Special purpose acquisition companies (SPACs) provide private equity sponsors with a way of tapping into high valuations provided in public markets and new sources of capital. They present fertile ground for private equity firms, but they are not without their challenges for the mid-market.
In a keynote interview for Private Equity International, we consider opportunities and explore the potential challenges and conflicts of SPACs. Here are some takeaways:
- There has been significant interest from private equity sponsors in SPACs over the past two years, both as a means to facilitate exits and as a new source of assets under management. This interest is not only from large private equity sponsors but also with a number of mid-market players who have sponsored SPACs.
- There are two primary use cases for private equity for SPACs. The first is the opportunity for private
equity funds to sponsor SPAC vehicles, about 10 percent of which are backed by private equity funds today. The second use case for private equity firms is their portfolio companies make for good targets for SPAC transactions.
- We have seen SPAC IPOs and stock prices experiencing a very sharp decline recently in light of market concerns and regulatory scrutiny and there has been a corresponding increase in difficulty in raising the private investment in public equity (PIPE) financing that usually accompanies a de-SPAC transaction.
- In terms of challenges of SPACs for mid-market PE funds, the lifecycle of a typical private equity buyout investment consists of firms buying complete control of a private company, spending four to six years fixing it up, and then selling it and generating returns through a combination of financial engineering and operational improvements. This playbook does not really work in a SPAC, where once you find a target you are taking a small minority stake with maybe a couple of board seats but none of the typical governance rights or ability to engage in substantial financial engineering of the capital structure. The other challenge is competition – there are currently 427 SPACs with USD 166 billion in trust, which is a lot of firepower all circling the same thing: a public market-ready mature start-up that is a diamond in the rough.
You can read the full interview on Private Equity International where we also share our thoughts around why private equity portfolio companies are good SPAC targets, conflicts that SPAC transactions can cause for private equity, and how the SPAC market will evolve going into 2022.