It’s a big loud acquisitions mania, and no one knows how it will end

SPACs are hot, but has this way of taking a company public created a risky game of musical chairs?

SPACS offer a shortcut to the stock market. But some experts worry that their rapid rise may not be sustainable.Michael Nagle/Photographer: Michael Nagle/Bloo

There are more than 400 companies running around with boxes of cash, looking to buy other businesses. Some, known as special purpose acquisition companies, or SPACs, are based in Massachusetts, and some of the companies they are considering buying are based here.

SPAC mania is like a giant, loud game of musical chairs, and no one knows exactly how it will end — or even whether it will end — because it hasn’t been played at this scale before. Essentially, SPACs allow the kinds of dealsthat can give their creators a big financial upside, and give privately held companies a shortcut to a public stock listing.

It begins with a “box of cash” — that’s a phrase that Tim Clarke, head of research at AGC, a Boston investment bank, likes to use — and ends with the acquired company being traded on the stock market. It’s a path to a public stock listing taken by Massachusetts companies such as XL Fleet, which converts trucks and vans into electric hybrid vehicles, and Berkshire Grey, which designs robots that work in warehouses.

One thing to understand is that the people who form these SPACs, and fill up the boxes with cash from other investors, stand to make millions of dollars, without a whole lot at stake, Clarke says. If they set up a hypothetical $100 million SPAC and take it public, they’d own 20 percent of the public company, but have ponied up only about $3 million in “at risk capital,” Clarke says.

The potential downside is that if a deal to acquire a business doesn’t come together within a defined time period, usually about two years, the SPAC creators stand to lose their money, while the other investors can get their original money back.

And a startup that chooses this route to the public markets doesn’t risk leaving money on the table if its stock price is set by investment bankers at $10 per share, but pops up to $20 on the first day of trading.

“It’s a more efficient pricing mechanism,” says Paul Deninger, a longtime Boston investment banker. He believes SPACs represent a fundamental change in how the stock market will operate.

For individual investors, SPACs may offer a chance to get in earlier on fast-growing companies, Deninger contends. They’re a “democratization of capital,” allowing individuals to buy stock in companies earlier in their growth trajectories, says Deninger, who believes that promising companies in recent years have stayed private for too long. (Yes, some of these companies may present an opportunity akin to buying Microsoft stock in 1986, but others may be like buying Pets.com shares just before the Nasdaq crash of 2000.)

Deninger, as it happens, has a box crammed with $350 million called Epiphany Technology Acquisition Corp., which he took public in January. (His partners in Epiphany are Peter Bell, a Silicon Valley venture capitalist, and Art Coviello, the former CEO of RSA Security.) That doesn’t mean that Epiphany is hunting for a $350 million purchase, Clarke explains, because SPACs can raise even more money from investors through a PIPE transaction — a private investment in a public equity — once they identify businesses to buy. Clarke says the average multiplier is about 7X, meaning that Epiphany could potentially put together a deal to buy a company worth about $2.4 billion. The average size of a SPAC deal, Clarke says, is about $2 billion.

In addition to Epiphany, two Boston-area venture capital firms, General Catalyst Partners and Highland Capital Partners, have also created SPACs. General Catalyst’s most recent SPAC entity, announced in March, is run by Jim Cash, a longtime Harvard Business School professor who has served on the boards of Walmart and State Street Corp. It’s seeking to acquire “disruptive enterprise software businesses,” according to a filing, and will dedicate an unspecified portion of its proceeds to a new foundation that will support the “economic empowerment and inclusion of underrepresented groups.” (Cash was Harvard’s first Black tenured professor, and he has often been the first Black board member at public companies.)

Asked about the 400 SPACs searching for companies to acquire — compared to fewer than 100 a year ago — Deninger acknowledges “it’s a bit of a bubble, and there’s likely to be a reckoning. But all I would say is, the Internet bubble burst, but the Internet was real.”

The companies that managed to survive the dot-com winnowing in 2000 and 2001 are all trading at higher prices than they were two decades ago, he says. “You can always count on Wall Street to do anything and everything to excess,” Deninger says. “And we’re at a moment of excess in the SPAC market right now.”

Boston-area startups such as Whoop, Iora Health, Formlabs, Flywire, Klaviyo, Thrasio, Circle, and Kyruus are probably fielding a lot of calls from SPAC executives sniffing around for potential acquisition targets, according to investors, bankers, and entrepreneurs with whom I spoke.

What about Toast, the restaurant management software startup that is reportedly preparing for a traditional initial public offering?

“I think they’re absolutely considering both paths,” says Clarke, referring to an old-school IPO versus a SPAC acquisition. (Others, like Paul Bowen of the investment bank Bowen Advisors, say that Toast’s valuation, likely north of $5 billion, may be out of reach for most SPACs.)

Venture capitalist Michael Greeley says he worries that with so many SPACs searching for companies to buy, the quality of what they eventually find will inevitably slide. Those that may not be able to raise a next round of funding from venture capitalists or private equity firms “are going the SPAC route, because there are so many SPACs,” he says.

As an investor in health care startups, Greeley hasn’t been tempted to advise them to go public via a SPAC acquisition, he says. In part, it’s because he’s wary of owning shares in a newly public company that may not have been ready to be public, with a share price that is getting pummeled. “The aftermarket performance of these SPACs has really disappointed,” Greeley says. “It’s well below other public benchmarks.”

And as the clock starts ticking down on SPACs formed in 2020 and 2021, Greeley says, they are likely to get more desperate to find companies that will accept their boxes full of cash, which will further lower the bar for quality.

Clarke observes that since Easter, SPAC deals seem to be taking a breather. “It has definitely hit the indigestion phase,” Clarke says. “From December through February, we were seeing 20 to 30 filings and completed [SPAC] IPOs a week, and now it’s down to four or five.” Clarke says the hedge funds and other investors that put the initial millions into SPACs simply can’t work through 30 deals a week. “It was unsustainable; it was unheard-of,” he says.

SPACs may be a fad, or they may be a path to a public listing that remains appealing for some companies. But one thing hasn’t changed about the stock market, amidst SPAC mania: Public companies are expected to hit their earnings targets. And if companies that go public via SPAC aren’t able to do that, caveat emptor.