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PE firms returning to special-purpose vehicles

PE Hot Topics - February 2018

A new generation of special-purpose acquisition companies (SPACs) is being raised by PE sponsors and others with well-established track records in private capital. What makes them so attractive?

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EY - Karim Anani

Karim Anani
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Alex Zuluaga
Partner, Americas Financial Accounting Advisory Services
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A structure with a turbulent history

SPACs are investment vehicles that raise capital from investors via an IPO to use at a later date in an acquisition of a target that is still undetermined as of the listing. They have seen a marked uptick in activity over the last 2-3 years, mostly driven by increasing interest from financial sponsors and management teams with experience in private equity.

Earlier generations of SPACs had a mixed reputation, the result of deals that didn’t play out as originally planned. This is beginning to change, however, with a new generation of SPACs backed by experienced management teams and sponsors with successful track records and long histories of strong performance for investors.

Legitimacy, and an increasing force in the market

SPACs have seen multiple boom and bust cycles since their advent in the 1980s. However, not only are SPACs raising more capital than ever, the proportion of the overall IPO market they represent is at a record high.

The amounts that individual SPACs are raising are also getting larger — since the beginning of 2016, 10 SPACs have raised more than US$500m each, enabling them to effect larger transactions, including several multi-billion dollar deals.

EY - SPACs and other BCCs see a record year in 2017

Why raise a SPAC?

As a structure that bridges the gap between public and private equity, SPACs fill a small but important niche in the market. Indeed, the resurgence in issuance is reflective of a number of benefits the structure has for sponsors, the companies they acquire and investors.

  • For sponsors
    • They allow sponsors to go beyond their traditional LP base
    • They allow for greater flexibility and creativity in structuring than a traditional IPO
    • SPACs can increase a firm’s investible universe — SPACs can attract management teams outside of a firm’s particular purview
  • For companies
    • SPACs can represent a streamlined regulatory approvals process relative to trade buyers
    • They can enable cost savings relative to traditional IPOs
    • A reverse merger with a SPAC allows for greater certainty in terms and conditions
    • SPACs can represent a streamlined regulatory approvals process relative to trade buyers
    • SPACs can give large asset owners a path to monetization for certain assets
  • For investors
    • They allow investors to participate in types of deals that might be otherwise off-limits
    • They have increased liquidity relative to commingled PE funds
    • The structure and economics of SPACs favor alignment

However, their compressed time frames often necessitate an accelerated public market readiness process

More on the way?

Particularly in light of recent market volatility, it’s reasonable to wonder whether SPAC formation will continue its upward trajectory, or whether future market disruptions, regulatory developments or investor disfavor might once again curtail their attractiveness.

There are a number of tailwinds that suggest that SPACs might become more prevalent in the coming years — both the increasing sophistication of public market investors and the strong demand for PE-style investments to represent powerful secular trends. Indeed, some SPACs have seen such strong demand that they’re moving away from the traditional 1:1 ratio for warrant offerings, instead offering investors warrants exercisable for a half-share or third-share.

US tax reform, which limits the deductibility of interest payments, could spur increased demand for equity capital, and other regulatory changes, such as the NYSE’s recent changes to its listing requirements to make itself more amenable to SPAC offerings, could represent additional enablers of growth.