University of Pennsylvania Journal of Business Law
Special Purpose Acquisition Companies, or SPACs, have come to play a large role in bringing together small and large investors in the acquisition and expansion of private companies. A pessimistic version of this relatively recent alternative to conventional initial public offerings (IPOs), and other methods of investing in companies ready to expand, is that clever sharks take advantage of overly optimistic and ill-informed small investors. This Article offers a very different view. It shows that common investors need someone to locate good investment opportunities, and then they often benefit if another well-informed party can credibly vouch for the entity that claims to have found a good target. It also suggests the development of other means of vouching for parties that claim to have found worthy targets for investment.
The analysis focuses first on SPACs that have recently arisen to play the important role of finding targets, and then on PIPEs (Private Investor(s)in Public Equity) that serve the role of evaluating and certifying those SPACs. Each of these is rewarded for what it does along the “financing chain.” SPACs and PIPEs are to be welcomed rather than feared, and they are not unlike parties that discover and vouch for good products and ideas in other sectors. Small investors would benefit from knowing when and at what prices potential PIPEs turned down deals, and they might benefit if SPAC founders earned lower rewards as the period during which they have use of investors’ funds comes towards an end. The discussion shows how these problems are related to those found in other markets, such as the information consumers can (and cannot) derive from knowledge about a large purchase that preceded them. Hertz’s purchase of a Toyota, and Warren Buffett’s purchase of stock, are not terribly different from a PIPE’s purchase of a SPAC.
Recent literature has strongly criticized SPAC founders, and the absence of much legal oversite, for aggressively seeking compensation at the expense of common investors. For most SPACs, founders must close a deal within two years in order to receive compensation. It is plausible that founders will rush to find a target as the deadline approaches. Although investors have the right to exit the SPAC at the price that they paid (known as a “redemption right”), they may believe that the SPAC has finally found a good investment—even in the final hour. To assess investor redemptions and deadlines, we construct a sample of eighty-seven SPACs that completed an IPO between June 2015 and December 2018, and then merged with a target before June 2022. The data suggest that investors do not regularly exit as the two-year deadline approaches, but instead often give the founder a single extension before growing impatient. We find that each additional day toward a three-year deadline impacts redemptions. Given the founders’ urge to close, we might expect the contractual rules governing investor exit, as well as stock exchange listing rules governing deadlines, to change so that SPACs are no longer rushed. This might be done in several ways, including a sliding scale reduction in the ownership retained by the SPAC as the search period proceeds. In the interim, a partial solution to this end-period problem seems to have emerged, though SPAC critics do not seem to have noticed the end-period problem or the evolving solution to it. In sum, investors rely on SPACs to discover targets; they will grant extensions, but grow impatient and eventually exit, as should be expected. Moreover, they rely on—and pay—sophisticated investors, in the form of PIPEs, to evaluate SPACs.
Finally, this Article suggests alternatives to SPACs that might arise with a little help from changes in law. Prediction markets could aggregate information possessed by many small parties. SPACs themselves, or yet other providers, might offer insurance against the possibility of a target whose bad quality can be detected only with fact finding that is difficult for dispersed, small investors to obtain.
Frank Fagan & Saul Levmore, "SPACs, PIPEs, and Common Investors," 25 University of Pennsylvania Journal of Business Law 103 (2023).