Will SPACs destroy PE?

SPACs will not kill PE. And it's because they only work in times of depressed valuations. Here's a few reasons why:

• The way the GP of the SPAC is compensated for finding a target company is through "Founder's Shares" in the newly acquired business. Usually the GP will get around 20% of the shares outstanding of the new business for finding a company. However, SPACs have stipulations where the stock price must increase by a certain amount in the first few years for the GP to keep their Founder's Shares, otherwise they must give them to the rest of the LPs. So GPs generally only want to raise money for a SPAC when valuations are low, as they want to keep their Founder's Shares, and it's easier for the stock price to increase by the required percentage when you pay less for the company. With standard PE funds, you have time to implement operational changes in a company, perhaps with short term pain in the hopes of achieving long term growth, without the scrutiny of public markets

• Additionally, this stipulation requiring the stock price to increase by a certain amount in the few years following investment to keep Founder's Shares makes it very important to NOT overpay for a business - yet for the most part you are still competing against PE funds and strategics for assets in highly competitive auction processes, where it can become easy to overpay for an asset

• As well, the money a GP raises from investors for a SPAC sits in escrow while the GP searches for a company. Then, the GP has a set period of time to find a company and complete an acquisition. The LPs that are putting up money generally want to decrease the amount of time allowed for a GP to find a target, as this is "dead time" where the LP can't put that money to work in other areas of the market

• Furthermore, LPs generally see SPACs as more risky, as you are giving money to a GP with PE-like fees /dilution (remember, 20% of the shares outstanding in the new business go to the GP which is basically the equivalent to carry for a SPAC) without the diversification that comes with investing in a PE fund - PE funds are able to invest in multiple companies, not just one

• Because the SPAC is only investing in one company, LPs want to make an attempt to secure the most favorable terms possible - decrease the percentage of Founder's Shares given to a GP, decrease the length of time for the GP to find and acquire a target, increase the percentage that the stock price must increase for the GP to keep their Founder's Shares, increase the amount that the GP commits to the SPAC to "increase alignment" with the SPAC. All of these measures make the SPAC much less appealing for the GP due to the risk of the SPAC not succeeding

• Lastly, and this is one of the biggest ones, if the GP doesn't find a target company within the allotted time period, then the GP must return all of the funds for the SPAC to LPs, with interest. And the GP loses all the money that they paid for employees, lawyers, and other services, all for nothing. And the time allowed for the SPAC to find a target is publicly available through the prospectus. So if a bank selling you a company sees that your SPAC is pushing up against its allotted time threshold, then they can really turn the screws on your for valuation - "we know you need to buy a company for your SPAC to complete an acquisition, so here's our price, take it or leave it"

In my opinion, SPACs are just the next passing fad. The same way that people said that direct listings were going to change the world of IPOs, yet we still see SaaS businesses going public at extremely high valuations through traditional IPO processes.

If valuations continue to increase, many of these SPACs will be in very tough situations, as it will be extremely difficult to find an asset at a fair valuation, and even more difficult to improve that asset enough in the public markets to increase the stock price and keep the Founder's Shares.