Recently, you may have seen a flurry of headlines about SPACs. Short for “Special Purpose Acquisition Company,” SPACs offer an alternative means for companies to access capital from the public outside of the traditional initial public offering (IPO) process.
While this option may seem to have popped out of nowhere, they have actually been around for a while, but have gained interest recently for a few reasons, which we will be discussing in this blog. Keep reading to learn more about what SPACs do, how they are structured, and more.
What is a SPAC?
A Special Purpose Acquisition Company (SPAC) is a shell company formed to raise funds in an initial public offering (IPO) with the intent to acquire or merge with an unspecified private business at a later date.
SPACs are formed by sponsors who usually have expertise in a specific field. While the investment teams may or may not already have at least one target in mind when the SPAC is founded, it is often referred to as a “blank check company” because investors don’t know what company the SPAC will ultimately target. Once the acquisition or merger happens, SPAC shares convert to shares in the new business.
The SPAC Process
SPACs must follow the usual IPO process to raise the funds that will be used for later acquisition. This includes filing a registration statement with the U.S. Securities and Exchange Commission (SEC), clearing SEC comments, and embarking on a roadshow to obtain underwriting commitments. Once an investment bank has been chosen to facilitate the IPO, securities are sold, and the proceeds are held in a trust until a private company is selected as a target for acquisition. The SPAC now has a set period of time (often 18 to 24 months but can vary) to find an acquisition target and complete the transaction. If the period lapses and acquisition isn’t completed, the SPAC is dissolved, and the funds are returned to investors.
Once a target has been selected, negotiations have been completed, and following the signing of the acquisition agreement, shareholders in both the SPAC and the target company must vote on the proposed transaction. Assuming that the merger is approved by shareholders (if that is a requirement) and the terms of the acquisition agreement are met, the SPAC and target will combine into a publicly-traded company. SPAC investors can then elect to sell out of their position or remain invested – now in the target company.
Advantages of SPACs
The traditional IPO process can be long, very expensive, and tend to favor the investment bank underwriting it. SPACs offer an alternative to this process with some additional potential advantages.
A huge check in the favor of SPACs is that, for a company seeking to go public, the process is quite abbreviated. Once a SPAC has chosen a target, it only takes about three to five months to complete that process from approval to closing, as most of the hard work has already been done. On the other hand, the traditional IPO process can take over a year.
During the traditional IPO process, companies only find out after the roadshow how much they’ll be raising and at what price. Through the SPAC process, there is less reliance on market demand. Companies negotiate a price with the SPAC once and it’s done. Pricing is transparent and upfront.
In addition to having more certainty regarding pricing, there is no need to fret about the timing of the IPO, which can have a significant impact on its success, as the money has already been raised.
Association with the sponsor
Depending on who is managing the SPAC, their association with the target company can offer the company some additional street cred, so to speak. While this effect won’t last forever, it can be a helpful boost in the short term.
A different dynamic
One thing to note is going public via a SPAC is not necessarily cheaper than going public through a traditional IPO. Typically, the SPAC will seek a substantial discount. However, with that in mind, the dynamic between a company and a bank underwriting its IPO is much different than that of a company and a SPAC. While a bank is generally more invested in the ecosystem as a whole, a SPAC is merging with the business it is taking public; therefore, it is more focused on the success of that specific company.
SPACs are not without risk
If shares in a SPAC are purchased at a premium, due perhaps to the perceived quality of a potential deal or because investor interest in SPACS is increasing, investors paying that premium can face substantial loss if a deal cannot be identified or closed. As of the end of last year, it was estimated that approximately $19 billion in capital raised via SPACs was still waiting to be deployed.
The Current Landscape
SPACs have been around for years but have gained interest recently. According to SPAC Research, SPACs raised $13.6 billion in offerings in 2019 and have already raised $21.1 billion so far in 2020. In 2019, some of the biggest names to become publicly traded after a SPAC transaction were DraftKings, Virgin Galactic, and Nikola Corporation. Recently, there has been talk that Topgolf is considering this route and that Airbnb has also been approached, and under uncertain economic circumstances, it makes sense that more companies may pursue this route moving forward.