Let's Talk About SPACs

It seems difficult to read a financial article these days without seeing the acronym “SPAC.” While they have been around for decades, this specific type of company has grown in popularity recently. Why is this? Also, what are they, and why do they suddenly seem to matter?

What is a SPAC?

SPAC stands for special purpose acquisition company. It is a shell company set up for the sole purpose of raising money to fund a potential future acquisition or merger. When the SPAC is established, it does not have an acquisition target in mind. Essentially, it’s a big pile of money looking for something to buy. For a SPAC, success involves:

1. Finding investors

2. Locating a target company

3. Completing the acquisition or merger

4. Listing the acquired company on a public exchange (i.e., NYSE or Nasdaq)

The main opportunity that a SPAC provides to investors is the opportunity to get into an investment on the ground floor prior to the company going public.  The main risk is that investors do not know which company will be purchased with their investment dollars, so it is highly speculative.

How to SPAC

A SPAC is established by a group of initial investors or sponsors. The sponsors get together to file the necessary documents to create the SPAC and provide seed money. The SPAC sponsors are often experienced investors and industry experts.

A SPAC then issues units to the public. Units are issued at a fixed price, usually around $10 per unit. The money raised is placed into an interest-bearing trust account.

Next, the SPAC management begins to pursue a private company as an acquisition or merger target. Typically, the SPAC has a set deadline (usually 18 to 24 months) by which they need to complete a deal. If a company is not purchased within the specified timeframe, the money in the trust account is returned to investors. However, the SPAC investors can vote to extend the deadline.

Once a potential merger or acquisition deal is announced, SPAC investors vote to approve the deal. They are also given the option to redeem their shares at the initial purchase price and exit the investment. Interestingly, an investor can vote to both approve the deal and exit their investment. Once the deal is completed, the SPAC is listed on a public exchange.

SPAC IPO vs. Traditional IPO

Here are a few reasons why a private company may look to go public through a SPAC as opposed to a traditional IPO.

1. The cost associated with a SPAC is a fraction of that associated with a traditional IPO.

2. There are strict rules governing what type of financial information a company must provide during the traditional IPO process whereas those same rules do not apply for a SPAC IPO.

3. The timeframe required to close a SPAC deal is shorter than the timeline for taking a company public through a traditional IPO. SPAC deals can be completed in a matter of months, whereas a traditional IPO can take years.

Notable SPACs

It seems like every day a new celebrity or famous investor is announcing their involvement in a SPAC. It is too early to tell whether recent SPAC successes will prove to be long-term flourishing businesses. However, there are some that appear to be off to a good start. Richard Branson’s Virgin Galactic $800 million deal, Bill Ackman’s $4 billion SPAC, and the $3.3 billion DraftKings agreement are only a few on a long list of recent high-dollar launches.

Why have SPACs become so popular?

There is a laundry list of reasons why SPACs have increased in popularity and media coverage over the last few years. The first is related to simple supply and demand dynamics. The number of publicly traded investable companies has fallen significantly over the past decades. It has been cut nearly in half. Meanwhile, the amount of money looking to enter capital markets has ballooned. As a vehicle that provides additional investment opportunities by increasing the number of publicly traded companies, SPACs have been the beneficiary of increased cash flows into equities.

Next, private equity investments have also seen higher inflows. Private equity funds make their money by buying companies and then selling them again. If there is not a buyer for a company, the private equity investor cannot exit the deal. If the private equity investor cannot exit a deal, it is harder for them to enter into new deals to keep their business going. SPACs have provided a willing and eager participant in the private equity investment cycle by serving as a purchaser of companies that the private equity investors are looking to unload.

Risky Business

It is important to note that despite their recent popularity, SPACs remain a highly speculative investment vehicle. It is a pile of money looking for something to buy. The very nature of the arrangement makes it risky. While SPAC sponsors and management teams are incentivized to procure deals with a high likelihood of success, concerns still exist about the added pressure to find something to buy by the deadline or risk SPAC dissolution. This might lead to overpayment for a target. In addition, the target company may lack the internal controls or financial reporting capability necessary to become a publicly listed company.

Conclusion

When investing for long-term goals, I believe that waiting to invest in a SPAC or IPO until the company has been public for a minimum of 6 to 12 months is prudent.  It provides time for the company to report their earnings over the first couple of quarters and helps alleviate some of the increased volatility that is typical with the IPO/SPAC process. If you have additional questions about investing in SPACs, I’m always here to answer them.