23andMe’s failure shows how risky it can be to invest in a SPAC

23andMe is going bankrupt — underscoring the great risks of investing in many of the companies that have gone public via mergers with special-purpose acquisition corporations.

When companies opt for traditional initial public offerings, they host roadshows with prospective investors who laser in on their financials. Since executives expect that sort of grilling, they typically wait until they have more mature businesses before moving forward with an IPO.

But mergers with SPACs have been a way for companies to get public-market listings without subjecting themselves to the heavy scrutiny of the IPO process. A private company will opt to merge with an already listed blank-check company, whose mission is to make acquisitions. Then the SPAC converts its ticker symbol and name over to one matching the name of the acquired business. This process in the past initially tended to attract higher-risk, early stage companies because there were fewer regulatory requirements and disclosure rules were not as stringent.

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Genetics-testing company 23andMe Holding Co. ME merged in 2021 with a SPAC formed by British billionaire magnate Richard Branson. The deal was valued at $3.5 billion, and the company said it had a pro-forma cash balance of over $900 million after the offering.

A few months later, when 23andMe addressed investors on its earnings call for the June quarter, it had $770 million in cash, an indication of the cash burdens involved in the SPAC process. Companies must give their sponsors 20% of the shares.

“The costs are so high,” said Michael Klausner, a professor of business and law at Stanford University Law School, who has been researching and writing about the risks of SPACs and their dilutive qualities for several years. “The cash out the door is higher than what the underwriters are paid” in a standard IPO, he added.

Cash is the lifeblood of startups and many public de-SPACs are still like startups. They, too, need a lot of cash, especially if they are not generating much revenue. In the case of 23andMe, revenue ultimately slowed, as customers only needed to buy the DNA test kits once. Its efforts to expand into telehealth and drug development did not generate much revenue.

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When 23andMe last reported earnings, it posted $44 million in revenue for its September quarter. That was down from $50 million a year earlier and $55 million in the September quarter of 2021, shortly after the SPAC merger. Last November, it had $127 million in cash and equivalents.

For investors, the ride has been painful. Just before the 23andMe SPAC deal closed, the stock belonging to its merger partner traded north of $266. Now shares trade under a dollar. The remaining board is now contemplating selling its vast trove of customer’s genetic data.

SPACs have been around for years, but they became popular on Wall Street in the immediate post-pandemic era, bringing life to a moribund IPO market. Despite warnings, and stricter regulations from the Securities and Exchange Commission, including additional new rules earlier this year that require enhanced disclosures, making them more aligned with traditional IPOs, SPACs continue to populate the U.S. IPO market and became popular again this year.

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It turns out 23andMe is not the only de-SPAC company to go bankrupt. Debtwire’s restructuring database since 2022 tracks 40 bankruptcies among companies that went public after merging with blank-check corporations

”The frenzy of 2021 saw funding going to lots of troubled names that, frankly, never should have received this kind of financing in the first place,” John Bringardner, the executive editor of Debtwire, told MarketWatch in an email.

The bankruptcies have mostly been Chapter 11 restructurings of troubled companies, including some high profile messes such as WeWork, Bird Global and Lordstown Motors that were able to re-emerge as streamlined businesses. He noted that there have also been two Chapter 7s, or straight liquidations — at Babylon Health, a digital healthcare company, and Electric Last Mile Solutions, a commercial EV maker.

This week, another de-SPAC company caught investor attention when its shares took a big plunge. Nuclear energy company Oklo Inc. OKLO which still has no revenue, posted a wider annual net loss and Monday told analysts it plans to increase its spending in 2025 for operations, with plans to spend between $65 million to $80 million, up from the $38.4 million it spent in 2024. Its shares fell 17.6% for the week.

Oklo went public in May 2024, in a deal that was initially poorly received, until Microsoft and Amazon began buying nuclear power sites to boost their power needs for AI data centers. As nuclear energy became a hot commodity for tech giants, Oklo’s stock hit a high above $55 in early February. It’s swiftly lost more than half its value since then.

Another problem with SPACs, is that once the blank-check company itself is formed, if they don’t find an acquisition target, typically within two years, they are required to return the money to investors and liquidate the SPAC, giving investors the impression it is a risk-free investment.

Some companies do not find appropriate acquisition targets and have to redeem the investors. “Redemption rates are extremely high,” said Klausner, referring to the process when blank-check companies have to return money to investors.

Klausner has written and litigated extensively on the huge dilution in SPAC deals. In January, he wrote that only 14% of the SPACs that merged between 2019 and 2022 were trading above $10.

“They won’t go away,” he said. “They are limping along, much to my chagrin, and I am hoping there are no real investors who are losing money. They have been warned by the market, by the SEC, by the courts. If they still want to take a gamble, that’s tough for them.”