Special Purpose Acquisition Companies (SPAC) or blank-cheque companies have come into the limelight in recent years. About 247 SPAC were created with $80 billion invested just in the first quarter of 2021, which was as low as only 2 SPACs came into the market in 2010.
What is SPAC?
It is a company not involved in any commercial operations. It is formed strictly to raise capital through an IPO (Initial Public Offering) to merge or acquire an existing company. Therefore, they will not have any current business operation at the time of their IPOs. The investors in SPACs can be anyone like the general public, celebrities, and well-known private equity funds. SPACs get two years to complete an acquisition and return the funds to the investors.
How does a SPAC work?
Commonly, investors or sponsors with expertise in a particular industry or business sector form a SPAC to pursue deals in their field of interest. Sometimes they might be targeting only one acquisition but do not identify the target to avoid extensive disclosure during the IPO process. Before offering shares to the public, they seek underwriters and institutional investors.
The fund raised by SPAC in an IPO is placed in an interest-bearing trust account. These funds are disbursed only to complete an acquisition or to return the funds to investors if the SPAC is liquidated. Sometimes, the interest earned from the trust is used as working capital for the SPAC. After an acquisition, typically, the SPAC is listed on one of the stock exchanges.
Advantages of SPACs:
- A company can go public through SPAC in a very short period compared to the conventional IPOs, which can take from six months to more than a year.
- The target company owners might get a good deal while negotiating with a SPAC, as it has limited time to settle the deal.
- As prominent financiers and business executives sponsor SPAC, it can provide the target companies with experienced management and enhanced market visibility.
Risks involved in SPAC:
- The investors in a SPAC IPO come with the faith that their promoters will successfully acquire or merge the target company in the future. They may be at risk sometimes by fraudulent activities. There may be a massive lack of disclosure on the part of SPAC.
- Returns from the SPAC as expected might go well below the expectation as it was speculated initially.
How to go about it?
Successful SPAC will create value for the investors as well as the targets. The greater the value, the better will be deals. The sponsors can generate greater value by tapping various institutional investors (mutual funds, family offices, private equity firms, pension funds, strategic investors). The sponsors need a solid team to steer a SPAC through the process, from conception to merger.
What we think is, SPAC will stay. There may be some unethical behaviors at times, but it is growing, and more changes and growth are on the way to come.