SPAC investors needed to read past the sponsor
The SEC's warning about SPACs backed by celebrities identified a deeper problem: the same transaction could offer very different economics to its sponsor, public shareholders and the company going public.
A famous sponsor could attract attention to a blank-check company without answering the question that mattered to its investors: on what terms would their money become ownership of an operating business? On 10 March 2021, the SEC's Office of Investor Education and Advocacy warned against choosing a special purpose acquisition company solely because a celebrity sponsored, invested in or endorsed it.
The alert pointed to sponsor conflicts, different economic terms and the need to examine each transaction. For a company backed by venture investors, those issues determined the quality of a prospective SPAC financing: how much cash would arrive, who would own the combined company and which shareholders wanted to hold the business after the transaction.
The shell and the operating company were different investments
The alert described a SPAC as a company without operations that raises cash through an IPO, then typically has two years to find and merge with a private operating company. Buying the shell meant relying on a management team to select a business later. After a combination, the shareholder's exposure rested on that business, its valuation and the ownership structure created by the transaction.
Celebrity involvement alone did not establish misconduct, and the SEC cautioned investors to examine each SPAC's terms. A prominent participant might tolerate losses differently and could obtain more favourable terms. Superficially similar offerings could give participants different rights and economic outcomes, making the prospectus essential reading. A familiar name supplied neither a valuation method nor a substitute for that reading.
A sponsor could succeed on different economics
The alert stated that sponsors generally acquired equity on more favourable terms than public investors. That could create an incentive to complete a business combination on terms less favourable to those investors. The sponsor's cost basis and reward for completing a transaction could differ from those of someone buying shares in the market.
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| Comparison | Economic position to examine | Decision it can influence |
|---|---|---|
| Sponsor | Acquisition cost, compensation and ownership after completion | Whether completing the proposed combination is attractive |
| Public shareholder | Market purchase price, redemption rights and continuing ownership | Whether to hold the operating company or seek redemption |
| Startup shareholder | Dilution, cash received and continuing obligations | Whether the transaction improves the company's financing position |
Based on the SEC's investor alert and subsequent bulletin on redemption rights and sponsor interests.
For a startup board, sponsor experience remained relevant. Sector knowledge, diligence and relationships in capital markets could help a company prepare for public ownership. The question was how those contributions related to the compensation and ownership the sponsor received. Modelling ownership under several outcomes made the costs and benefits visible, including additional financing, any changed sponsor terms and securities capable of creating further shares.
A subsequent investor bulletin distinguished units, common shares and warrants. A unit can combine a share with a right to buy additional shares under specified conditions. Those instruments may subsequently trade separately. Their exercise terms, expiry and redemption provisions affect the holder differently, so a quoted ticker or headline share price cannot describe every investor's position.
This matters to a startup's capital planning even when its management is focused on product and revenue. A fully diluted ownership model needs the relevant securities and contractual terms. Investor communication should explain which figures refer to operating performance, transaction valuation and ownership. Presenting those measures together without their definitions can obscure how much of the future business each participant will own.
Cash in trust was not a promise to every participant
The updated bulletin also explained the mechanics of redemption. Investors could redeem for their share of the trust account rather than remain invested after the combination. That choice changed the financing available to the operating business. Additional funding might be needed to complete a transaction, including sponsor financing with different rights from public shareholders' investments.
Its example distinguishes a share's market purchase price from the amount associated with the trust account. Paying more in the market does not enlarge the corresponding share of the trust. For an operating company negotiating a transaction, the related cash question is equally concrete: cash raised by the shell and cash ultimately available to the combined business need not be the same amount. Redemptions, transaction costs and any additional committed financing belong in the funding model.
A public listing was an operating commitment
For a growing enterprise software company, choosing a route to public markets also meant accepting an operating commitment. Public ownership required a financial reporting process, governance and a credible explanation of the business to shareholders. A transaction timetable could accelerate that work, but it could not complete it on the company's behalf. Readiness had to be assessed for each company.
A board should assess the transaction against the operating company's future cash needs and responsibilities. It can compare the proposed cash proceeds with its financing plan, examine ownership under realistic alternatives and evaluate what the sponsor contributes beyond attention. Those questions put the SEC's concerns about incentives into practice; the merits of a combination still depend on its documents and circumstances.
Sources
- Celebrity Involvement with SPACs – Investor Alert (opens in a new tab)
US Securities and Exchange Commission, Office of Investor Education and Advocacy
- What You Need to Know About SPACs – Updated Investor Bulletin (opens in a new tab)
US Securities and Exchange Commission, Office of Investor Education and Advocacy
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