SPAC’s are one of the hottest and most talked-about investment trends today. Wall Street and mainstream media are in a frenzy over them, but most people don’t know how they work. So, what exactly is a SPAC, how does it work, and what makes it such a unique investment opportunity over traditional IPOs?
Let’s find out.
- A SPAC is created to pool funds together through an IPO to purchase another company
- SPACs consist of sponsors and public investors
- The SPAC process can take anywhere from 12 months to 36 months
What is a SPAC?
A SPAC is the acronym for a “special purpose acquisition company”, and is also referred to as a “blank check company”. A SPAC is created for the purpose of pooling funds together through an IPO to finance a merger or acquisition within a specified timeframe. Since SPAC’s are registered with the SEC and are publicly-traded companies, regular retail investors can buy shares before a merger or acquisition takes place.
Although SPAC’s have been around for quite some time, their popularity has been significant in recent years. According to SpacInsider.com , there were 248 SPAC’s created in 2020 raising over $83 billion dollars, and 605 SPAC’s created in 2021 raising over $161 billion. As a reference, a decade ago there were only seven SPACs created in 2010. See the data below for further details.
Special purpose acquisition companies can be a bit complicated if you’ve never been formally introduced to them. Our guide focuses on breaking them down into the simple categories below step by step.
- SPAC Timeline Process
- How Does a SPAC Work?
- The Formation Process
- The Funding Process
- The SPAC IPO
- The Merger Process
- Investor Voting
- De-SPAC or Dissolve
Standard SPAC Timeline Process
How Does a SPAC Work?
SPAC’s have become the preferred way for investors and sponsors to take companies public. They raise capital through an IPO in order to acquire an existing company. Before this is done, there is a formal formation and funding process that takes place.
Formation and Funding (Stage 1)
The Formation Process
SPACs are generally formed by seasoned investors and managers who have previous experience with IPO’s and bringing private companies to the public. The founders and investors function as the management team, and are also known as “sponsors”.
They will outline a minimum of one acquisition in mind in a specific niche and come up with the timeline. The timeline represents the time to complete an official merger. It can take anywhere from 12 months up to 36 months. However, most SPAC’s tend to have a hard timeline of 24 months.
The Funding Process
Once the management formation is in place there is a funding process. The funding process is usually split up between founder shares and public shareholders. Founder shares and public shares will have very similar voting rights. The main difference is that founder shares have the authority to elect managing directors of the SPAC.
Part 1) Founder shares
During first part of the funding process the sponsors will put up a nominal amount of capital and typically represent 15-20% interest in the SPAC. In return, they will received “founder shares”.
Part 2) Public Shares
The remaining portion of the funding is held in public shares ~80-85% through “units”. The units are offered in an IPO of that SPAC’s shares and usually price at $10 per share. The main difference between the public shares and the founder shares is that the public shares, or “units” are partly common stock and partly warrants.
Once the formation and the first part of the funding process is complete, the IPO will be launched. However, the identity of the target company the sponsors plan on acquiring will not be disclosed.
Since IPO investors have no clue what company they will be investing in, a SPAC is often-times referred to as a “blank check company“. In general, a SPAC’s only assets are the monies raised through the IPO.
The SPAC IPO (Stage 2)
Generally, 85% of the funds raised through a SPAC IPO are placed in an interest-bearing trust account that can be used at a later date for the merger or acquisition stage. Once the funds are placed in the trust account, the SPAC has 12-24 months (target date) to complete a merger or acquisition for their target company.
This process is referred to as “de-SPACing”.
If the SPAC fails to complete a merger or acquisition within the set target date, the SPAC will dissolve the funds back to the sponsors and public shareholders. SPAC sponsors can extend the target date of the SPAC by adding contributions to the trust account to incentivize shareholders to vote for an extension.
The Merger Process (Stage 3 and 4 )
Once the IPO process has been carried out, the investors and sponsors of the SPAC will present the public shareholders with their merger and acquisitions plans. This would be considered stage four from the SPAC timeline process. In this stage, the investors will disclose the company they plan to acquire and present their due diligence and financial analysis.
Some of the information that will be disclosed to investors in this stage includes:
- Complete audited financial statements (dating back a minimum of 5 years)
- Terms of the proposed business combination through an SEC merger proxy statement (Form S-4)
- Statements showing the effects of the merger
This process is critical for investors to fully understand. It’s the deciding stage between returning to target search or dissolving the SPAC.
Investor Voting (Stage 5)
In this stage, shareholders vote whether or not they will approve the merger.
The common share stockholders of the SPAC are given voting rights to approve or reject the merger. The funds held in the interest-bearing trust account will be released if the shareholders vote to approve the transaction. Before the funds are released all regulatory dealings will need to be cleared.
If the shareholders vote against the merger, the sponsors can either search for another company that will be a better fit or comes to a mutual decision to dissolve. As previously mentioned, the sponsors can choose to extend the target date of the SPAC to find a better target company. So, if the investors vote down the merger, it doesn’t always mean that the process is over.
De-SPAC or Dissolve (Stage 6)
Once the regulatory part is taken care of, the merger will fully close and the target company will convert to a publicly-traded entity. Within four days of the merger closing, a Form 8-K is required to be filed with the SEC. After all the appropriate forms are filed with the SEC the company will have to put in place the necessary processes and procedures that are legally required for public companies to follow. Some of these include:
- Quarterly financial reporting on forms 10-Q and 10-k
- Earnings calls and investor relations
- Project management and support
- Internal control over financial reporting
If shareholders chose to vote down the merger and agree to dissolve, the assets held in the trust will be returned to the shareholders. Most sponsors try to avoid dissolving and almost always push to get an extension to find a company that is a better fit.
Important: Please note that this is a simplified view of the SPAC process. Each one will be much different depending on the type of company that is being acquired or if multiple acquisitions are going to take place.
Investing in SPAC’s – Things You Should Know
If you’re considering investing in a special purpose acquisition company it’s important to understand some of the benefits as well as some of the inherent risks.
- SPACs have a clear intention and goal from the start – to acquire a company in a specific niche in a specific period of time.
- They have the potential to sell themselves for a higher price than a traditional IPO.
- Much faster and cost-effective than a traditional IPO.
- Provides a reduced regulatory burden over traditional IPO’s.
- Provides less risk for investors because they hold the option to redeem their shares for what they paid for them plus the interest which accrues in the trust account.
- SPAC management and sponsors have a strong incentive to close a deal since they have their own money in them.
- People may invest in them simply due to the public name behind the SPAC instead of the actual deal at hand. This can include celebrities and well-known people in the space.
- One of the inherent risks is the fact that a SPAC could never end up launching due to investors voting down a deal.
- They offer less transparency and information about the target company up until the date of the merger.
- The share price of a SPAC is not an accurate or reliable measure of the true valuation. Therefore you can end up overpaying in the aftermarket once a company goes public.
Knowing these risks and benefits can help you make a more informed decision about investing in SPACs.
Where to Find and Invest in SPACs?
Once you have a better understanding of how special purpose acquisition company’s work you may be interested in knowing how to find currently active SPACs. Below are a few different websites that provide a current list of active SPAC’s that are pre-IPO and in the searching process.
Once you have found a company that piques your interest its time to perform your due diligence. After that you can check and see whether or not your broker lists the ticker symbol for trading.
Now that you have a better understanding of the mechanics of SPACs, start researching which ones may be a good investment for your risk appetite. The demand for special purpose acquisition companies is only going to continue to go up in the future. They may provide an alternative method to helping you improve your returns in the market.