What Is A SPAC? A Simple Guide To This Investment Trend
Lately, there has been a SPAC mania which has taken Wall Street by storm. This guide aims to provide a simplified explanation on what is a SPAC and how they work.
SPAC, or Special Purpose Acquisition Company, also known as a “blank check company“, is a shell corporation that raise money from investors through stock market listings. A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing operating company. After going public, they look for private companies to acquire, allowing these private companies to go public without having to go through the traditional IPO process, which involves roadshows and other marketing campaigns with the purpose of creating investor awareness and interest.
SPACs have become a preferred way for many experienced management teams and sponsors to take companies public. They are forming in many different industries, and are being used for companies that wish to be listed but otherwise cannot. Subsequently, an operating company can merge with (or be acquired by) the publicly traded SPAC and become a listed company.
Since the 1990s, SPACs have existed in the technology, healthcare, logistics, media, retail and telecommunications industries. However, it has gained traction in recent months as more private companies eye exit opportunities amidst uncertainty brought by the COVID-19 pandemic.
According to data from Dealogic, the was a 400% increase in the total value of SPAC deals completed between 2019 and 2020. In 2021, the number of completed deals totaled more than half of those done in 2020.
SPAC Formation and Funding
A SPAC is usually led by an experienced management team with prior private equity, mergers and acquisitions, and/or operating experience. Investors profit from SPACs by taking a bet on a SPAC’s management’s ability. The general public can buy its shares before the merger or acquisition. The management team of a SPAC typically receives 20% of the equity in the vehicle at the time of offering, exclusive of the value of the warrants. The remaining 80% is held by public shareholders through units offered in an IPO of the SPAC’s shares. Each unit consists of a share of common stock and a fraction of a warrant.
Founder shares and public shares generally have similar voting rights, with the exception that founder shares usually have sole right to elect SPAC directors. Warrant holders generally do not have voting rights and only whole warrants are exercisable.
The equity is usually held in escrow for 2 years and the management usually agree to purchase warrants or units from the company in a private placement immediately prior to the offering. The SPAC liquidates and the IPO proceeds are returned to the public shareholders if the SPAC does not complete a merger within the time frame.
The management team does not receive salaries, finder’s fees, or other cash compensation prior to the business merger, nor participate in a liquidating distribution should the merger fail. In many cases, the expenses (in excess of the trusts) are borne by the management teams in the event of a liquidation of the SPAC because no suitable target is found.
Typical SPAC timeline
The IPO of a SPAC is typically based on an investment thesis focused on a sector and geography, such as the intent to acquire a technology company in a certain country, or a sponsor’s experience and background. After the IPO, proceeds are placed into a trust account and the SPAC typically has 18-24 months to identify and complete a merger with a target company.
Once a target company is identified and a merger is announced, the SPAC’s public shareholders may alternatively vote against the transaction and elect to redeem their shares. If the SPAC requires additional funds to complete a merger, the SPAC may issue debt or issue additional shares.
The SPAC merger
Once formed, the SPAC will typically need to solicit shareholder approval for a merger and will prepare and file a proxy statement. This document will contain various matters seeking shareholder approval, including a description of the proposed merger and governance matters. It will also include financial information of the target company, such as historical financial statements, management’s discussion and analysis, and pro forma financial statements showing the effect of the merger.
Once shareholders approve the SPAC merger and all regulatory matters have been cleared, the merger will close and the target company becomes a public entity.
Why have SPACs become so popular?
A well established, profitable company would likely choose the traditional IPO approach. On the other hand, a company which is more early-stage, or is in a sector which is more complicated for the layman to understand, benefits by having a SPAC because it allows a company to share with investors its forward business plan.
The SPAC approach offers several advantages over a traditional IPO, such as providing companies access to capital, even when market volatility and other conditions limit liquidity. They can also potentially lower transaction fees as well as reduce the time required to become a public company. Some SPACs go public with a specific target industry while others do not.
The SPAC essentially has a 24-month period to get that acquisition. But if it does not in 24 months, investors’ capital is redeemed. This was a feature which basically led to the spurt in growth of SPACs because of the protection of investors’ capital.
In conclusion, SPACs continue to gain popularity in the recent months because of its potential liquidity option for many companies, a substantially shorter timeline to to public, lower transaction fees, and capital protection for the investor in the event the merger does not take place.