SPAC, or Special Purpose Acquisition Company, is established to acquire another business with the help of an initial public offering (IPO). SPACs are now a popular legal structure in the United States as they are mainly formed to take over specific target businesses.
Ever since their inception in the 1900s, SPACs have been acquiring target businesses within two years after their IPO, which explains their “special purpose” in a very attractive manner.
SPAC acts as a shell company that has no business operations but is mainly used as a vehicle to acquire other target businesses. In this article, we take a detailed look at SPACs, the trends in the SPAC sector, and the different stages of the SPAC.
Special Purpose Acquisition Company (SPAC)
David Nussbaum came up with SPACs in 1993 when blank check companies were not legally allowed in the United States. Since then, over 700 SPACs have emerged in the United States, raising more than hundreds of billions of dollars in acquisitions in the United States and around the globe. SPACs have been considered a major driving force in the financial markets.
They have revolutionized the way small companies receive capital and how investors can invest in promising private businesses without having to wait for an IPO to take place. SPACs are typically formed by sponsors or investors who are closely associated with the specific industries and are business experts. Thus, they have knowledge of specific industries and market trends, which makes them a great asset to acquire another business with the help of an IPO.
What is SPAC?
SPACs are created as blank check companies that can be used to acquire other businesses through an IPO. They are commonly used to acquire private-sector businesses that are not ready for an IPO but want to go public. These blank-check companies are set up by sponsors who act as market experts and business leaders.
While SPACs have no independent operations and would use the money raised in an IPO to acquire businesses. As a result of the blank-check nature of SPACs, the company does not need to have a full-fledged business plan. Rather, SPAC only acts as a shell company with the sole intention of acquiring other businesses.
How Do SPACs Work?
SPACs have a set time frame within which they have to complete their acquisitions. On average, SPACs are given two years from their IPO to find suitable targets and complete an acquisition deal.
Typically, SPACs are formed as blank-check companies with the sole purpose to serve as vehicles for acquiring or merging with other businesses to go public. Unlike publicly listed companies, SPACs do not have any independently operating business units.
Instead, they only use their capital raised in the IPO to acquire other businesses within a fixed time frame. This serves as a massive advantage for several corporations as SPACs provide an effective way to go public and raise capital quickly. Therefore, the SPACs are structured in such a way that they only acquire another business after they have completed an IPO.
How are the SPACs different from traditional IPOs?
In basic terms, traditional IPOs are directly made by the companies, while in SPACs, investors first establish the SPAC in a form of a blank-check company, then launch the IPO to raise capital from investors, and finally, complete the acquisition of other businesses.
The SPACs are structured in such a way that the purpose of the IPOs is used to acquire other businesses. When a private company wants to go public without the hassle of an IPO, a SPAC is an ideal choice.
While it is essential to note that, the basic aim of SPAC or IPO is to turn a private company into a public company, however, the means to achieve this is what differentiates between the two.
Pros and cons of SPAC
SPAC has evolved as one of the most popular legal structures for acquiring businesses. SPACs are known as legal entities that are created to acquire and merge with other businesses while they remain in a blank check form. However, there are a few disadvantages of SPACs as well. The followings are the pros and cons of SPACs concerning the traditional IPOs:
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Pros of SPAC:
- SPAC offers better results when compared with conventional IPOs. It is because a SPAC can be acquired in a short period, allowing the company to raise capital quickly and cash out in exchange for stocks or other securities.
- SPAC has a predetermined time frame attached to it. Since it has an established time frame, it assures potential investors and shareholders that the acquisition will take place within a fixed timeframe.
- The speed of going public with the help of a SPAC is high because there is limited scrutiny compared to an IPO. However, that is not the case with traditional IPOs as there are ample regulations to abide by.
Cons of SPAC:
- The costs associated with SPAC may be more than those of IPO in terms of underwriter fees and other expenses. In addition to this, very limited attention is paid to the target company’s operations.
- If the company falls below expectations, there may be a competing interest, which might lead to investors withdrawing their money. As a result of this, the value and credibility of the company may go down.
- The investors are essentially dealing in a blank check firm, which means they are just providing funds without having any insight into the target business without actually knowing what company they are investing in. Thus, the investors could be exposed to the risk of the company being acquired.
Stages of SPAC
SPACs are formed by sponsors or investors who plan to acquire other businesses through an IPO. From setting up a blank-check company to conducting the IPO and initiating a merger, 4 stages of SPAC are as follows:
- Pre-IPO – The sponsor or investors will carefully form a SPAC and likewise register with Security and Exchange Commission (SEC). Form S1/F1 is used to submit to the SEC. Once accepted, the blank check company is then identified and submitted to the stock exchange. It is important to note that, various disclosures and costs including underwriters and legal fees are incurred after the formation.
- The IPO – The IPO creates the initial capital in the SPAC and the trading of units is started. The funds collected from the IPO will be added to the trust account, and thus, it is important to keep track of the trust account. During this, the underwriter may collect a fee in the event of compensation being deferred. Therefore, the trust account will remain intact until the time the business is acquired.
- Pre-Merger – This is the stage where the SPAC will start reviewing the available businesses to acquire to be merged with it. The SPAC will work on proposing a merger and acquisition deal. Since there are several other factors to be considered, a potential target company must be reviewed and studied by the sponsor, who will evaluate its financial reports and shareholder agreements. Once approved by SEC, the merger with the SPAC is made.
- Post-Merger – The acquisition process is complete and the merged business becomes another business unit in the SPAC. Post-merger, the SPAC will be considered as a public company in the United States and subsequently listed on exchanges. The SPAC will now be authorized to carry out its operations as a new business unit with the legal status of an operating subsidiary.
Trends of SPAC
The SPAC market has been experiencing tremendous growth, however with some volatility in the last few years. SPACs have become a more convenient route to the marketplaces when the circumstances for a mature company’s launch are favourable.
A number of the 1,000+ worldwide unicorns may consider the SPAC as a fast route out if investors are pressuring them to quit. As per the SPAC trends, it has seen prominence as a go-to method for raising capital, particularly in the last decade.
Several prominent companies have utilized the SPAC to come public. For instance, the biggest SPAC ever was sponsored by Bill Ackman, the founder of Pershing Square Capital Management, in 2020. Pershing Square Tontine Holdings raised $4 billion in its first public offering on July 22, 2020. But, what about the current scenario?
What is the current scenario of SPAC?
Well, it was not a smooth journey for SPACs because, in the year 2022 alone, the volume of SPACs that went public drastically decreased by 80%. The reason is that, the target companies that went public as SPAC turned out to be less profitable and less successful than the market anticipated.
By the market pullback of 2022, businesses that went public through blank-check offerings were some of those hardest damaged. 2022 saw the most SPAC transactions that were withdrawn ever, which only served to aggravate the situation. Thus, this led to the downfall of SPAC. However, it is not just complete negativity; SPACs have still enormous potential.
Is it worth investing in SPAC?
The idea of SPACs had been around for a long time among investors. While there are some risks associated with investing in SPACs, however, if the general strategy of a SPAC is very clear, it can be a successful investment.
The growth of SPACs can be attributed to the fact that it is a great alternative to traditional IPOs. While the future of SPACs is still uncertain, it would be reasonable to assume that with proper execution, planning, and management, SPACs can become a lucrative investment.
Before deciding to invest, the benefits and risks of the SPAC must be weighed. As a result of this, proper analysis is vital.