Are SPACs a Cheaper Way to Go Public?

Written By: Ryo Hashimoto

Reviewed by: Ralph DiFiore (CCO), Marcus Magarian, Chris Gioffre

Digital World Acquisition Corp (NYSE: DWAC) skyrocketed by as much as 1,657% in October 2021, after former US President Donald Trump announced a deal to list Trump Media & Technology Group through a Special Purpose Acquisition Company, commonly known as “SPAC.” Both the number of SPACs IPOs and gross proceeds have seen tremendous growth in 2020; the Gross Proceeds have grown more than six times compared to the previous year. Some recent commentary has referred to a SPAC “bubble” and SPAC “hype” due to the rapidly-growing IPO funding.  However, are SPACs a cheaper way to go public?

While SPACs have been touted as a cheaper way to go public than an IPO, the question is: Is SPAC really a cheaper way for private companies to go public than the traditional IPO? There are a few factors that we need to consider to evaluate the real cost of a SPAC; such as: the underwriting fee, the promote and warrants. 

Underwriting Fees

Underwriters typically charge their clients 5-7% of IPO proceeds in traditional IPO. On the other hand, SPAC underwriting fees are typically between 5% and 5.5% of IPO proceeds, which are slightly less than the typical fees in a traditional IPO. One thing that we should always keep in mind is that in most SPACs, most shares are redeemed upon merger. When a SPAC proposes a merger, SPAC shareholders have an option to redeem their shares rather than participate in the merger. When the SPAC shareholders decide to redeem the share, they get back their full investment. The underwriting fee, on the contrary, is not redeemed and rarely is it adjusted at the time of the merger. So, if one measures the fee in relation to the funds ultimately invested in a company that goes public, the underwriting fee ends up being higher than 5 – 5.5%. Hypothetically, if 50% of a SPAC’s shares are redeemed upon the merger, the fee what was initially 5.5%, soars up to 11%. From the perspective of the merged entity, underwriting fees represent depleted cash. To the extent the post-merger company receives cash from the SPAC, the underwriting fee is the cost of receiving that cash. The table below displays underwriting fees for the 2019-20 Merger Cohort. The table is created based on the underwriting fees for all 47 SPACs that merged between January 2019 and June 2020. First, it shows the fees by IPO proceeds, as an underwriting fee is typically measured. The median is 5.5% of IPO proceeds. Then, it modifies the fee as a percentage of proceeds from IPO shares that are not redeemed and that are therefore invested in the target company. Measured that way, median fees are 16.3%. This clearly reflects what I have discussed in the earlier paragraph; redemption drives up the actual underwriting cost. Furthermore, the median redemptions are over 73%, and redemptions over 90% are not unusual[2]. With that being said, the effective underwriting fees in SPACs are a lot higher than that of traditional IPOs’. 

Mysterious Promote

In a SPAC, unlike IPOs, the Sponsor (forms a corporation and working with an underwriter to have the SPAC go public in an IPO) receive a 20% stake, called a “Promote,” Sponsors compensate themselves for the work they do for a SPAC by taking, at a nominal price, a block of shares equal to 25% of IPO proceeds, or equivalently, 20% of shares outstanding after the IPO. Nonetheless, this clearly dilutes the equity. As discussed in the previous section, shareholders’ redemption plays a significant role here as well; more redemption means greater impact of promotes on overall dilution. Since redemption happens too frequent, the percentage of promote tends to be higher than the rates shown. Promote fee structure is highly questionable; it is hard to believe that people who establish the SPAC spending a couple hundred thousand dollars for IPOing the blank-check company can walk away with almost a quarter of the stake.

Warrants

Lastly, let’s consider warrants. The role of SPAC warrants is to attract IPO investors and compensate them for investing in a vehicle that will hold Treasury notes between the time of the SPAC’s IPO and the time of its merger. But from the perspective of a post-merger company, warrants and rights are legacy claims that dilute post-merger share value. The dilution caused by the warrants and rights associated with redeemed shares is clear. The redemption price equals the IPO price of a full unit, and yet a shareholder that redeems its shares keeps the warrants. Warrants, therefore, are in effect given out for free to the extent of redemptions. For post-merger shareholders, this is straightforward dilution. Suppose, however, this SPAC experiences 50% redemptions. There will still be the same number of warrants outstanding. Effectively, then, the number of warrants per unit—and the resulting dilution per share—has doubled.

The sponsor’s promote, the underwriting fee for redeemed shares, and the warrants included in publicly issued units create an overhang of dilution for the SPAC’s eventual merger, and the redemption right amplifies that dilution. If the SPAC merger generates enough surplus to fill the hole created by this dilution, then the target and the SPAC shareholders can come out ahead although the dilution is still present as a cost.

The table below shows the total cost of these three sources of dilution: the sponsor’s promote, the underwriting fee, and the warrants and rights for all 47 SPACs that merged between January 2019 and June 2020. The first panel of the table shows the total cost as a percentage of the cash SPACs deliver to target companies. The cost shown here is staggering. The median cost of dilution is 50.4% of the money raised. In other words, if the median SPAC has $100 to deliver to the combined, post-merger company, the company will bear a cost of $50.40 in dilution.

Speaking of the most post-merger performance, SPACs are not performing well. Two-thirds of the 36 currently publicly traded SPACs that went public after Jan. 1, 2019, are reporting a loss in value. And for the most part, they are not small dips: The average depreciation in value of the 24 negatively performing post-merger entities is 26%, with the two worst performers reporting a loss in value of over 60%[3].

We agree with the claim that a SPAC merger may offer advantages over the IPO process for firms with information that is difficult to convey to investors or firms that investors have difficulty valuing. However, the costly structure of SPACs and their related poor post-merger price-performance leaves SPAC a big question. It is hard to believe that SPAC shareholders will continue for long to buy and hold shares through mergers that leave them bearing the costs of the SPAC structure. People might have noticed how ridiculous it is already – After the SPAC issuance peaked out in February 2021, the number of SPACs seems to be in the downward trend. Considering the very un-efficient fee structure and poor post-merger performance, I am not surprised if the bubble has already burst.

[1] ”SPAC IPO Transactions: Summary by Year”: 

[2]”A Sober Look at SPACs”:

[3]”ANALYSIS: YTD Post-Merger SPAC Performance Is Mostly Negative”:

[4]”SPAC IPOs by week”: