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.
Aspect
Explanation
SPAC (Special Purpose Acquisition Company)
A SPAC, also known as a blank-check company, is a publicly traded shell company with no operational business of its own. The primary purpose of a SPAC is to raise capital through an initial public offering (IPO) and then use those funds to acquire or merge with an existing private company.
Structure
A SPAC is typically formed by experienced investors or a management team with expertise in a particular industry or sector. The SPAC goes public through an IPO, and the funds raised are placed into an escrow account until a suitable target company is found.
Blank-Check Nature
The term “blank-check” refers to the fact that SPACs do not have a specific business or company in mind when they go public. Investors buy shares in the SPAC with the understanding that their money will be used for a future acquisition.
Timeline
SPACs have a limited timeframe, typically around two years, to identify and complete an acquisition. If they fail to do so within this period, the funds are returned to investors.
Acquisition Target
Once a suitable target is identified, the SPAC negotiates and completes the acquisition, effectively taking the private company public through the merger. The target company’s financials and operations are then reported as part of the SPAC’s public filings.
Risks and Rewards
Investors in SPACs face risks, as the success of the investment depends on the SPAC’s ability to find a profitable target company. However, SPACs offer the potential for higher returns if the acquisition is successful and the target company performs well as a public entity.
Liquidity and Exit Strategy
SPAC investors have the flexibility to sell their shares on the open market at any time, providing liquidity. Additionally, sponsors of the SPAC may receive founder’s shares or promote as an incentive for successful acquisitions.
Popularity
SPACs gained popularity in recent years as an alternative to traditional IPOs for private companies looking to go public quickly. They offer a streamlined process and the ability to provide forward-looking financial projections, which is not common in traditional IPOs.
Regulation
SPACs are subject to regulation by the U.S. Securities and Exchange Commission (SEC) and must adhere to certain rules and disclosure requirements. The SEC closely monitors SPAC activity to protect investors and maintain market integrity.
Examples
High-profile SPACs include Virgin Galactic Holdings (SPCE), DraftKings (DKNG), and Nikola Corporation (NKLA). These companies went public through SPAC mergers.
Conclusion
SPACs have become a popular mechanism for companies to go public and raise capital quickly. While they offer opportunities for investors and private companies, they also come with risks, particularly if the SPAC fails to identify a suitable target or if the target company underperforms as a public entity.
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.
How Do SPACs Get Formed?
Formation of the SPAC:
A group of investors, often led by experienced individuals such as hedge fund managers, private equity professionals, or high-profile CEOs, forms the SPAC. This group is referred to as the sponsor.
Capital Contribution:
The sponsor contributes a relatively small amount of capital to the SPAC, typically around $25,000 to $50,000. In return, they receive founder shares, usually representing a 20% interest in the SPAC.
Initial Public Offering (IPO):
The SPAC goes public through an IPO. During the IPO, the SPAC issues units that are typically priced at $10.00 per unit. Each unit typically consists of one share of common stock and a warrant.
Warrants:
The warrants included in the units give investors the option to purchase common shares of the SPAC at a predetermined price, often around $11.50 per share, at a future date. These warrants provide additional potential upside for investors.
Funds Held in Trust:
The proceeds from the IPO are placed in a trust account. These funds are held separately from the SPAC’s operational expenses and are typically invested in low-risk securities such as U.S. Treasury bonds.
Trading as a Public Company:
Once the SPAC is publicly traded, it operates like any other publicly listed company. Investors can buy and sell SPAC shares on the stock exchange.
Mergers and Acquisitions (M&A) Search:
After the IPO, the SPAC has a limited time frame, typically around two years, to identify and negotiate a merger or acquisition target. The SPAC’s management team, often led by experienced industry professionals, actively seeks potential targets.
Due Diligence and Negotiation:
The SPAC conducts due diligence on potential targets, evaluating their financial health, business prospects, and valuation. Negotiations between the SPAC and the target company may take place.
Shareholder Approval:
If a suitable target is identified and negotiations are successful, the proposed merger or acquisition requires approval from the SPAC’s shareholders. Shareholders typically vote on the transaction.
Completion of Transaction:
Once approved, the merger or acquisition is completed, and the target company becomes a publicly traded entity. The SPAC’s ticker symbol may change to reflect the new company.
Redemption Option:
Shareholders often have the option to redeem their shares at the time of the merger or acquisition if they do not wish to remain invested in the new entity. Shareholders who choose this option receive their initial investment plus any interest accrued while the funds were in the trust.
Post-Merger Operations:
After the merger or acquisition, the combined entity operates as a publicly traded company. The former SPAC shareholders now own shares in the new company.
Reporting and Compliance:
The newly merged company must comply with regulatory reporting requirements and financial disclosures, just like any other publicly traded company.
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.
Key Highlights
Definition: A Special Purpose Acquisition Company (SPAC) is a company with no commercial operations formed to raise capital through an IPO. The purpose of a SPAC is to acquire another company, effectively taking it public.
SPAC Formation: A group of investors, often including institutional investors, private equity funds, or high-profile CEOs, creates a SPAC. These investors contribute a small amount of capital and receive founder shares, usually representing a 20% interest in the SPAC.
IPO Process: After formation, the SPAC goes public through an IPO, with units typically sold at $10.00 per share. Each unit comprises a share of common stock and a warrant that allows investors to purchase a common share at a future date, usually at $11.50 per share.
Trading and Behavior: Once publicly traded, a SPAC operates like any other listed company. However, it does not disclose its merger or acquisition target at this stage. Shareholders can buy and sell SPAC shares without knowledge of the target company.
Merger or Acquisition: The SPAC has approximately two years to seek or negotiate a merger or acquisition. If successful, the SPAC’s ticker symbol changes, and shareholders’ ownership transfers to the acquired company. Investors can also redeem their SPAC shares for their initial investment plus accrued interest.
Liquidation: If a deal cannot be reached within the specified timeframe, the SPAC is liquidated, and investors receive their capital back with interest.
Advantages:
Efficiency: SPACs offer a quicker route to going public compared to traditional IPOs, which can take more than a year.
Bargaining Power: Target companies may negotiate better terms when selling to a SPAC due to the defined time window for making a deal.
Disadvantages:
Risk: Investors in SPAC IPOs take on significant risk, as success relies on the SPAC finding a merger or acquisition target.
Low Returns: Many SPACs trade below their $10 IPO offer price, resulting in losses for investors.
Case Studies
Example
Description
Implications
Virgin Galactic Holdings (SPCE)
Chamath Palihapitiya’s SPAC merged with Virgin Galactic to take the space tourism company public. The move attracted significant attention to the emerging space industry.
– The merger allowed Virgin Galactic to access public markets and raise capital for its ambitious space tourism endeavors.
DraftKings Inc. (DKNG)
A SPAC merger with Diamond Eagle Acquisition Corp. took DraftKings, a sports betting and daily fantasy sports company, public. It leveraged the growing interest in online sports betting.
– The merger provided DraftKings with capital to expand its operations and capitalize on the expanding sports betting market in the United States.
QuantumScape Corporation (QS)
QuantumScape merged with Kensington Capital Acquisition Corp. to go public. The company focuses on developing solid-state lithium-metal batteries for electric vehicles.
– The SPAC merger enabled QuantumScape to access capital to accelerate battery technology development and compete in the electric vehicle market.
Opendoor Technologies Inc. (OPEN)
Opendoor went public through a SPAC merger with Social Capital Hedosophia Holdings Corp. II. The company operates in the real estate technology and homebuying space.
– The merger provided Opendoor with the capital needed to expand its digital platform and disrupt the traditional real estate market.
MultiPlan Corporation (MPLN)
Churchill Capital Corp III acquired MultiPlan, a healthcare cost management company, through a SPAC merger. The move aimed to capitalize on healthcare cost containment.
– The merger allowed MultiPlan to access public markets and pursue growth opportunities in the healthcare sector.
23andMe Holdings (ME)
23andMe merged with VG Acquisition Corp. to become a publicly traded genetic testing and biotechnology company, leveraging the growing interest in personal genetics.
– The merger provided 23andMe with capital to advance its genetic research and commercialize its genetic testing services.
Lucid Motors Inc. (LCID)
Churchill Capital Corp IV acquired Lucid Motors, an electric vehicle manufacturer, through a SPAC merger. The move positioned Lucid as a competitor in the luxury EV market.
– The merger enabled Lucid Motors to access capital for production and compete in the electric vehicle market against established players.
Hims & Hers Health, Inc. (HIMS)
Hims & Hers went public through a SPAC merger with Oaktree Acquisition Corp. The company focuses on telehealth and wellness services.
– The merger provided Hims & Hers with capital to expand its telehealth offerings and pursue growth opportunities in the digital health sector.
Desktop Metal, Inc. (DM)
Desktop Metal merged with Trine Acquisition Corp. to become a publicly traded 3D printing technology company, aiming to disrupt traditional manufacturing.
– The merger allowed Desktop Metal to access public markets and invest in developing innovative 3D printing solutions.
SoFi Technologies, Inc. (SOFI)
SoFi went public through a SPAC merger with Social Capital Hedosophia Holdings Corp. V. The company offers a range of financial services, including lending and investing.
– The merger provided SoFi with capital to expand its financial offerings and compete with traditional banks and financial institutions.
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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.
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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.
