Despite its intimidating name, a Special Purpose Acquisition Company (SPAC) is merely a different process through which a company goes public. The different process presents benefits and opportunities for both seasoned and novice investors, and allows companies another channel for going public, one where the acquired company can benefit from the management’s specific expertise of valuation and taking companies public. However, similar to a regular IPO process, a SPAC raises capital from investors, needs an underwriter, issues different types of stock shares, fills out Securities and Exchange Commission (SEC) forms and, at the end of the day, creates a new public company. However, within the same components, there are also differences.
From an investor’s perspective, there is an essential difference regarding the nature of the investment. For a company going through a regular IPO, investors are investing in a product or service, whereas in a SPAC, investors are putting their trust and money in the knowledge and experience of seasoned investors to make a good investment on their behalf.
A SPAC vs. traditional IPO
A SPAC is a company that raises money for an IPO, in which, at the time of the IPO, the SPAC is actually nothing more than a group of people holding capital with the intention of investing it in the future. Some call this a shell company or a “blank check” company. The process is that a group of investors, usually well known and respected, raise capital through an IPO and then search for a company to purchase with the funds raised. The purchase of the target company needs to be approved by the shareholders and the regulator. Subsequently, the acquired company performs a process akin to a reverse merger where it becomes part of the parent company that is already public and the two companies are now traded as one. After the necessary approvals from the regulators and shareholders are achieved, the SPAC’s name on the ticker will change to reflect the name of the acquired company.
This differs from a traditional IPO where a company develops a product, raises money, reaches a certain valuation, prepares all the SEC filing to go public and hopes that their entrance into the public markets will draw investors and help the company raise capital for future operations.
Another difference between a traditional IPO and a SPAC IPO is the length of the SEC filing process. A SPAC IPO process can be as short as eight weeks since the SEC filings are different. In a traditional IPO offering, there is a focus on the history of the business, revenues, disclosing assets, whereas, in a SPAC, the prospectus (the legal document filed to the SEC) focuses mainly on the managers or sponsors of the business.
History of SPACs
SPACs first appeared in the 1990s with the goal of providing a pathway for smaller companies to go public without having to go through the regular IPO process. With tech companies raising capital through traditional IPOs, interest in SPACs waned. In 2019, 59 SPACs existed, raising a total of $13.6 billion. In 2020, there were 124 SPACs globally, with 50 SPACs in the US alone, that raised more than $20 billion.
Investing in a special purpose acquisition company
Investors checking out a company going through the traditional IPO process, look at the company, assess its accomplishments, its future prospects, and then decide if they want to invest their money in the company. In short, do they believe in the company and its future potential?
For a SPAC, investors give their money to a group of investment managers (in financial terms ‘sponsors’) who have stated that their intention is to go out and acquire another company, and that the acquired company will potentially yield profits to the investors.
To put it in simpler terms: investing in a regular IPO is like you opening an account on an investing platform and starting to trade. A SPAC is similar to you going to a stockbroker, giving them an amount and telling them to start investing for you.
How does the SPAC’s acquisition process work?
For regular companies going through the traditional IPO process, the IPO is the moment the company transforms from a private to a public company. After a SPAC goes through an IPO, although the company is public, there is only a shell company, and now that shell company will begin searching for a company to acquire. Once the SPAC acquires another company, receives approval from the shareholders and regulators, then it begins the De-SPACing process in which the shell company and the private company are merged and the newly acquired company trades publicly under the name of the acquired company.
Where does my money go after I have invested it?
The SEC warns investors that if you invest in a SPAC, it is important to understand the terms of your investment. In other words, before parting with your cash, know exactly what you are receiving in return and what the structure of your investment is, since each SPAC can be structured differently.
They also point out that since the SPAC has no operating or revenue history, it is critical that the investor has confidence in the people who are going to manage their money. Look them up, check them out.
The typical SPAC takes all of the money invested at the time of the IPO and puts it in a trust account. This refers to all the proceeds minus certain fees and expenses taken by the managers.
As previously mentioned, once a SPAC raises money, it is the job of the managers to go out and acquire a company. But while they are engaged in that process, the money needs to be put somewhere and something needs to be done with it. That is the trust account. It is held by a third party and is usually invested in some type of safe, minimal risk investment.
The funds in the trust either go to fund the De-SPAC transaction or to redeem public shares connected with the De-SPAC transaction or liquidation of the SPAC.
The SPAC has approximately 24 months to find a company in which to invest. If they fail to do so, there is an option to extend the date with a vote from the shareholders, or the company is dissolved and the capital returns to its investors.
In return for the investments made, investors receive units, each consisting of a share of the common stock and a warrant to purchase additional stock at a later date at a fixed price. Unit prices can vary although many are $10 per unit.
Founder shares are given to those early investors in the company at a deep discount and they usually make up about 20% of the shares of the company. Founder shares are subject to a lockup period during which the shares cannot be sold. This is the period when the SPAC is looking for a company to acquire and during the De-SPACing period.
Some differences between founder shares and regular public shares include that if a company is not acquired during the two-year period, then founder shares, in many cases, become worthless. Founder shares can also significantly increase in value when an acquisition is made or when certain milestones to making the acquisition are cleared. It is important to note that the value of all founder shares is not the same and how they are valued is connected to where the SPAC is in the process.
What happens to the SPAC after the merger announcement?
Assuming there is a merger lined up, an announcement is made publicly, outlining the details of the intended merger. During the time of the announcement, the SPAC stock, which is usually quite dormant up until this point, could suddenly become quite volatile, due to speculation surrounding the outcome of the merger. Next, the SPAC shareholders must vote to approve it. The process of the merger itself may take a few months to complete.
After the merger is finalised, the SPAC will merge with the target company, and the SPAC’s shareholders will become shareholders in the merged entity. Even though the ticker symbol for the public company is likely to change from that of the SPAC to that of the merged company, the value of the respective holding and the value of the shares of the SPAC shareholder remain the same post completion. Naturally, the value of the new entity’s stock is subject to market volatility, supply, and demand.
What are the main risks when investing in a SPAC?
There are a few risks associated with SPACs:
- There is the possibility that the SPAC will fail to acquire a company in the relevant time frame. In that case, the investor, who was hoping to receive high returns on the investment, may receive their money back after 2-3 years accruing interest only.
- With SPACs becoming more widespread, companies looking to be acquired have many options and with that, leverage for negotiating better terms for themselves, and less favourable terms for the investors.
- While in most cases, SPACs that fail to acquire a company will return the money to investors, it does not happen under all circumstances. It is, therefore, important for investors to read the prospectus, so they are clear about the terms of investment.
- One of the main advantages of a SPAC is also a potential risk. Investing in a SPAC means investing in the expertise and abilities of the people running the SPAC. With more and more people starting their own SPAC, investors need to be sure that the person running the SPAC is someone credible, qualified and experienced to make a good deal, and not just someone who has a public persona. Consequently, even if the people running the SPAC are credible, an investor may still want to perform their due diligence when a deal is announced, to ensure that deal is actually a good deal for investors.
- Shares of a SPAC may go down after the IPO. Swirling rumours may artificially raise the value of a SPAC which suddenly plunges for various reasons.
What are the benefits of a SPAC?
A SPAC has benefits for both the investors and the target company being acquired, as opposed to going the traditional IPO route.
- Opportunity to work with an experienced sponsor/SPAC management team.
- During periods of market volatility, companies may be hesitant to go public for fear that market volatility could impact their stock’s IPO.
- Going through a SPAC allows the company being targeted to negotiate its value as opposed to the market deciding it.
- Quicker access to the market than through a regular IPO and cheaper. Four to six months as opposed to 12-18 months.
- Companies that would otherwise not qualify for an IPO according to the stock market’s guidelines, but have potential for growth, have an alternative for going public.
- SEC regulations, which exist for regular IPOs, do not exist with SPACs. That allows the target company to receive attention from analysts more quickly and the ability to provide favourable information about future growth of the company, both of which can increase investor interest.
- Low risk for investors since all funds are entered into a trust until the merger is materialised, and if it does not happen, then the money is returned to the investors. And the investment is time bound and not open ended.
- Investors have input or a vote concerning the investment decision of the SPAC.
The SPAC option provides companies with another channel for going public, in partnership with a sponsor/SPAC management team. It has proven to be a very popular route to market and the signs suggest that it is a model that is here to stay.