SPACs - How can IPO investors incur losses?

Question

I'm trying to understand the role of the initial IPO investors of a SPAC. From the Beginner's Guide of r/SPACs:

When the IPO occurs, a SPAC generally offers Units – generally at \$10 per Unit. These Units are comprised of one share of common stock (Share) and a Warrant (or portion of a warrant) to purchase common stock (generally exercisable at $11.50).

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In the weeks after the IPO, the common stock (Shares) and Warrants included in SPAC Units become separable. At that point, the Warrants and Shares trade separately alongside the unseparated Units.

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[SPAC] Companies will typically have a \$10 floor on their share price, as that is what must be paid out to holders of shares if the company does not successfully reach a deal.

The IPO investors could just sell their common shares for at least $10 right after the IPO (often much higher as we have seen recently) and are left with the warrant. This is essentially an opportunity for free money without any risks or downsides, apart from cash being locked up before before the common shares are traded publicly. For sure such an arbitrage opportunity cannot exist, so what am I missing here?

Answer 1

NB: IPO investors are not the same as sponsors. "Sponsor" refers to the entity putting up the risk capital.

"The IPO investors could just sell their common shares for at least $10 right after the IPO" - no, they cannot. The unit (stock + warrant) doesn't split until a certain number of days after IPO (often but not always 52).

"For sure such an arbitrage opportunity cannot exist" - it's not an arbitrage. There have been periods where many or even most SPAC IPOs have traded below par on day one; some remained there for extended periods.

EDIT: re "[SPAC] Companies will typically have a \$10 floor on their share price, as that is what must be paid out to holders of shares if the company does not successfully reach a deal" - this is wrong, or at least misleading, in several regards. Firstly, there is no "floor", simply a put. Secondly, it's at trust value, not at $10. Thirdly, investors can exercise their put irrespective of whether or not the SPAC completes a 'business combination'.

Answer 2

I've done research on SPAC last fall. Happy to share the link if you are interested.

Long story short, it is an arbitrage because of the volatility of stocks and investors being paid for that volatility (Very unusual). Refer to this Bloomberg article: https://www.bloomberg.com/news/newsletters/2021-01-08/money-stuff-spac-magic-isn-t-free

It is also a risk-free trade for IPO investors who are able to redeem their shares before any official merger/acquisition announcement for the following reasons:

1. Current SPAC IPO units (stock + warrant) basically consists of 1 stock and 1/3 warrant per unit. Each unit typically costs $10. Reference to Navigation Capital Acquisition VII Corp which just filed their S-1 today. https://www.sec.gov/Archives/edgar/data/1860430/000119312521201862/d63915ds1.htm

This is an initial public offering of our securities. Each unit has an offering price of $10.00 and consists of one share of Class A common stock and one-third of one redeemable warrant.

2. You can redeem your stock from the SPAC company at $10/share from their trust account.

NYSE rules provide that at least 90% of the gross proceeds from this offering and the sale of the private placement warrants be deposited in a trust account.

As long as you are not the last out of the door, your stock is guaranteed a floor of $10 + interest (assuming positive interest rates in the USA) prior to the major shareholder meeting.

You do not even have to sell it on the market. Hence the market price of SPAC stocks is floored at $10.

the proceeds from this offering and the sale of the private placement warrants will not be released from the trust account until the earliest of (i) the completion of our initial business combination,

However, after the initial business combination is completed, the proceeds in the trust account is subjected to creditors' claims.

The proceeds deposited in the trust account could, however, become subject to the claims of our creditors which would have higher priority than the claims of our public stockholders.

3. The warrant has a strike price of $11.50. Most SPAC stocks do not even cross that mark for warrants to be ITM. Refer to this research titled "SPAC IPOs" https://www.econstor.eu/bitstream/10419/177392/1/2017-02-12%20SPAC%20IPOs%20Chapter%20SSRN.pdf

You can read up more about SPACs in-depth in this series of Harvard Law School articles. https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/ https://corpgov.law.harvard.edu/2020/08/17/update-on-special-purpose-acquisition-companies/ https://corpgov.law.harvard.edu/2020/08/22/the-resurgence-of-spacs-observations-and-considerations/ https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/ https://corpgov.law.harvard.edu/2020/11/21/investing-in-a-spac/