Special Purpose Acquisition Companies (SPAC) an alternative to traditional IPO have been quite popular among investors during the pandemic. Let us understand in brief on how they operate.
Crux of the Matter
What Are SPACs?
Special Purpose Acquisition Company (or SPAC) is created solely for raising capital via an IPO for purchasing another company. Typically, it is established by investors who are experts in a particular industry domain.
What Is So Peculiar?
The founders usually have one target acquisition – which is not disclosed to avoid lengthy disclosures. Thus, SPACs are also known as Blank Cheque Companies since the investors have no clue where the money will be invested.
How Does It Work?
A SPAC raises money through IPO by selling shares (typically at $10 each). Along with it, a warrant is sold that gives investors preference to buy more stock at a fixed rate in future. The money raised via IPO is kept in an interest bearing trust until one of the two things happen:
- The sponsors identify the target and acquire it or buy a stake in it using the funds raised. If the target is an unlisted firm, it becomes public via SPAC’s acquisition.
- The SPAC is unable to find a company to merge/acquire in a time span of 2 years (subject to change) – resulting in its liquidation.
SPAC v/s IPO
Traditional IPOs are subject to:
- Heavy regulations
- Investor scrutiny
- Take 4 -6 months to complete
- Need to hire underwriters, do roadshows, pitch meetings, etc.
- Quick listing possible due to no scrutiny
- More like shell companies
- Rely on the reputation of sponsors
- Sponsors usually receive 20% of the target’s shares at a heavily discounted price .
- Bill Ackman raised $4 billion through its SPAC Pershing Square Tontine Holdings Ltd.
- Chamath Palihapitiya’s (former Facebook executive) Social Capital Hedosophia Holdings acquired a 49% stake in Virgin Galactic in 2019.
Curious to know how IPOs work? Read here
- A reverse merger or reverse IPO is the acquisition of a public company by a private company so that the latter can bypass the lengthy and complex process of going public. An IPO through a SPAC is similar to a standard reverse merger. SPACs are essentially set up with a clean slate where the management team searches for a target to acquire. This is contrary to pre-existing companies going public in standard reverse mergers.
- According to an industry study published in January 2019, from 2004 through 2018, approximately $49.14 billion was raised across 332 SPAC IPOs in the United States. NASDAQ was the most common listing exchange for SPACs in 2018, with 34 SPACs raising $6.4bn.
- SPACs compete directly with the private equity groups and strategic buyers for acquisition candidates. The tightening of competition between these three groups could result in a bid for the best company and possibly increase valuations.