The Special Purpose Acquisition Company (SpAC) has recently attracted a lot of attention from corporate boards, Wall Street and the media. SPAC, which is an alternative to traditional IPOs, has existed in various forms for decades, but the past two years have seen success in the United States. In 2019, $59 and $13 billion were invested, in 2020, $247 and $80 billion, and in the first quarter of 2021 alone, $295 and $96 billion. And here are the following amazing facts: in 2020, SPACs accounted for more than 50% of new companies registered in the U.S.
What is an SPAC?
A special purpose company is essentially a shell company that investors create to raise funds through an IPO and eventually acquire other companies.
For example, Diamond Eagle Acquisition Corporation was founded in 2019 and incorporated as a SPAC in December of that year. The company then announced a merger with DraftKings and gambling technology platform SBTech. The Draft Kings began trading as a public company when the deal was finalized last April.
As such, SPAC does not conduct any commercial operations. We don’t manufacture products; we don’t sell anything. In fact, according to the SEC, SPAC’s only assets are usually money raised through its own IPO.
SPAC is usually created or sponsored by institutional investors, private investors or Wall Street experts from the hedge fund world, while well-known executives such as Richard Branson and fellow billionaire Tillman Puttitta have used the flow to form their own SPAC.
How does SPAC work?
A SPAC is a shell company or company that exists mostly on paper, with no offices or employees. In this way, the SPAC makes its founders a selling point. Founders with a good investment history and experience in mergers and acquisitions (M&A) help attract investors.
Often a SPAC is created before a “target company” is identified. The target company is the business the SPAC wants to acquire. SPACs are often referred to as “white paper companies” because investors give money to SPACs before acquisitions begin.
Why have private companies turned their eyes to SPAC?
Private companies looking to get on the list can take the SPAC route for a variety of reasons. The most important of which is access to the capital and operational expertise provided by SPAC.
In addition, it is much cheaper to disclose through the SPAC. Typically, private companies list through an IPO, which can cost a significant amount of money. Finally, listing schedules in a SPAC environment are much faster, unlike an IPO, mainly because there are fewer regulatory barriers. Private companies can get around these hurdles by acquiring a SPAC that is already open, or by merging with a SPAC.
SPAC Life Cycle.
If this sounds confusing, don’t worry. Here’s everything you need to know about the general SPAC workflow.
- Space Formation. SPACs are often formed by a group of sponsors–known investors, private equity firms or venture capitalists.
- SPAC IPO. A SPAC goes through the normal IPO process. Although the sponsor does not publicly name the company it intends to acquire, this is used to avoid the more complicated process with the SEC. The SPAC is assigned a ticker symbol, and most of the money invested by shareholders is held in escrow.
- Acquisition Search. An SPAC usually takes two years to find a private company to merge or acquire, and becomes part of a registered SPAC and goes public in the process. It can be very easy to meet this timeline because sponsors may have a specific company or industry in mind early on. However, if SPAC does not merge with a company within two years, the money will go back to the shareholders. This makes SPAC less risky than a traditional IPO. If the acquisition fails, the investment can be recouped. Traditional IPOs, on the other hand, provide listed stock that does not guarantee a return on investment.
- Completion of the acquisition. When the SPAC sponsor determines the company to be acquired, it must be formally announced and a majority of shareholders approve the transaction. SPAC may need to raise additional funds (often by issuing more shares) to acquire the company. When all this is completed, the target company will be listed on the stock exchange.
What happens with SPAC mergers?
SPACs start by raising capital on the stock exchange, usually setting the price of the common stock at $10 and providing warrants to buy additional shares as a sweetener to lure investors into buying unknown shares. The initial stock sale is an SPAC promotion or SPAC IPO, and the money is held in a trust account until a merger partner is found.
The SPAC then identifies and negotiates the business bonds with the private companies, exchanging the cash raised by the IPO and the interest held by the business after the merger for its position as a registered company. Institutional investors often seek to provide more cash for the merger and in return receive shares of the target company.
Shares valued at $10 or more tend to fluctuate once investors learn the terms of trade with the target company. Investors have a better idea of the value of the stock, and the stock price adjusts accordingly. Spack stock usually skyrockets when an acquisition is announced, but Spack stock can fall after a transaction is announced if sentiment changes or if the inclusion of too much money from new investors excessively dilutes the value of the circle.
When the transaction is announced, the move to divide the space begins. Usually there is time between the official announcement of the merger and the end of the transaction when investors vote on the deal and other legal issues are resolved.
Richard Branson’s space tourism startup Virgin Galactic (NYSE:SPCE) offers one of the first SPAC deals to attract attention. In late 2019, venture capitalist Hamat Palihapitiya formed SPAC under the name Social Capital Hedosophia Holdings. SPAC merged with Virgin Galactic to go public. Social Capital Hedosophia Holdings shareholders received 49% of the combined company, and Virgin Galactic received a public ticker for about $800 million in cash and trading on the stock exchange.
SPAC typically has 18 to 24 months to find a merger partner after fundraising. If not, the funds held in the trust account will be returned to the investor.
SPAC governance structure.
One of the important things investors should look at when investing in an SPAC is its governance structure. This is due to the fact that management is in the acquired company, and management is responsible and accountable to the SPAC board of directors.
It is important for SPAC investors to do their due diligence before investing. Make sure that the executives of the subsidiaries are experienced and performing well.
Spacing and Reverse Connection.
One important advantage SPAC has over private equity is that it uses its public status to reverse mergers. The acquired company will be incorporated by merger with an SPAC that is already listed on major stock exchanges.
This is a quick and easy way for subsidiaries to list without going through the IPO process, which can be time consuming and expensive. The disadvantage of this structure is that the SPAC management team has better control over its subsidiaries. SPAC executives are essentially the majority shareholder of the business, which can be a good thing.