SPECIAL PURPOSE ACQUISITION COMPANY (SPAC)

Most financial analysts have declared 2021 as the year of the SPAC. Special Purpose Acquisition Company (SPAC) is established with no commercial operations but strictly to raise capital through an initial public offering (IPO).  

They’ve become more popular in recent years attracting big business investors, underwriters and raising a record amount of IPO in 2019. About 200 SPACs went public in 2020 raising the sum of almost $64 billion total funding, as much as the previous year’s IPOs combined, as recorded by Renaissance Capital.

For the year 2021 SPACs lined up includes, Bill Gates-backed portable ultrasound start-up Butterfly Network (valuing at $1.5 billion). DNA-testing start-up 23andMe is reportedly in talks of going public through a $4 billion deal. A buzz also hints that some digital media companies such as Bustle Media Groups, Vice Media, BuzzFeed, etc could use SPACs to finally bring in money for their investors.

What is a SPAC?

A special purpose acquisition company (SPAC) is essentially a shell company set up by experienced business executives that are confident in their reputation and wealth of knowledge to enable them identify a profitable company to acquire. For example, Diamond Eagle Acquisition Corp was set up in 2019 and went public as a SPAC in the same December.

 Its merger was announced with DraftKings and Gambling tech platform SBTech. When the deal was closed in April of the next year, DraftKings began trading as a public company. 

The SPAC is also known as ‘a blank check company’. The special purpose acquisition company is a publicly traded entity that exists for the sole aim of raising money to acquire an existing private company. SPAC thereby has no commercial operations as it makes no product and does not sell anything.

Most SPACs are formed or sponsored by a team of Wall Street professionals, institutional investors from the world of hedge funds or private equity. Even high-profiled CEOs such as Tilman Fertitta and fellow billionaire Richard Branson also formed their own SPACs.

When a SPAC raises funds, the people buying into the IPO do not know the eventual acquisition target company. Hence, institutional investors with track records of success can more easily convince people to invest into the unknown. That’s why it is called a blank check company.

What do they do?

The Special Purpose Acquisition Company is a shell company is typically based on an investment thesis, focused on a sector and geography. The intention of the SPAC is to acquire another company.

 A special purpose acquisition company is a way for companies to move from a privately held to publicly traded in a less complicated way than an initial public offering(IPO), according to Peter McNally, global sector lead at Third Bridge, a research firm.

To go public following the traditional way could take years, in some cases, and to find the right time could be tricky, says McNally. SPAC is hence, a faster and very efficient option for management and boards of companies to go public.

By agreeing to be purchased by a SPAC a company goes public, reducing the red tape and costs associated with a traditional IPO.

How the SPAC works

We will breakdown the discussion of how a SPAC works according to stages.

Founders

A SPAC is formed by experienced business executives and professionals who have built a reputation in the system and are confident that their wealth of experience can enable them spot a profitable company to acquire.

The start-up capital for the company is been raised by the founders and the anticipate to benefit from the sizeable stake in the company which they acquire.

Issuing the Initial Public Offering (IPO)

The management team of the SPAC contracts the services of an investment bank to handle the IPO. The charge for the service is always agreed upon by the investment bank and the management team and this is mostly about 10% of the  proceed from the IPO. During the IPO the securities sold are offered at a unit price.

The sponsors are the major focus of the prospectus. Less focus is placed on the company history and revenues of the SPAC since it lacks performance history or revenue report.

The proceeds from the IPO are held in a trust account which serves as an escrow until there is a private company is spotted as acquisition target.

To Acquire a Target Company 

After funds are raised through an IPO, the SPAC management team has 18 o 24 months to spot a target and get the acquisition completed. This activity may vary depending on the industry and company. There must be a fair market value of the target company of about 80% or more of the SPACs trust assets.

The founders will profit from their stake in the new company once it is acquired. This is usually 20% of the common stock and the investors receive interest according to their capital contribution.

In a case whereby the predetermined period lapses before the completion of an acquisition, the SPAC is dissolved and the IPO proceeds in the trust account are refunded to the all investors.

Founder Shares 

The founders of the SPAC buys the founders shares at the period of SPAC registration, and pay nominal amount for the number of shares that will enable a 20% ownership stake in the outstanding shares after the IPO has been completed.

The essence of the shares is to compensate the management team as they are not allowed to receive any commission or salary from the company until the completion of the acquisition transaction.

Warrants

The units that are sold out to the public includes a fraction of a warrant and it allows the investors to purchase a whole share of a common stock.

The bank issuing the IPO might determine the size of the SPAC. One warrant may be excisable for a fraction of a share or a full share of stock.   

In conclusion, buying a share of  a SPAC before it makes acquisitions will provide the regular investors an opportunity to take part in the stratospheric growth many associate with IPOs.

Investing in a SPAC is more like a bet on the sponsors, their reputation and whether there will be a successful deal within two years. These might either be favorable to the investor or not just like any other investment.

‘But as long as we see these innovative disruptors and there’s demand from retail traders, I think SPACs are here to stay’, says Jablonski.