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.
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
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.
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.
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.
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.
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.
- 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
Main Free Guides: