Why is Pershing Square's SPAC Different? What's a Tontine? Why Should I care?

A brief overview of financial history and financial engineering.

Historically, SPACs have turned out to be a bad deal for retail investors, and have underperformed the market. And some have collapsed due to fraud.

Traditionally, SPAC sponsors received shares and warrants as compensation for sponsoring the SPAC. Further, these sponsors could redeem (sell) their shares upon acquisition of a target, and hold onto the warrants. The warrants are essentially a call option on the shares: if the shares perform well in the public markets, the sponsors could convert the warrants back into shares and ride the equity rocket. If the shares underperform, well, the sponsors already redeemed their shares, and pocketed some profit. Heads, the sponsor wins, tails, the retail investor loses.

Pershing Square’s SPAC is structured somewhat differently. Sponsors still receive a put option on their shares: they can sell the shares upon acquisition of a target company. However, a penalty is assessed upon those who exercise the put option: they forfeit 2/3rds of the warrants they were given. Since there is an arbitrage opportunity between the SPAC equity and the SPAC warrants, those who redeem shares have a smaller arbitrage opportunity than those who hold onto their shares.

The “tontine” part of the structure: the forfeited warrants are re-allocated, pro-rata, to those Sponsors who retain their shares. This is similar to how a traditional tontine life insurance policy works: interest in the pooled fund is re-allocated, pro-rata, every time one of the insurance holders dies, to the surviving policyholders. (The fact that tontine owners benefit when one of their cohort dies is why tontines have traditionally been so controversial.)

The net result here is that (in theory), Pershing Square SPAC sponsors have an incentive to hold on to their shares. Further, since these sponsors have an incentive to retain their shares post-acquisition, these sponsors also have an incentive to ensure that the company the SPAC acquires is not just any company that fulfills its investment mandate, but rather that the acquisition is a good opportunity which will grow over time.

Thus, this structure should align the SPAC sponsors’ interests with those of other shareholders and those of the acquisition target. It is in the SPAC sponsors’ interest to (1) hold their shares and (2) ensure that only a quality company is acquired.