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A SPAC (special purpose acquisition company) is a publicly traded shell company that is created for the purpose of raising capital in order to acquire an existing company. SPACs are typically formed by sponsors who have expertise in a particular industry and who are looking to acquire a company in that industry. They are also known as blank check companies.
The Special Purpose Acquisition Company, commonly known as SpAC, has garnered significant attention from corporate boards, Wall Street, and media in recent times. As an alternative to traditional IPOs, SpAC has been in existence in various forms for decades, but its success in the United States has been remarkable over the past two years. The investment figures are quite astonishing, with $59 and $13 billion invested in 2019, $247 and $80 billion in 2020, and an impressive $295 and $96 billion invested in the first quarter of 2021 alone. In 2020, more than 50% of new companies registered in the US were SpACs, underscoring the increasing popularity of this unique investment vehicle.
What is an SPAC?
A special purpose company, or SPAC, is a type of shell company that investors establish to raise funds through an initial public offering (IPO) and subsequently acquire other firms. For instance, Diamond Eagle Acquisition Corporation was formed in 2019 and became a SPAC in December of that year. Subsequently, it announced a merger with DraftKings and gambling technology platform SBTech. Once the deal was completed last April, Draft Kings started trading as a publicly traded company.
SPACs do not engage in any commercial activities. They do not produce or sell goods. In reality, according to the SEC, the only assets of a SPAC are usually the funds raised during its IPO.
Institutional investors, private investors, and Wall Street professionals from the hedge fund sector typically establish or sponsor SPACs, while well-known executives like Richard Branson and billionaire Tillman Puttitta have used this route to create their own SPACs.
How does SPAC work?
A SPAC, also known as a special purpose acquisition company, is a company that primarily exists on paper and lacks offices or employees. This allows the founders of the SPAC to be a major selling point, particularly if they have a strong track record of successful investments and experience with mergers and acquisitions (M&A), which can attract potential investors.
Frequently, a SPAC is established without identifying a specific "target company." The target company is the business that the SPAC intends to acquire. SPACs are often referred to as "white paper companies" since investors provide funds to the SPAC before any acquisitions are initiated.
Why have private companies turned their eyes to SPAC?
Private companies seeking to go public can opt for the SPAC route for various reasons, the most significant of which is access to capital and operational expertise that SPACs offer.
Moreover, listing through SPACs is much more cost-effective than traditional IPOs, which usually entail substantial expenses. Additionally, listing schedules in SPACs are usually much quicker since there are fewer regulatory obstacles to navigate. Private companies can overcome these obstacles by acquiring an existing SPAC or merging with one.
SPAC Life Cycle.
If you find the SPAC process complicated, don't worry. Here's a step-by-step guide to the typical SPAC workflow:
- SPAC Formation: SPACs are generally formed by a group of sponsors, which can include established investors, private equity firms, or venture capitalists.
- SPAC IPO: The SPAC goes through a standard IPO process, but the sponsor doesn't publicly name the company it intends to acquire, avoiding the more complex SEC process. The SPAC is assigned a ticker symbol, and most of the money invested by shareholders is held in escrow.
- Acquisition Search: SPACs typically have two years to locate and merge or acquire a private company, during which time they become part of a registered SPAC and go public. Meeting this timeline can be easy because sponsors may have a particular company or industry in mind early on. If the SPAC doesn't merge with a company within two years, shareholders get their money back. This makes SPAC less risky than a traditional IPO, which offers listed stock that doesn't guarantee ROI.
- Completion of Acquisition: Once the SPAC sponsor determines the company to be acquired, it must be formally announced, and a majority of shareholders must approve the transaction. The SPAC may require additional funds, often by issuing more shares, to purchase the company. When all is said and done, the target company will be listed on the stock exchange.
What happens with SPAC mergers?
SPACs, or Special Purpose Acquisition Companies, are entities that raise capital through a stock exchange listing with common stock priced at $10 and warrants offered as an incentive to attract investors. This initial stock sale, also known as an SPAC promotion or IPO, generates funds that are held in a trust account until a suitable merger partner is identified. Once a merger partner is found, the SPAC negotiates business bonds with private companies by exchanging the IPO funds and interest for its position as a registered company.
Institutional investors may also contribute additional capital in exchange for shares in the target company. While shares valued at $10 or more typically fluctuate once investors learn the terms of trade with the target company, the stock price often increases significantly when an acquisition is announced. However, sentiment changes or excessive dilution resulting from new investor contributions may cause the stock price to fall after the transaction is announced.
The process of dividing the SPAC typically begins after the merger is announced, with investors voting on the deal and other legal matters being resolved. In 2019, Richard Branson's space tourism startup Virgin Galactic merged with Social Capital Hedosophia Holdings, an SPAC formed by venture capitalist Hamat Palihapitiya. Shareholders of Social Capital Hedosophia Holdings received 49% of the combined company, while Virgin Galactic received around $800 million in cash and a public ticker for trading on the stock exchange.
SPACs typically have 18 to 24 months to identify a suitable merger partner after raising funds. If a merger partner is not found within this timeframe, the funds held in the trust account are returned to investors.
SPAC governance structure.
Investors considering investing in an SPAC should pay close attention to its governance structure. Since the management of the acquired company is accountable to the SPAC board of directors, it's crucial to ensure that the SPAC's board is well-structured and competent. Before investing in an SPAC, investors should conduct thorough due diligence on the subsidiary's executives to ensure they are experienced and have a track record of success.
One of the key advantages of SPACs is their ability to facilitate quick and easy reverse mergers. This allows the subsidiary to be incorporated by merger with an already-listed SPAC, which is beneficial because it avoids the time-consuming and expensive process of an IPO. However, this structure also means that SPAC executives have more control over their subsidiaries, as they are the majority shareholders. While this can be advantageous, it's important for investors to carefully evaluate the potential risks and benefits of this arrangement.
