A special purpose acquisition company (SPAC) is a company with no commercial operations that are created to raise capital through an IPO to acquire another company. The SPAC is also called for that reason a “blank check company” as it will use the money provided by investors to enable private companies to go public via the SPAC.
Understanding a SPAC
A special purpose acquisition company is a stock exchange-listed shell corporation created by investors to acquire a private company.
In so doing, the private company becomes public without holding a traditional IPO.
For example, Diamond Eagle Acquisition Corp. was set up in 2019 and went public as a SPAC in December of the same year.
The company then announced a merger with fantasy sports platform DraftKings and gambling tech platform SBTech.
When the deal was closed in April, DraftKings began trading as a public company.
In a period occasionally referred to as the “blank check boom”, SPACs raised a record $82 billion in 2020 as the favorite source of financing for private companies looking to go public.
The companies are usually created or sponsored by a team of institutional investors, private equity hedge funds, or even high-profile CEOs like Richard Branson and Tilman Fertitta.
How SPACs work
As hinted at in the previous section, a SPAC is formed by a management team (sponsor) with a specific skill set in a niche industry.
This team invests a small amount of investor capital – typically around $25,000 – and receive founder shares in return which equates to a 20% interest in the SPAC itself.
Next, the company executes the IPO to raise more money from public markets.
Units are typically sold at $10.00 per share, with each unit consisting of a share of common stock plus a warrant giving investors the chance to buy a common share at some future point.
The price for exercising these warrants is usually $11.50 per share.
From this point onward, the SPAC trades and behaves like any other listed company, but investors do not disclose a merger or acquisition target.
Shareholders are free to buy and sell as they please, despite having no idea about the company they are ultimately investing in.
Once the IPO does occur, the company has around two years to seek or negotiate a buy-out.
If this process is successful, the company ticker is changed and shareholder ownership transfers to the acquired company.
Alternatively, investors can redeem their SPAC shares to recoup their initial outlay plus any interest accrued while those funds were in trust.
If a deal cannot be struck, the SPAC is liquidated with investors receiving their money back plus interest.
Advantages of SPACs
While the SPAC movement is unlikely to disappear soon, there are some inherent risks to the approach for investors and businesses alike.
Let’s take a look at some of the main advantages and disadvantages.
Efficiency
A company can go public using a SPAC in as little as a few months. Conventional IPO processes, on the other hand, can be tedious and play out for more than a year.
SPACs have become popular primarily because they increase business agility in an increasingly volatile global market.
Bargaining power
The owners of the target company may also be able to negotiate a better price when selling to a SPAC.
This is because the latter has a predetermined time window with which to make a deal.
Disadvantages of SPACs
Risk
Investors who choose to invest in a SPAC IPO are absorbing a tremendous amount of risk.
For one, they are assuming the SPAC will be able to find a merger or acquisition target.
These companies are also characterized by less oversight and less disclosure, which can result in retail investors being exploited.
Low returns
In a September 2021 report from Fortune, it was discovered that approximately 70% of SPAC companies who had held an IPO in the same year were trading below their $10 offer price.
This suggests that after the initial excitement has waned, investors lose money more often than not.
Key takeaways
A special purpose acquisition company (SPAC) is a company with no commercial operations that is created to raise capital through an IPO to acquire another company.
SPACs are usually created or sponsored by a team of institutional investors, private equity hedge funds, or high-profile CEOs. Investors typically receive shares and warrants in the IPO, which are redeemable or transferrable once the company completes a successful merger or acquisition.
Creating a SPAC is a more efficient way to complete an IPO than traditional approaches. But the strategy is inherently risky for retail investors and may result in low returns, with 70% of SPAC companies trading below their 2021 IPO price in September of the same year.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.
Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country.
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.
Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.
Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.
Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.
Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
The Weighted Average Cost of Capital can also be defined as the cost of capital. That’s a rate – net of the weight of the equity and debt the company holds – that assesses how much it cost to that firm to get capital in the form of equity, debt or both.
A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.
A profitability framework helps you assess the profitability of any company within a few minutes. It starts by looking at two simple variables (revenues and costs) and it drills down from there. This helps us identify in which part of the organization there is a profitability issue and strategize from there.
The Triple Bottom Line (TBL) is a theory that seeks to gauge the level of corporate social responsibility in business. Instead of a single bottom line associated with profit, the TBL theory argues that there should be two more: people, and the planet. By balancing people, planet, and profit, it’s possible to build a more sustainable business model and a circular firm.
Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
