motors changed its capital expenses projection through 2022 from $135 million to $300 million, more than double the amount projected in 2020 when it raised $780 million, and the US Securities and Exchange Commission (SEC) opened an inquiry regarding its vehicle preorders after a report from a short seller. XL Fleet will no longer provide guidance about its revenue for 2021.

The Nikola Corporation acquisition is probably the best example of how badly a merger can go wrong. This manufacturer of battery-electric and hydrogen-powered trucks went through a merger with VectoIQ, a SPAC, on June 4, 2020. In response to the news, investors rushed to buy stock and bid shares up to $93.99, a more than 170% gain. Those priced marked an all-time high for the company’s stock. [18]

On September 10, 2020, Hindenburg Research, a short-selling firm, released a report that accused the Nikola Corporation of fraud. The report detailed alleged false statements made by Nikola founder Trevor Milton, and how those statements were used to mislead partners into signing agreements under false pretenses.[19]

The Hindenburg Research report led to investigations by the SEC and Department of Justice. In late September of 2020, Milton announced his resignation. Nikola Corporation stock fell to $26.40, reaching pre-merger prices.[20]

Shareholders in the Nikola Corporation filed class-action lawsuits in Arizona, California, Delaware, and New York. The lawsuits carried allegations of securities fraud both before and after the merger was completed. The T3 Trading Group alleged it owned nearly 30,000 VectoIQ shares when the shareholders voted on the Nikola merger, and alleged that it had lost $15 million.[21]

Such litigation is only likely to become more frequent as SPACs become more popular. The trend of SPAC shareholder lawsuits filed after merger announcements is growing, and those lawsuits often seek to prevent the transaction and to attain monetary damages. Class-action suits are also being filed more often.[22]

Most of these lawsuits allege issues like a SPAC’s failure to disclose conflicts of interest between management and shareholders, and a failure to disclose information about the merger. Some lawsuits also allege that a SPAC made false or misleading statements.[23]

With SPACs surging in 2020, the effects of many of those completed mergers are yet to be seen. However, the recent SPAC craze has prompted the US Securities and Exchange Commission (SEC) to look into the risks of SPACs. The SEC opened an inquiry in March of 2021, sending letters to Wall Street banks to request voluntary information about their SPAC dealings. While the letters did not formally demand information for investigative purposes, this step is evidence of increased scrutiny and awareness of SPACs.[24] On April 7, the commission also warned companies against misleading statements about their projected growth.

Alternatives to SPACs

SPACs are high-risk options that aren’t suited to many autotech companies. Unfortunately, though, SPAC creators are targeting automotive and other mobility companies around the world. SPAC representatives call business owners and try to entice them with the benefits of a SPAC merger. Often, those representatives who are calling don’t have the financials on the automotive company they’re calling. Business owners assume that the callers are well-informed and see significant potential in their business, and business owners may enter into a SPAC without understanding the risks or unsuitability.

There are plenty of funding alternatives for businesses to explore instead of a SPAC. Options like institutional investments from hedge funds, sovereign wealth funds and large family offices are just a few viable alternatives. If a company can justify $50 million to $500 million in funding, then a regular institutional funding effort from a hedge fund is frequently a better option than a SPAC merger. If that company has operations, profitability and critical mass, an operating company might make an investment.

While SPACs may be the talk of the auto tech finance market today, the cracks in this financing method du jour are already beginning to show. Business financing isn’t one-size-fits-all, and it’s rare that a SPAC is a good, viable option for an autotech business. With failures and lawsuits piling up, it’s only a matter of time before business owners realize that SPACs aren’t all they’re cracked up to be. Come six months or a year, we’ll still be talking about SPACs – but for all the wrong reasons.

Founded more than 30 years ago, Capstone Financial Group, Inc. has consummated more automotive M&A transactions than any other investment bank in the world and has created scores of synergistic automotive alliances. Today, Capstone continues to change the balance of power so that it favors founders of autotech companies, not the middlemen. As the most experienced investment bank in the space, Capstone strategically designs every transaction so autotech and mobility companies can scale into the highest tiers of the auto ecosystem.

6 SPAC Questions With Dan Smith, Founder and CEO of Capstone Financial Group, Inc.

For 32 years, Dan Smith has provided reputable, incomparable investment banking services to the automotive world, established himself as a respected expert with whom automotive industry stakeholders connect when they seek a successful deal with optimized results.

When autotech companies approach you about a SPAC merger, what advice do you give them?

This comes up almost daily, where an autotech company has been looking into SPACs. My first question to them is always, “What are you going to do with the SPAC?” Their response is usually, “We need to raise money,” and I share why a SPAC usually won’t work for their company’s situation. The numbers don’t work for less than $200 million, or usually $300 million. If a company gets the $200 million and can’t justify that amount, the founders will suffer significant dilution. Many company owners don’t understand this concept and what they’ll really be left with after a merger. They are frequently receiving no cash at closing, and turning over their entire company to the public markets.

We started meeting with SPAC underwriters in November 2018, but just never saw a way to give the process legitimacy with most of the mobility companies we know.

There are lots of glamorous stories of SPAC acquisitions – do you feel they’re contributing to the problem?

Absolutely. Business owners read these articles about “billionaires” in their mid-20s. It’s usually a façade, and it’s all on paper. Their company might actually have that much value in a few years, but not now. There are all sorts of stories about celebrities who are doing SPACs, which is one reason why SPACs are so popular. They’re relying on the credibility of the sponsor. Colin Kaepernick has a SPAC – you just can’t take it as legitimate financial advice.  

Are there any businesses that you feel would benefit from a SPAC merger?

Certainly. We have a client now that is looking at three SPACs, and it has real sales, real earnings, and has received an investment from a Fortune 500 company which values it at $700 million. It’s a perfect candidate for SPAC because it is ready for a regular IPO. If a company is doing $500 million in sales and is already making $80, $90, or $100 million a year, then a SPAC might work for them. If they go the public route, they might be valued at $1.5 billion by a real IPO in a real public market. That makes sense. For them to do a SPAC is logical, since they have revenue, and the numbers make sense.

What do you think we’ll see happen with SPACs in the future?

There will be a day of reckoning. Usually, it comes after a company goes public at a $2 billion valuation, and it has $400 million in cash, and the value of the shares keeps going down until they’re no longer worth the amount of cash in the bank.

Something’s going to happen. Will some survive? Yes, but usually not because of the SPAC. They’ll survive because they have a proven business model.

What financing routes would you recommend to businesses that aren’t suited for a SPAC?

It depends on how much money they really need. Regular institutional funding from a hedge fund means that a company doesn’t have to go through the rigors and constant scrutiny of public ownership.

We constantly survey almost 5,000 hedge funds, sovereign wealth funds, eternity funds, growth funds, and private equity funds around the world. We ask them specifically what they’re looking for in mobility investments, including categories like electrification, smart city, aftermarket, sensor fusion, LiDAR and SaaS revenue. They tell us what they’re interested in, if they will consider pre-revenue companies, and what their minimum investment is. We know these investors are all over the world, and it’s a lot easier than doing a SPAC. There are no public shareholders, no public board, and you usually don’t lose voting control of your company.

Of the private equity funds we survey, often their limited partners won’t let them invest in startups, but if a private equity firm owns a portfolio company in the automotive industry, which many do, then they can invest in a startup without having to get LP approval. We’re seeing that happen now. We’re identifying the portfolio companies and what they may invest in, and we have a lot of them looking at our mobility companies.

There are many funding alternatives to SPACs.

What would be your advice to a business owner who’s considering a SPAC merger?

Get sound financial advice before making your decision, and get that advice from someone who knows your industry and who truly understands SPACs. Be realistic about how much money you need and how you’ll use it. It’s also essential to be realistic about your “valuation” versus your business’ actual value, which we will help them determine upfront. SPACs can work in some situations, but they’re usually limited to businesses with the income and value to justify that decision.

What are you hearing from the investment community regarding SPACs?

Much like Rodney Dangerfield, they are getting no respect. The institutional investors who are serving as the sponsors are mostly credible, well-respected people, and the private equity firms with suitable holdings are frenetically working with SPACs to get these portfolio companies sold. However, we seldom talk to anyone who speaks glowingly about this financing method, and most of our contacts around the world see it as another flash in the pan. I recently asked one of the world’s most noted automotive investors why one of his friends was sponsoring a SPAC, and if his friend was concerned about the possible fallout. In reply, this PE guy told me his friend was not concerned because it was “just a SPAC.”

[1] Kathleen J. Owens, CEO, Aurora Financial Planning & Investment Management

[2] Huebscher, R. (2020, December 21). How SPACs Destroy Investor Wealth. Retrieved April 01, 2021, from https://www.advisorperspectives.com/articles/2020/12/21/how-spacs-destroy-investor-wealth

[3] What You Need to Know About SPACs. (2020, December 10). Retrieved April 01, 2021, from https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin

[4] Huebscher, R. (2020, December 21). How SPACs Destroy Investor Wealth. Retrieved April 01, 2021, from https://www.advisorperspectives.com/articles/2020/12/21/how-spacs-destroy-investor-wealth

[5] Ruan, E., Klausner, M., & Ohlrogge, M. (2020, November 19). A Sober Look at SPACs. Retrieved April 01, 2021, from https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/

[6] SPACs Explained. (2021, February 11). Retrieved April 01, 2021, from https://www.fidelity.com/learning-center/trading-investing/SPACs

[7] SPACs Explained.

[8] Huebscher, R. (2020, December 21). How SPACs Destroy Investor Wealth. Retrieved April 01, 2021, from https://www.advisorperspectives.com/articles/2020/12/21/how-spacs-destroy-investor-wealth

[9] Tse, C., & Kim, C. (2021, March 05). SPACs Were Hot in 2020 and are HOTTER Now. Here’s Why. Retrieved April 01, 2021, from https://www.seattletimes.com/business/what-is-this-thing-called-spac-they-were-hot-in-2020-and-are-hotter-now/

[10] Tse, C. (2020, August 27). Blank Check IPOs, the Status Symbol of 2020, Have Raised $32 Billion This Year. Retrieved April 01, 2021, from https://www.bloomberg.com/news/articles/2020-08-27/what-are-spacs-the-hottest-stocks-of-2020

[11] Sherman, R. (2002, December 28). Why Private Equity Has Jumped on the SPAC Boom of 2020. Retrieved April 01, 2021, from https://breakoutpoint.com/blog/2020/12/wolf-pack-on-spac-pack/

[12] CB Insights. (2021, February 12). Who Benefits – and Who Doesn’t – From a SPAC. Retrieved April 01, 2021, from https://www.cbinsights.com/research/spac-pros-cons/

[13] Huddleston Jr., T. (2021, February 24). What is a SPAC? Explaining One of Wall Street’s Hottest Trends. Retrieved April 01, 2021, from https://www.cnbc.com/2021/01/30/what-is-a-spac.html

[14] SPAC Analytics. (n.d.). Retrieved April 27, 2021, from https://www.spacanalytics.com/

[15] Contributor Renaissance Capital Renaissance Capital. (2020, October 1). Updated: SPAC returns fall short of traditional IPO returns on average. Retrieved April 01, 2021, from https://www.nasdaq.com/articles/updated%3A-spac-returns-fall-short-of-traditional-ipo-returns-on-average-2020-10-01

[16] Contributor Renaissance Capital Renaissance Capital.

[17] Ruan, E., Klausner, M., & Ohlrogge, M. (2020, November 19). A Sober Look at SPACs. Retrieved April 01, 2021, from https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/

[18] Stevens, P. (2020, September 21). Nikola Saga Hits Three Speculative Areas at Once: SPACs, Robinhood Traders and Electric Vehicles. Retrieved April 01, 2021, from https://www.cnbc.com/2020/09/21/nikola-saga-hits-three-speculative-areas-at-once-spacs-robinhood-traders-and-electric-vehicles.html

[19] Nikola: How to Parlay an Ocean of Lies into a Partnership with the Largest AUTO OEM in America. (2020, September 10). Retrieved April 01, 2021, from https://hindenburgresearch.com/nikola/

[20] Stevens, P. (2020, September 21). Nikola Saga Hits Three Speculative Areas at Once: SPACs, Robinhood Traders and Electric Vehicles. Retrieved April 01, 2021, from https://www.cnbc.com/2020/09/21/nikola-saga-hits-three-speculative-areas-at-once-spacs-robinhood-traders-and-electric-vehicles.html

[21] Frankel, A. (2020, November 30). The SPAC Shareholder Class Action Boom is Coming. Retrieved April 01, 2021, from https://www.reuters.com/article/legal-us-otc-spac-idUSKBN28A31K

[22] SPAC Litigation Likely to Surge in 2021. (2021, February 1). Retrieved April 01, 2021, from https://www.mcguirewoods.com/client-resources/Alerts/2021/2/spac-litigation-likely-to-surge-in-2021

[23] SPAC Litigation Likely to Surge in 2021.

[24] Godoy, J., & Prentice, C. (2021, March 24). Exclusive: U.S. Regulator Opens Inquiry into Wall Street’s Blank Check IPO Frenzy – sources. Retrieved April 01, 2021, from https://www.reuters.com/article/us-usa-sec-spacs-exclusive-idUSKBN2BH09F

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