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What is a SPAC? SPAC In A Nutshell

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 and disadvantages 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.

Advantages

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

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.

Connected Business Concepts

Economies of Scale

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In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

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In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Creative Destruction

creative-destruction
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

happiness-economics
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Command Economy

command-economy
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Animal Spirits

animal-spirits
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

state-capitalism
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

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The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.

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