Filling in the blanks
Special purpose acquisition companies are about to have a moment. With initial public offerings struggling and mergers effectively halted, pools of cash sitting in publicly-listed vehicles provide an opportunity for dealmaking and going public. But the fees and valuation methodology of SPACs favors their managers. They will be unloved in the deal world until that changes.
A SPAC’s backers, usually one or more folks with relevant track records, set up a company and raise money from investors in an IPO with the intention of making acquisitions. Blank-check companies, as they are also known, used to be a relatively obscure area of the capital markets business. Over the last several years, though, they have become more commonplace as well-known investors including TPG and Third Point have formed them and bought familiar companies like Hostess Brands.
Last month Diamond Eagle Acquisition, a SPAC backed by former MGM Chief Executive Harry Sloan, bought online gambling outfit DraftKings and back-office firm SBTech for cash and stock, effectively merging them and taking the combination public at the same time.
The risk is that the biggest beneficiaries are a SPAC’s managers. They typically receive a 20% stake. In some ways this is like the carried interest that private equity managers get as part of their reward for buying good companies. But carried interest is effectively a share of gains. SPAC executives typically keep a slug of equity whether or not a deal turns out well for other investors although sometimes, as in the case with DraftKings, part of it will be forfeited when negotiating a deal.
Investors in a SPAC have the right to approve a merger. But they have incentives to take a deal even on mediocre terms. As well as shares, they generally receive warrants exercisable only after a transaction is done. While the warrants are only valuable if the vehicle’s stock price goes up, they’re worth nothing if no acquisition is completed. And SPAC investors are stuck with whatever deal terms the manager presents to them.
SPAC managers could better align their incentives by tying compensation more closely to stock-price performance after they make an acquisition, rather than collecting a hefty payoff just for doing a deal. Some managers would gain credibility by adding more of their own cash to the mix, too. A blank check needn’t come with carte blanche on governance.