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Can SPACs Accelerate the Move Towards a Carbon Free Economy?

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Basketball ball legend Shaquille O’Neal is playing the game. Former House of Representatives Speaker Paul Ryan has become a part of the wave. And Microsoft co-founder Bill Gates is funding it. I am referring to the newest way of making money for investors: Special Purpose Acquisition Companies (SPACs).

Also known as reverse mergers, SPACs are the latest method for startups to raise money from public markets. The mechanics of SPACs are an inverse to the traditional initial public offering (IPO) process. A shell company, generally focused on a specific sector, and with a sponsor (a private equity company or an investment firm) and without any revenue, goes public with the help of investors. The publicly-listed company has two years to merge with a startup (or another company) using funds raised in the public offering. Once it identifies a suitable target, the shell company performs a reverse merger with it. Investors in the original SPAC venture cash out and the shell ceases to exist, its listing replaced with that of the target venture.   

According to data from research firm Dealogic, U.S – listed SPACs raised $82 billion in 2020, almost six times greater than their total for the previous year. Startups from various sectors, including real estate and healthcare, have gone public using this new form of funding.  SPACs have also attracted clean energy startups interested in bolstering their balance sheet with funds from public markets.  

While they could be pivotal to making the energy transition for a zero-carbon economy, SPACs come with several caveats. As such, they might end up being a bubble that generates short-term profits for investors but does little to transform the sustainability industry.

SPACs And Green Energy: A Complicated Equation

According to the Wall Street Journal, more than a dozen blank check firms were formed last year to take startups focused on sustainability public. Bloomberg reported, at the end of September last year, that there were nine clean-energy companies with SPAC partners.

The attraction of SPACs to investors in climate change and sustainability startups lies in their structure. Unlike IPOs, which have stringent disclosure rules for companies going public, SPACs are pretty lax in the way that they treat entrepreneur claims for estimated revenue figures. In an ecosystem currently infested with regulatory bottlenecks that cut into and delay revenue, that can be blessing. Startups focused on green energy tech are stuck in a limbo due to the tangle of regulations that govern green energy and electricity markets. Typically, the time horizons for investors to get a payout from such companies is also longer as compared to other industries due to industry’s structure and emphasis on regulation.

But a SPAC offering shortens the timeframe for their investment. They guarantee a return even in the absence of revenues because investors can offload their companies onto public markets. The short timeframes should help generate more funds and encourage development of riskier technology, which may not have a market yet, in the cleantech sector.  Several investors got burnt in the first wave of cleantech funding, when after multiple clean energy startups failed, sinking their investors’ money, even after the Obama administration passed the American Recovery and Reinvestment Act (ARRA) that encouraged clean tech investments.

While this state of affairs may not always be in the best interests of retail investors, it can buy valuable time and funds for the company to develop a marketable product. A great example is electric car company Tesla, which recently turned profitable after multiple quarters of losses and operational delays.

But fewer SPAC curbs on disclosure can also have the opposite effect and encourage fraud in public markets. In recent times, companies have made outlandish future revenue estimates that could end up harming retail investors. Nikola, an electric truck company whose shares soared on debut and crashed after it was found to have lied about its prospects, is an instructive case from the cleantech sector. Other companies are not shying away from lofty valuations either.

Consider the case of Eos Storage, a company I have written about earlier. It merged with B. Riley Principal Merger Corp. – II last year. The merger valued Eos at $550 million, a figure that represents approximately two times its estimated revenue in 2022. For the first three quarters last year, the company reported a total of $35,000 in revenue. It would require a leap of faith on the part of investors and senior management to believe that the company will reach its estimated revenue figures for 2022.

The story does not stop there. Of the nine clean-energy companies with SPAC partners I referred to earlier, five had no revenues and only one – LIDAR tech company Velodyne – had a “meaningful revenue” of $1 million in 2020.

Of course, this does not mean that all SPAC companies are doomed. At least, as far as cleantech is concerned, SPACs have strong tailwinds in the form of a global shift towards clean energy. ESG disclosures, which might become mandatory for publicly-listed companies with the incoming administration, will bring in more business for such companies. Regulation, which was an impediment to their revenues earlier, now facilitates their growth. Plus, public listings will allow these companies to access greater reserves of cash than they could garner in private markets and accelerate the move towards a zero-carbon economy. But those expectations must be balanced with realistic and strong execution on the ground. Else, cleantech might just become another stock market bubble. 

Rakesh  Sharma's picture

Thank Rakesh for the Post!

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Matt Chester's picture
Matt Chester on Jan 20, 2021

According to data from research firm Dealogic, U.S – listed SPACs raised $82 billion in 2020, almost six times greater than their total for the previous year.

Wow, 2020 was a huge year for them-- is there anything perhaps tied to the economic conditions from COVID that played into this? Is there a different risk profile maybe? Or was it the other way-- tempered by the recession and a 'normal' year would have seen even greater growth? 

Rakesh  Sharma's picture
Rakesh Sharma on Jan 20, 2021

Good question, Matt. I think COVID played a decisive role in moving the needle on green energy and climate change. The economic conditions it fostered - low interest rates, stimulus money - also led to a general macroeconomic stability that had investors looking for other profit instruments besides Treasury bonds. As I highlighted in the piece, SPACs do not undergo the same due diligence process as an IPO. Therefore, they are riskier instruments that are generally avoided by institutional investors looking for target returns. But last year's economic uncertainty has propelled alternative instruments, such as Bitcoin and corporate bonds, into the spotlight, ahead of traditional safe havens, such as gold and government bonds. 

The Biden administration's decisive pivot towards green technologies helped make startups in the sector more attractive to investors because now they have government backing, in the form of regulation, to create new markets. 

Plus, SPACs are a good proposition for investors and entrepreneurs. Instead of slogging for years on end to generate revenue (and profits) for a healthy balance sheet to show to public markets, entrepreneurs can actually take this back entry door to access them. From what I understand, SPACs also allow institutional investors - hedge funds, pension funds, and sovereign funds are among those who invested in SPACs last year - to redeem their shares before the reverse merger actually happens while collecting interest money and the right to purchase one-half and one share of the company at an exercise price of $11.50 any time over the following five years.

A Stanford law professor studied SPACs that completed a merger between January 2019 and June 2020 and found that even with an average drop of 12% in the company's value six months after being listed, SPAC sponsors enjoyed a return on investment of more than 500% at the end of 2020.    

Ok, now I must get back to work. 

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