Definition and Examples of Special Purpose Acquisition Company
How does a SPAC work?
SPACs vs Traditional Initial Public Offerings
Advantages and Disadvantages of Special Purpose Acquisition Companies
Definition and Examples of Special Purpose Acquisition Company
A Special Purpose Acquisition Company (SPAC) is a company that is formed and goes public with the goal of raising capital to merge with or acquire another company. SPACs provide a unique opportunity for investors to enter a company even before it has a product or a proven business model.
How does a SPAC work?
A SPAC is a type of shell company that does not have any commercial operations at the time of its formation and holds no core assets other than cash.
SPACs handle initial public offerings (IPOs) differently from most businesses. Most companies start operating and prove their business models before undergoing an IPO to help them raise more capital and expand operations. But a SPAC remains a shell company when it undergoes the IPO process.
Typically, a SPAC goes through three phases: formation, searching, and acquisition or merger.
Definition and Examples of Special Purpose Acquisition Company
A SPAC is a company specifically formed to raise capital. It is typically a shell company that goes through the IPO process and then uses the capital it raises to merge with or acquire another company within a set timeframe.
A SPAC is a type of “blank check company,” which is a company in the development stage that does not yet have a specific business target. Many blank check companies aim to build capital as a startup or merge with another company.
Blank check companies are considered high-risk investments and fall under the definition of the U.S. Securities and Exchange Commission for small-cap stocks (which have a low market capitalization).
How does a SPAC work?
A SPAC is a type of shell company that does not have any commercial operations at the time of its formation and holds no core assets other than cash.
SPACs handle initial public offerings (IPOs) differently from most businesses. Most companies start operating and prove their business models before undergoing an IPO to help them raise more capital and expand operations. But a SPAC remains a shell company when it undergoes the IPO process.
Typically, a SPAC goes through three phases: formation, searching, and acquisition or merger.
Formation, Searching, and Acquisition or Merger
In the first phase, the company officially establishes itself and issues founder shares. During this phase, the company also prepares and files an S-1 form, which is the form that companies must submit to the U.S. Securities and Exchange Commission before conducting an initial public offering. The first phase typically lasts at least eight weeks.
In the second phase, the SPAC identifies target companies for merging or acquiring. It researches companies and conducts thorough due diligence on the financial data of the target companies. Once the target company is identified, the SPAC begins negotiations for the merger or acquisition and starts arranging its financing. The second phase lasts over a year, during which the SPAC continues to file its regular reports with the U.S. Securities and Exchange Commission. During this period, the proceeds from the IPO are held in a trust account, akin to an escrow account during a home purchase.
The third phase is when the SPAC closes the merger or acquisition deal. It publicly announces the deal, informs investors about it, and obtains shareholder approval. The SPAC must also file an 8-K form (known as Super 8-K) within four days of closing the deal. The 8-K form allows all interested parties to be informed about significant events – in this case, the significant event is the merger or acquisition. The third phase typically lasts between three to five months, and the end of this phase signals the conclusion of the SPAC.
Once
Closing the deal, investors in a SPAC have the option to become shareholders in the merged entity or redeem their shares. The redemption is based on a proportionate share of the total amount in the trust account.
Important: Investors who buy SPAC shares in the open markets are entitled to a proportionate share of the trust account, not their purchase price. For example, if an investor bought a SPAC share at $15 in the open market and the SPAC’s initial public offering price was $10 per share, their share in the trust account would be only $10, not $15.
SPACs vs. Traditional Initial Public Offerings
An initial public offering (IPO) is when a company sells its shares to the public for the first time. The company issuing the IPO is typically portrayed as “going public” because it is transitioning from private ownership to public ownership. While a SPAC undergoes an IPO process, it looks completely different from a traditional IPO.
SPAC
- The company does not have any commercial operations.
- The company starts the IPO process immediately.
- The company goes public to raise capital and acquire another company.
Traditional Initial Public Offering
- The company has commercial operations and a product or service.
- The company begins the IPO process after proving its business model.
- The company goes public to raise capital and expand its existing business.
Note: The IPO process appears similar whether the company starts as a SPAC or takes the traditional route. Both scenarios require the company to file the same paperwork and issue public shares. However, this occurs at completely different points in the company’s business journey.
Advantages and Disadvantages of Special Purpose Acquisition Companies
Advantages
- Cheaper shares: SPACs typically price their IPOs at $10 per share, which is cheaper than many other companies. By comparison, Airbnb launched its IPO in 2020 at $68 per share. Thus, SPAC IPOs may be more accessible for investors.
- Faster than traditional IPO: Many companies do not undergo the IPO process even after being in business for years and proving their business models. It is a long process. But with a SPAC, a company can issue an IPO and acquire another company within a year or two.
Disadvantages
- Investors may not know where the money is going: SPACs often have a targeted company or specific industry identified at the time of the IPO, but not always. Therefore, investors have to rely on management to take the company in the right direction.
- Doubtful returns: Shareholders often do not realize good returns when investing in SPACs. According to a study of 47 SPACs that acquired companies or merged between January 2019 and October 2020, the median shareholder returns in SPACs were -14.5%, -23.8%, and -65.3% in the three, six, and twelve months following the merger, respectively.
Key Takeaways
A special purpose acquisition company (SPAC) is a shell company that does not have any commercial operations or product/service at the time of its IPO. The purpose of a SPAC is to raise capital later to merge with or acquire another company. SPACs differ from traditional IPOs, where companies usually have proven business models and years in business before going public. SPAC shares are typically priced at $10 per unit, which is lower than many companies taking the traditional IPO route. SPACs may yield questionable returns for investors.
Sources:
الهيئة
U.S. Securities and Exchange Commission. “What You Need to Know About SPACs – Investor Bulletin.” Accessed February 26, 2021.
Michael Klausner, Michael Ohlrogge, and Emily Ruan. “A Skeptical Look at SPACs,” Stanford Law and Economics Working Paper No. 559, New York University Law and Economics Working Paper No. 20-48, available at SSRN. Accessed February 26, 2021.
Source: https://www.thebalancemoney.com/what-is-a-special-purpose-acquisition-company-spac-5114375
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