VCs Used SPACs to Offload Lower-Quality Companies, Study Finds

What's New: 

According to a recent study published in the Journal of Corporate Finance, venture capital firms exploited a lack of regulation and investor naivety in the SPAC market to exit from lower-quality ventures, resulting in substantial underperformance compared to traditional IPO exits.

Why It Matters: 

This research exposes a significant market misconduct pattern during the 2020-2022 SPAC boom, when SPACs accounted for more than half of all U.S. IPOs. The findings suggest that while SPACs offered faster public market access, they may have been used strategically by VCs to divest underperforming assets.

Key Research Findings:

• VC-backed companies exiting through SPACs showed inferior financial metrics compared to IPO peers

• The study examined 129 SPAC mergers with VC-backed ventures and 757 IPOs of VC-backed companies

• Statistical analysis confirmed that exit channel selection, not market conditions, drove performance differences

• Using instrumental variables to control for selection bias, researchers concluded lower-quality ventures were deliberately channeled to SPACs

• Negative correlation between venture quality and SPAC exit likelihood was statistically significant

Big Picture Drivers:

• Selection - VCs channeled smaller, less profitable companies with lower market capitalizations toward SPACs rather than traditional IPOs

• Performance - VC-backed ventures merging with SPACs underperformed the benchmark index by 45% over 180 days, while VC-backed IPOs outperformed by 13%

• Quality - Companies exiting via SPACs had lower analyst-projected future profitability and reduced debt capacity

• Regulation - Insufficient SPAC market gatekeeping and disclosure requirements enabled this exploitative behavior

• Incentives - SPAC sponsors and affiliates had strong motivations to complete mergers regardless of target quality

By The Numbers:

• 45% - Underperformance of SPAC mergers with VC-backed ventures vs. benchmark index

• 31% - Underperformance of SPACs with non-VC-backed targets

• 13% - Outperformance of VC-backed IPOs vs. benchmark

• 129 - SPAC mergers with VC-backed ventures analyzed in the study

• 757 - IPOs of VC-backed companies examined for comparison

Key Trends to Watch:

• New SEC rules adopted in January 2024 aim to enhance SPAC disclosure requirements and investor protections.

• The correlation between exit channel selection and performance suggests investors should scrutinize VC motivations for SPAC exits.

• Less experienced VC syndicates appear more likely to use SPACs as exit vehicles for their portfolio companies.

• Aftermarket volatility is significantly higher for SPAC exits than for traditional IPO exits.

The Wrap: 

This research demonstrates how VCs exploited market inefficiencies to present "lemons as peaches," underscoring the importance of recent regulatory reforms and the need for greater investor caution when evaluating SPAC targets, particularly those backed by venture capital.