SPACs — or special-purpose acquisition companies — were all the rage on Wall Street last year but have since cooled in the glare of increased regulatory scrutiny. Still, billions of dollars have been invested into these “blank-check” companies, which have a single purpose: Seek out desirable private companies, acquire them and, in the process, take them public.
Though some consider them risky and unconventional investments, SPACs are now traded on major exchanges and supported by the investment arms of traditional banks. There was a giant burst of SPAC activity in the past two years, with 248 SPACs raising $83.4 billion in 2020 and 613 raising $162.5 billion in 2021, but as of August 2022 there have been only 74 this year, raising a total of $12.4 billion. While no longer a popular fad, SPACs remain a viable funding approach for certain situations and certain types of companies.
But what exactly are SPACs, and how do they work? More importantly, how seriously should a businessperson consider a SPAC? To understand the risks, advantages and potential of SPACs, it’s essential to learn why they became so popular today, their advantages, pitfalls, and how they differ from traditional IPOs. Here’s everything you need to know about SPACs.
What Is a Special-Purpose Acquisition Company (SPAC)?
At its heart, a special-purpose acquisition company (SPAC) is a business created for the sole purpose of pooling funds that will be used to buy a private company. They are usually formed by investors who are entrepreneurs with previous experience operating successful companies, though there have been notable exceptions involving celebrity investors. SPACs don’t make any products or offer any services. The only assets a SPAC has are the funds provided by private investors to create the company and the proceeds from its initial public offering (IPO). Because SPACs aren't required to disclose any information about potential acquisition targets when filing for an IPO, they are commonly referred to as “blank-check” companies.
After a SPAC’s IPO, individual investors can purchase stock in the company on a public stock exchange. The goal of a SPAC is to then acquire (or merge with) one or more promising private. After the acquisition, the SPAC is usually listed under the name of one of the acquired companies, or under a new name, after undergoing its de-SPAC process.
SPACs vs IPOs.
SPACs offer private companies a way to become publicly traded companies without facing the daunting regulatory hurdles — and expense — of going public on their own via a traditional IPO. Essentially, the SPAC has already done some of the heavy lifting by conducting an IPO of its own. It then operates as a type of shell company, looking for a private company or companies it can purchase.
In the process of making an acquisition, the SPAC provides that private company with the capital it may have received in an IPO of its own.
- SPACs can bring promising companies to public markets faster than they normally could on their own.
- SPACs have existed for nearly 30 years but began to garner significant interest only after regulations were introduced a decade ago.
- The demand for new public companies to invest in and uncertainties in the market have accelerated the popularity of SPACs.
- However, the lack of scrutiny of acquisition targets means SPACs still present risks to retail investors.
Special-Purpose Acquisition Companies (SPAC) Defined
The definition of a SPAC is readily apparent right in its name: It’s a publicly traded entity created for one special purpose — namely, to acquire a private company or companies. SPACs became suddenly popular two years ago as a way for investors to make significant returns in the process of transitioning a business from being privately held to being a publicly traded company.
Compared with traditional IPOs, a SPAC offers more certainty as to pricing for the private company and reduces the chances that a deal will be scuttled by regulatory hurdles at the last minute.
How Special-Purpose Acquisition Companies (SPAC) Work
SPACs are typically founded by experienced executives, wealthy investors or both. Founders with a past record of entrepreneurial success in a particular industry or industries are better able to attract additional investors, even though SPACs’ regulatory filings generally state that they don’t plan to look for acquisition targets in any one industry, sector or geographic region.
Instead, to quote from an April 2019 SPAC filing with the U.S. Securities and Exchange Commission, they usually say something like: “… we intend to capitalize on the ability of our management team to identify, acquire and operate a business or businesses that can benefit from our management team’s established global relationships and operating experience.”
The management team typically receives about 20% of the SPAC’s equity in return for about 3% to 5% of the funding, and then takes the SPAC public through an IPO.
SPAC managers then begin to search for a promising private company or companies to acquire. The stock exchanges on which SPACs list, including the U.S.’s NASDAQ and NYSE, typically allow them three years to find and acquire or merge with a target business. But SPACs’ official regulatory filings usually give themselves only 18 to 24 months from the IPO date because investors don’t like to have their money tied up for too long. If they don’t acquire a business by their self-imposed deadline, SPACs must dissolve and return their money to shareholders. Or, shareholders can vote to give the SPAC an extension to continue its search.
Assuming a SPAC successfully acquires or merges with another private company, it goes through a “de-SPAC” process in which, among other things, its trading symbol changes to reflect the new business.
As the accompanying timeline shows, SPACs by their natures are usually short-lived corporate entities. A typical SPAC lasts for no more than three years. The initial spinning up of the SPAC, with the founders and managers soliciting investments from institutions and underwriters, takes a few months. Once the IPO occurs, SPACs are usually obligated to their investors to find and acquire a target company in less than two years. If the investors reject the deal, the managers may look to another acquisition or return money to the investors.
Going Public With a SPAC
From a private company’s point of view, going public either via an IPO or a SPAC looks somewhat similar — in the beginning. A private company looking for public capital usually develops an IPO readiness initiative to determine that it has the right processes and personnel in place to handle the duties and filings of a public company, such as quarterly financial statements.
If the private company attracts the interest of a SPAC to help it achieve its funding goals, it applies the work done for its IPO readiness initiative to its negotiations with the potential SPAC partner. These materials should articulate the private company’s value and operating model and become part of the SPAC managers’ due diligence. Other companies that may not be exploring an IPO process may be approached by SPAC managers and then need to quickly go through a similar process.
After agreeing to a letter of intent to be acquired by the SPAC, the private company’s path to the public market looks very different from a traditional IPO. Instead of preparing public offering documents and presentations, hiring underwriters and conducting IPO road shows to sell the company’s value to institutional investors, the SPAC’s managers and the private company’s leaders begin working together to determine how the merged entity will operate. Various securities filings are required, for example, to detail the merged entity’s new capital structure and equity plan.
Assuming all goes well, the ultimate result is not an IPO but rather a press release announcing the acquisition — or acquisitions — and a date when the new company will begin trading in place of the original SPAC, usually with a new stock symbol.
Why SPACs Exist
SPACs were originally created as a way for blank-check companies to raise funds from individual investors in public markets. Such SPACs also initially offered smaller but promising businesses a way to access the kind of money otherwise available only to larger companies that could do their own IPOs. In the early days of SPACs, they were also used to help distressed firms get to market.
Special-Purpose Acquisitions Pros and Cons
Despite their current popularity, SPACs are only one type of business funding option — and not one likely to be accessible to the vast majority of private companies. For example, there are millions of small and midsize companies in the world but only a few hundred SPACs were formed even in the peak year of 2022.
So what are SPACs’ pros and cons?
Why Are SPACs So Popular?
SPACs have become popular for several reasons. For the initial founders, it can be a way to bring what they see as valuable companies public quickly and make a hefty profit. For investors who invest in the listed SPAC, it can be a way to bet on experienced managers and get in on the ground floor before the announced acquisition may send the stock price soaring. Finally, for private companies, a SPAC reduces concerns about the regulatory demands involved in going public and about swings in the market to which a traditional IPO is subject.
An acquisition by a SPAC for a set price avoids those concerns.
Advantages of SPACs
- They can bring a private but popular technology or service company to market quickly.
- They can eliminate the complexities and expense of going public for the acquired private company.
- They offer individual investors the opportunity to put money into what amounts to a venture capital fund.
Criticisms of SPACs
There are definite drawbacks to SPACs, both for investors who purchase SPAC stocks and for some private acquisition targets.
- Potentially less money: For private companies, there is the possibility they could receive more money from an independent IPO, depending on market conditions.
- Uncertainty: For investors, when a SPAC initially lists on a stock exchange, it does not disclose any details about possible acquisition targets. So those who purchase the stock don’t know exactly what they are buying.
- Increased risk: Perhaps the biggest criticism of SPACs is that even after the acquisition, because of more limited oversight compared with traditional IPOs, investors could be left holding a company of questionable value.
Witness the scandal involving once high-flying electric vehicle startup Nikola. It went public using a SPAC, but within months its founder and chairman resigned following allegations that he had deceived investors about the company’s technology — though the company denied the allegations.
SPAC Capital Structure
Some otherwise common terms in public company finance have specialized meaning in the capital structure of a SPAC deal. These include:
Despite being called public units, these are not publicly available. These units are given to institutional investors for their investment in the SPAC before it goes public in an IPO. A single unit usually will be equal to one share of the common stock (when the company goes public) and a warrant to purchase more stock in the future at a set price.
The SPAC founders are entitled to purchase so-called “founder’s stock” at a special rate before the company goes public. It usually amounts to 20% ownership in the company. The shares are to compensate the management team and incentivize them to find the best deal possible.
A warrant is a contract that gives the initial investors and SPAC managers the right to purchase additional shares in the future at a specific price, usually higher than the initial IPO share price. Conditions as to timing and availability of warrants vary widely in SPACs, but the expectation is that the difference in market price of the stock and a warrant will provide additional incentives for SPAC managers to make the highest value deal possible and bring additional profits to the initial investors.
The variety and number of SPACs continue to rise. However, some of the more well-known SPAC deals of the recent past include Virgin Galactic, DraftKings and ChargePoint.
In 2019, Richard Branson’s Virgin Galactic merged with the Social Capital Hedosophia SPAC and began trading on the New York Stock Exchange, becoming the world’s first publicly traded commercial human spaceflight company. The deal gave SPACs, at the time a relatively unknown investment option, celebrity appeal and status.
DraftKings was purchased by the Diamond Eagle Acquisition SPAC in 2020 with an initial estimated valuation of $3 billion. Recently, a wave of SPACs have been aimed at the coming electrification of the automotive business. Witness electric charging station company ChargePoint, which merged with SPAC Switchback Energy Acquisition Corp. early in 2021 for an initial estimated total value of $2.4 billion.
A SPAC with a new-record valuation was announced in April 2021: Grab, the Southeast Asian technology platform company that began as a ride-hailing startup, said it would merge with the Altimeter Growth Corp. SPAC in a near-$40 billion deal.
How to Invest in SPACs
Traditional institutional investors put money into SPACs just as they would in advance of a traditional IPO. Those banks and underwriters support the SPAC’s founders based on the founders’ expertise and confidence that the investment will pay off.
Individual investors can put money into SPACs after the SPAC has gone public and is listed on an exchange simply by buying shares as they would of any public company. Shares of the SPAC may rise and fall, depending on speculation about the company’s acquisition target.
- $2 trillion: The aggregate value of all the private companies researchers expect to be brought to market by SPACs in 2021.
- 1,000: Number of SPACs expected to form in 2021. This is expected to be the first year in which there are more SPACs than IPOs.
- 176: Number of SPACs brought to market during the first two months of 2021, raising $49.5 billion.
- 12: Number of SPACs formed in 2014, worth a total of $1.8 billion.
- 3: Average number of SPACs formed daily in the first two months of 2021.
The History of SPACs
SPACs were created in 1993 by investment banker David Nussbaum and lawyer David Miller, to give private firms a way to access money from everyday investors who are otherwise excluded from acquisition deals. SPACs avoided some regulations that, at the time, barred so-called “blank check” companies from trading with consumers.
Initially, SPACs were viewed as shell companies that could take a private company public that otherwise would not pass regulatory hurdles in a traditional IPO. As such, they were seen as questionable investment instruments at best. However, about 10 years ago, new SEC regulations were introduced for SPACs regarding voting rights and fees. Afterward, they became more respectable because the new regulations offered more protection for individual investors. In May 2017, the New York Stock Exchange listed its first SPAC, giving it a respectable imprimatur for regular investors.
Preparing for SPACs With Accounting Software
Judging whether a SPAC is right for your company can be a complex task. As a private company, there are financial and process issues to consider. For example, is the additional capital really necessary for growth? Do your company’s accounting and finance operations meet the standards required for public company reporting? To make such assessments easier — and as accurate as possible — sophisticated accounting software is absolutely necessary and enterprise resource planning (ERP) is highly recommended. Tools like these can give any company a precise picture of where it stands and where the right investments could take it in the future.
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What does SPAC mean?
SPAC stands for special-purpose acquisition company. SPACs do not manufacture anything, deliver services or own assets — they are created to form a fund whose only purpose is to purchase one or more private companies. It is also known as a “blank check” company because when the SPAC is created, no specific acquisition target is designated.
What’s a SPAC stock?
SPAC stock is essentially shares in an investment company that is publicly traded so that individual investors can participate. However, the company does not make or sell any products; rather, its goal is to buy a private company or companies and in the process effectively take that private company public. That’s what makes it a “special-purpose acquisition company.” Investing in a SPAC stock means the investor believes the managers of the SPAC will make a smart acquisition even though there may be no announced or planned purchase at the time.
How does a SPAC work?
Initially created by experienced operational managers and/or other types of investors, a special-purpose acquisition company (SPAC) then solicits investments from institutional investors to create a pool of money. Then the SPAC opens itself up to individual investors via an initial public offering (IPO), in the process meeting all of the necessary regulatory requirements. Its shares are then available to the public on exchanges like the NYSE or NASDAQ. Usually within two years, the SPAC will use its capital to purchase a private company, sometimes referred to as a merger. The acquisition has the effect of taking the private company public without that company having to go through the more complex and expensive process of conducting its own IPO.
What is a SPAC vs IPO?
SPACs are special-purpose acquisition companies that conduct their own IPOs (initial public offerings) before seeking a target company or companies to acquire. For a private company, the attraction of being acquired by a SPAC versus conducting its own IPO is that the hard work of meeting those IPO requirements has already been done.
Who can form a SPAC?
Special-purpose acquisition companies (SPACs) are usually created by experienced managers with expertise in a particular business, such as retail or telecommunications, and/or investment professionals or celebrity investors. However, operational experience is usually necessary to attract major underwriters and institutional investors and, later, individual investors. It’s also helpful when evaluating companies to acquire.
How is a SPAC formed?
The management team or sponsors form a special-purpose acquisition company (SPAC) with an initial investment that usually represents ownership of 20% of the company. The remaining 80% of the company is usually acquired by private investors who inject additional capital into the business and/or institutional investors and public shareholders when the IPO debuts.
Are SPACs safe?
For regular consumers, buying shares of a special-purpose acquisition company (SPAC) presents risks like any other stock purchase, with the added twist that you may not know what you are buying. In general, SPACs are still considered to be an investment that is worthwhile only for those who can get the IPO price. Post-acquisition, SPACs have historically underperformed the overall stock market.