The world of finance is not untouched by trends. There are new products and services coming up all the time and then there are those which make a comeback.
A special purpose acquisition company (SPAC) forms part of the latter category. It has existed for long, but has come back to prominence only in the last few years. Given the surge in its demand and palpable market interest, it becomes useful to know about this interesting entity. This process of merging with a SPAC is also sometimes referred to as reverse merger.
What is a SPAC?
A SPAC is a company which does not conduct any business operations and exists for a single purpose: raising money via an initial public offering (IPO).
Why would anyone invest in an IPO for a company with no operations? Because the money so raised, is to fund a merger or an acquisition later on. Via this structure, the sponsors of a SPAC are able to get investors to contribute money before they go ahead and acquire other companies.
Companies using this structure are also known as “blank check companies.” This is so because while undergoing the IPO process, the founders of sponsors either don’t have a target company in mind or don’t identify it even if they do. As a result, the investors in the IPO don’t know which company they would be eventually investing in.
As outlined earlier, SPACs have existed for quite some time. However, in their current form, they have existed since 2003, and have gone mainstream only in recent years and were able to raise a record amount of money in 2019.
In 2020, the US has seen the formation of over 50 SPACs by the start of August and they have raised a combined $21.5 billion.
The Wall Street Journal has opined that this will be a record year for SPACs. This structure has emerged as a viable alternative to the traditional IPO, an aspect we will detail later in this article.
The SPAC USP
One question that you may have at this point is given the fact that a SPAC does not operate a business and is used only to raise money via an IPO for an as yet uncertain acquisition later, why would anyone want to invest in them? In other words, what is the unique selling proposition (USP) that makes investors interested in investing in a no-business company?
The USP for a SPAC are its founders or sponsors who are experienced and sometimes well known business executives. Investors invest in a SPAC based on their reputation. These executives have certain areas of expertise or industry segments that they are interested in and know quite well.
It is generally in those segments that they intend to pursue an acquisition once they raise investment capital via this company. Even if these founders have a potential acquisition target in mind before raising money, they avoid identifying it so that they don’t have to make extensive disclosers during the IPO process.
Baseball executive Billy Beane, Silicon Valley wizard Kevin Hartz, and retired Republican politician Paul Ryan all operate SPACs. This year, founder of Pershing Square Capital Management Bill Ackman sponsored his own SPAC, Pershing Square Tontine Holdings. It is the largest SPAC on record, having raised $4 billion in its IPO on July 22.
Chamath Palihapitiya – Also known as SPAC king
Since we’re speaking of popular SPACs, we need to mention venture capitalist Chamath Palihapitiya’s structure named Social Capital Hedosophia Holdings which did one of the most high-profile deals in SPAC history. It bought a 49% stake in Richard Branson’s Virgin Galactic for $800 million before listing the company in 2019.
Chamath did not stop there. He has registered tickers IPOA (now Virgin Galactic) through IPOZ – Yes you read that right… 26 SPACs. He is already being referred to as the SPAC king in the investor community. IPOB is most likely going to acquire Opendoor, a leading digital marketplace to buy and sell real estate and IPOC is all set to acquite Clover Health.
How a SPAC functions
According to Harvard Law School, there are three phases in the lifespan of a SPAC.
The first is the ‘IPO Phase’ which lasts for a little over 8 weeks. In this phase, founders pool in the starting capital, counsels and auditors are appointed, and the company is incorporated. Then it files for an IPO with the SEC and responds to the regulator’s comments, if any. Once approved for raising funds, it engages underwriters and conducts road shows. The phase ends with the closing of the IPO in which retail and institutional investors invest.
For the most part, the purchase price per unit of the securities is $10. The entire money raised is held in a trust account. Investors get unit shares in proportion to the capital invested in a SPAC and each unit comprises a share of common stock and a warrant or a fraction of a warrant which they can use to purchase more stock of the company later. If the SPAC acquires a company, these units get converted into units of that company. Warrants are issued as an additional compensation for investing in the SPAC. Both common stock and warrants can be traded in public markets after the IPO.
In phase two, the SPAC searches for its target private company to acquire or merge with and negotiates a deal. It is not necessary that the SPAC only looks for those companies whose valuation is equal to the money it has raised. It can always arrange for more funding if so required. In other words, there is no ceiling on the size of the company a SPAC can acquire. There is a floor, though. The fair market value of the target company must be at least 80% of the money raised.
In the third phase, it needs to announce the agreement reached with the target company and seek shareholder approval for the deal. Once received, it can close the transaction. This is known as a De-SPAC transaction. After an acquisition, a SPAC lists on a stock exchange. For phase two and three, it generally has about 1.5-2 years combined. Until such time that a deal is closed, its management team cannot collect salaries.
The reason that the aforementioned time period is essential is because there is always a possibility that a deal is not closed in that timeframe. If this happens, the SPAC is liquidated and the money from the trust is credited back to the investors after deducting bank and broker fees.
So why go public via SPAC and not a traditional IPO?
The boom in SPACs seen in this year has been in the electric vehicle segment with companies like Lordstown Motors, Nikola, XL Fleet, and Canoo, among others, having agreed to be acquired by a SPAC. But why are these and other companies choosing this route instead of the traditional IPO process?
- The simple answer is that being acquired by a SPAC is easier and less risky that undergoing an IPO. SPAC IPOs are easier and quicker to do than traditional IPOs because SPACs do not operate any business.
- Thus, the financial statements they need to file are quite brief and can be arranged in a matter of weeks instead of months for a traditional IPO.
- There are no assets to describe or revenues to report. Because of this, even the SEC does not have many questions to ask, leading to less or no revisions in the filed documents.
- The problems with a traditional IPO don’t stop at document filing. Companies need to undergo a roadshow to attract investor interest. Given the multiplicity of investors, the success of an IPO is never certain, thus increasing the risk for a company. There are also worries over valuation and pricing of the IPO.
- In case of a SPAC, a company being acquired does not need to worry about the IPO as it is already done. Instead of having to court multiple investors, the target company needs to negotiate with only the SPAC. This itself tremendously speeds up the process.
- SPACs also allow companies which are too mature for the startup or VC spectrum to raise late-stage capital instead of having to try to list directly.
- Lastly, with corporate stalwarts at the helm, the target company can get access to premium talent in lieu of getting acquired.
These factors have favored SPACs over traditional IPOs and with uncertain times ahead of the US election and the ongoing pandemic, it looks like the trend is here to stay.
However, not ever SPAC does well. Because there is less scrutiny and fewer requirements compared to a traditonal IPO, some companies without any revenue and profit are also going public. There isa SPAC called HOV village that is trading around 70% below its floor price and there is also a SPAC (now Nikola) that is tainted with scams as its founder resigned few months intot he merger.
Consider SPACs as investing in early stage growth companies, not every stock will have revenues or profit but look at the product, the management team of both the SPAC as well as the merger company before making a decision.
Examples of some successful SPACs that went public recently
Virgin Galactic Holdings
Chamath’s first SPAC. The period you see before the end of 2019 is when this SPAC was trying to find an acquisition and negotiating prospects. It was trading around the floor price of $10 per stock. Once the deal was announced, you can see that the stock has not gone back to pre merger levels.
Stock shot up to $80 levels adfter the merger from $10 levels few months ago. However, as the saga unfolded of the founder resigning among other things, the stock price is back to a modest $22.
Formerly known as Forum meger, this is one of my favorite SPACs (disc, holding). One of the few listed plant food players.
IPOB aka Opendoor
Chamath’s second SPAC. IPOB is all set to merger with Opendoor. All the optimism you are seeing in the stock price is because investors are buying the stock before the merger is complete.