A special purpose acquisition company (SPAC) is a company that has no commercial operations and is formed to raise capital through an initial public offering (IPO). It is an investment structure that is set up especially to make an acquisition or a buyout.
They are also called “blank check companies.” The only aim of a SPAC is to raise capital via an IPO to acquire a business at a later date and then take it public without going through the traditional route of IPOs.
The amount of money raised through SPAC IPOs in the US since 2014 is as given below:
· 2014: $1.8bn across 12 SPAC IPOs
· 2015: $3.9bn across 20 SPAC IPOs
· 2016: $3.5bn across 13 SPAC IPOs
· 2017: $10.1bn across 34 SPAC IPOs
· 2018: $10.7bn across 46 SPAC IPOs
· 2019: $13.6bn across 59 SPAC IPOs
· 2020: $83.3bn across 248 SPAC IPOs
History of SPACs
The SPACs have existed since the 1990s in the technology, healthcare, logistics, media, retail, and telecommunications industries. They began with investment bank GKN securities with founders David Nussbaum, Roger Gladstone, and David Miller, who developed the template.
Since 2003 the SPACs witnessed a resurgence, and public offerings sprang up in many industries such as the public sector; mainly looking for deals in homeland security and government contracting markets, consumer goods, energy and construction, financial services, sports, and entertainment. They are becoming popular in many emerging economies such as China and India.
SPACs are used in many companies that wish to go public. They are also used in areas where financing is difficult. Many SPACs go public with a particular industry in mind, while others do not have such preset criteria. SPACs compete with private equity groups and strategic buyers for acquisition candidates. This competition can result in companies getting good valuations.
The process is like this; the management team, which is invested in a SPAC (around 20 percent), goes out to raise resources by offering the remaining 80 percent to the public shareholders by selling shares and warrants in a bundled unit.
This is where the management’s experience, professional reputation, and domain expertise come in handy. The IPO money is kept in an escrow account or trust to be accessed later after an acquisition target is identified. The cash is conserved till a deal is spotted.
SPACs generally trade as units or as separate shares and warrants on the Nasdaq and New York Stock exchange once the public offering is declared effective by SEC. The trading liquidity of the SPACs provides investors with an exit option. The common share price must be added to the trading price of the warrants to get a correct picture of SPACs’ performance.
A typical SPAC IPO structure consists of a Class A common stock share combined with a warrant. A warrant gives the holder the right to buy more stock at a fixed price at a later date. Investors who participate in the SPAC IPO are attracted by the opportunity to exercise the warrants so they can get more common stock shares once the acquisition target is identified and the transaction closes.
Structure of SPAC
To allow for the stockholders of the SPAC to make an informed decision on whether they wish to approve the business combination, the company must make a detailed disclosure to the stockholders about the business they wish to acquire like the audited financial results and the terms of the proposed business combination.
The shareholders are given voting rights at a shareholder meeting to approve or reject the business combination. Since the financial crisis, many protective measures have been implemented for the protection of shareholders.
The SPAC is led by an experienced management team that has three or more members with experience in private equity, mergers, acquisitions, and other operational matters. The management team of SPAC receives 20% of the equity in the vehicle at the time of offering; exclusive of the value of warrants. The equity is held in an escrow account for 2–3 years and the management agrees to purchase warrants from the company before the offering.
No salaries or cash compensation are paid to the management team before the business combination and the management team does not participate in liquidating distribution if it fails to find a suitable business.
SPAC research (a premier resource for information on special purpose acquisition companies) maintains an underwriter league table which can be sorted by book-runner volume or other criteria for any year. I-bankers stated that it had participated in 132 SPAC IPOs from 2004 till January 2021. Citigroup, Goldman Sachs, and BofA have all built a good SPAC practice.
The money SPACs raise in an IPO is placed in an interest-bearing trust account. These funds can’t be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated. A SPAC generally has two years to complete a deal or face liquidation. In some cases, some of the interest earned from the trust can be used as SPAC’s working capital. After the acquisition, the SPAC is listed on one of the major stock exchanges.
When the SPAC sponsors identify a potential target they make a formal announcement and the day the public is notified about the acquisition is called the announcement date. After the announcement, the SPAC sponsors perform due diligence and negotiate the acquisition structure. The US Securities and Exchange Commission also reviews the acquisition terms.
The next step is the proxy vote. If more than 50 percent of the shareholders approve the acquisition and less than 20 percent vote for liquidation, the transaction is approved and the acquired form listed on the stock exchange.
If more than 50% of shareholders approve the acquisition and more than 20 percent want to liquidate the shares, the escrow account is closed, and money is returned to the shareholders.
As a SPAC investor, if you are not comfortable with a planned purchase and disagree, then you can sell your shares and exit, but you get to keep the warrants. These warrants give you an additional upside if the SPAC is successful and goes better than expected.
Some Famous Investors
· In this Reddit era of investors, Chamath Palihapitiya is the SPAC king and a self-confessed answer to Warren Buffet. He has raised $4.5 billion by sponsoring 6 SPACs in the US market. Palihapitiya founded Social Capital in 2011 to invest in companies and fields being ignored by other venture capitalists like health, financial services, and education. The firm has expanded to invest in tech companies like Amazon, Tesla, and slack.
· Serena Williams launched a venture capital firm Serena Ventures, in 2014 and is on the board of a Miami beach-based SPAC called Jaws Spitfire Acquisition which is eyeing consumer tech targets.
· Baseball executive Billy Beane, former astronaut Scott Kelly, basketball luminary Shaquille O’Neal, former Speaker of the House Paul Ryan, and billionaire David Geffen all have one thing in common; they are all involved in SPACs,
SPAC exchange-traded funds are seeing their assets under management soar as special purpose acquisition companies remain hot with investors. There are many SPAC ETFs available to investors.
A passive option is the Defiance NextGen SPAC-derived ETF. It tracks the performance of the Indxx SPAC and NextGen IPO index. The downside to this ETF is that 80 percent of its portfolio consists of companies where the reverse merger has already taken place.
An active ETF is the SPAC, and New Issue ETF managed by Tuttle Tactical Management. This fund invests in only the new issue SPACs and able to purchase some of them at IPO price. The ETF was launched in December 2020 and has $180 million in assets under management.
· SPACs are considered safe during the choppy markets. Traditional IPOs are expensive and much more time-consuming due to the involvement of registrations, disclosures, and processes. SPACs involve lesser parties, lesser negotiations and are a faster route for venture capital funds and private equity majors to take their private company public (two months for a SPAC IPO versus six months for a traditional IPO.)
· SPACs are cheaply priced and accessible to the mass retail investor segment. They often pick a unique futuristic business in the tech and consumer space as an acquisition target and are popular with young new-age investors.
· SPAC founders can keep only 20% of the equity, so there is a significant dilution of the company that has been acquired.
· The SPAC sponsor gets to keep their 20 percent only if they consummate a deal within two years. Otherwise, they have to return the capital. Therefore it is in their interest to consummate a deal.
· SPAC investors usually don’t know how their funds will be used or what the eventual target will be. Their funds can stay stuck and lie idle for as long as two years. So there is an uncertainty factor.
· There are many SPACs in the market, so the popular private companies have many SPAC suitors. Due to this, the popular private companies set up a condition where various SPACs pitch their deal mostly competing on price. This is good for the company that is being acquired but not for the investors. The higher the acquisition price the lower the future return for the SPAC investor.
SPACs are here to stay and represent a viable alternative to an IPO. The terms of SPAC may change over time and become more attractive to investors. As is required in all investments the investors should do their homework properly and choose the best out of the available SPACs.