5 minute read 12 Apr 2021
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How the SPAC shockwave will shake private equity

Authors
Winna Brown

EY Americas Financial Accounting Advisory Services Private Equity Leader

Trusted advisor to fast-growing, transitional companies. Believes in what matters is who is with you for the ride. Family. Friends. Trusted Relationships.

Pete Witte

EY Global Private Equity Lead Analyst

Helping clients and stakeholders understand the trajectory and impact of vital trends. Developing thought leadership and insightful content. Aspiring platform tennis pro.

5 minute read 12 Apr 2021
Related topics Private equity IPO

SPACs have caused such a stir, PE firms are still imagining their impact.  

In brief
  • SPACs can mean opportunity, competition and conflict for PE investors seeking to deploy a tremendous amount of capital, quickly.
  • The extent to which PE will leverage this new liquidity option will be one to watch.

While SPACs (special purpose acquisition companies) have rotated in and out of investors’ favor in conjunction with the investment cycle, their current boom is wholly unprecedented. Since the beginning of 2020, SPACs have raised a collective US$167b in new capital from investors. Just three months into 2021, SPACs have already exceeded the amount raised in the entirety of last year. January–March saw 258 SPACs raised, with an aggregate value of just over US$83.3b.

SPACs raise capital from investors via an initial public offering (IPO). Funds are held in trust until a suitable target is found, at which point investors can vote to either accept or reject the merger. Shareholders can also redeem their shares in the event they’re not interested in participating in the proposed merger. SPACs generally have two years to find a target; if they don’t, then money is returned to investors.

SPACs can — and are — being sponsored by a wide range of people and institutions, with varying levels of experience and backgrounds: everything from hedge funds to experienced management teams to corporate investors; even certain celebrities have gotten in on the act. With their background in origination, financing and value creation, private equity (PE) firms would appear to be naturally aligned with the SPAC structure and model. Many firms have histories with SPACs that predate the current boom, while others have just recently launched inaugural vehicles. Overall, PE-backed SPACs account for about 10% of the SPACs that have been raised over the past 15 months.

But the implications of the SPAC boom transcend the universe of funds that have sponsored their own vehicles. Indeed, there are implications for the PE industry as a whole:

A tremendous amount of firepower

The critical question: what does it mean for PE from the standpoint of competition? Even before the SPAC boom, PE firms were competing heavily with one another for high-quality assets. And, while SPACs don’t always fish in the same waters as PE firms, there’s enough overlap that many firms are rightly concerned about the impact on deal flow and valuations. Valuations barely budged in 2020, despite the pandemic closing down deal activity for a period of several months last year. The average PE leveraged buyout traded at a multiple of 11x, roughly in line with the 11.1x seen in 2019, and well above the 9.3x at which deals traded in 2007.  

Whether or not new SPAC issuance continues this blistering pace is, at this point, effectively immaterial. With more than US$166b in trust (and another US$59b that is pre-IPO, according to SPAC Research), SPACs have a tremendous amount of assets that must be deployed over the next two years. The average SPAC announces a deal valued at about 4.4x its capital raise (with the additional capital coming from the debt markets and private investment in public equity investors). As such, even without another single new SPAC offering, existing SPACs are on track to announce deals valued at more than US$700b–$800b over the next two years. Compared with an average year for PE, which might see somewhere between US$500b and $550b in deal value in a given year, it’s clearly a tremendous amount of capital for the universe of private companies to digest.

The fourth liquidity option

Talk to any general partner these days, and they’ll tell you they’re fielding multiple calls each week from SPACs looking to transact with PE portfolio companies. The primary benefit of increased liquidity in the market is that it makes exiting portfolio companies easier. So, the increase in SPACs will offer yet another option for firms in addition to their typical exit routes of sales to corporates buyers, sales to other PE firms and traditional IPOs. Since the beginning of the SPAC boom, approximately 30% of companies targeted by SPACs have been owned by PE firms.

In the US alone, there are more than 2,800 companies currently backed by PE firms that were acquired between four and six years ago, the period during which firms tend to look at exiting. For sellers, a merger with a SPAC can be a compelling option; relative to a traditional IPO, the sale process can be easier, cheaper and faster, with economics that are more certain. And, relative to a trade sale, where there may be just a small handful of appropriate strategic acquirors for a particular asset, the universe of potential SPAC transactors is now huge.

Moreover, firms with US-based assets aren’t the only ones likely to benefit from sales to SPACs. As competition for deals grows, SPAC buyers are expected to look cross-border in increasing numbers, seeking targets in both Europe and Asia.

Not without challenges

For sponsors interested in raising SPACs, they’re not without challenges. Where a typical PE deal is focused on value creation during the hold period, with SPACs, the focus is different: target selection, the acquisition process and the right management team are paramount. Additionally, there may be reputational risks for SPACs that perform poorly such that they impact the sponsors’ broader fund complexes.

Limited partners are watching the current crop of SPACs closely for conflicts of interest, for example, in instances in which a SPAC and a fund might be pursuing the same opportunity or for conflicts of interest in how sponsors manage their time across funds and SPAC vehicles. Some funds are experimenting with ways to share the economics with their LPs, by placing the SPAC inside of the fund or by effectively negotiating a co-investment with the SPAC.

Time will tell the degree to which SPACs remain such a dominant mode of capital formation. Already, the market is seeing a measure of change in SPAC economics as their proliferation spurs more investor-friendly terms, such as lower promotes and longer lockup periods. What’s certain is that whatever happens over the next several months with respect to issuance, SPACs’ presence will be widely felt in the M&A arena for at least the next two to three years. 

Summary

The extent to which PE may embrace a SPAC strategy to rethink hold period priorities or recalibrate portfolio company exits remains to be seen. 

About this article

Authors
Winna Brown

EY Americas Financial Accounting Advisory Services Private Equity Leader

Trusted advisor to fast-growing, transitional companies. Believes in what matters is who is with you for the ride. Family. Friends. Trusted Relationships.

Pete Witte

EY Global Private Equity Lead Analyst

Helping clients and stakeholders understand the trajectory and impact of vital trends. Developing thought leadership and insightful content. Aspiring platform tennis pro.

Related topics Private equity IPO