What is a Special Purpose Acquisition Company (SPAC)?
Particular Purpose Acquisition Company (SPAC): A business without commercial activities created only to raise money via an initial public offering (IPO) to buy out or merge with an existing firm is known as a particular purpose acquisition company (SPAC).
SPACs, often called blank check firms, have been around for decades, but their profile has grown significantly in recent years. With $80 billion invested, 247 SPACs were established in 2020, while a record 613 SPAC IPOs occurred in 2021. In contrast, a mere 59 SPACs entered the market in 2019.
How does a Special Purpose Acquisition Company (SPAC) work?
Typically, sponsors or investors with experience in a particular business sector or industry create SPACs and look for transactions there. Though they may have an acquisition target in mind, the SPAC founders choose to keep it private to avoid making disclosures during the IPO process.
Known as “blank check companies,” SPACs don’t provide IPO investors much information before they invest. SPACs only issue shares to the public once they have found underwriters and institutional investors. SPACs rose in 2020–2021, drawing in big names like Goldman Sachs, Credit Suisse, Deutsche Bank, and semiretired or retired senior executives.
SPACs earn money via initial public offerings (IPOs) and deposit it into an interest-bearing trust account that can only be accessed to finalize acquisitions. Should it fail to close a deal, money will be reimbursed, and the SPAC will eventually be wound up.
A SPAC has two years to close a transaction or risk going out of business. A portion of the trust’s interest income may sometimes be used as the SPAC’s operating capital. A SPAC is typically listed on one of the leading stock markets after an acquisition.
SPAC IPOs raised $13.6 billion in 2019. The $3.5 billion they raised in 2016 was more than four times this amount. SPACs attracted more attention in 2020 and 2021, raising $83.4 billion and $162.5 billion, respectively. SPACs have raised $9.6 billion as of March 13, 2022.
What benefits does a SPAC offer?
SPACs provide benefits to businesses aiming to go public. When using a SPAC, the path to a public offering might only take a few months, while a traditional IPO could take up to a year.
Furthermore, because of the short time to start a transaction, the target company’s owners may be able to negotiate a higher price when selling to a SPAC. The acquisition or merger with a SPAC supported by well-known financiers and business executives offers the target firm more market visibility and seasoned management.
The worldwide COVID-19 epidemic may have contributed to the rise in popularity of SPACs in 2020, as many firms opted out of traditional initial public offerings (IPOs) due to market instability and uncertainty.
What Dangers Does a SPAC Pose?
An investor in a SPAC IPO has faith that the promoters will eventually acquire or merge with a suitable target business. However, because of the need for more transparency from the SPAC and the diminished level of control by regulators, ordinary investors are left with the possibility that the transaction is overpriced or even fraudulent.
Poor Returns
SPAC returns might need to catch up to what was promised during the advertising phase. Goldman Sachs strategists observed in September 2021 that from their IPO to transaction announcement, the median SPAC outperformed the Russell 3000 index out of the 172 SPACs that had concluded a deal since the beginning of 2020. Nevertheless, the median SPAC underperformed the Russell 3000 index by 42 percentage points six months after the acquisition closed.
A Renaissance Capital analyst estimated that by the end of 2021, up to 70% of SPACs that had their IPO were trading below their $10 offer price. This negative trend may indicate the impending implosion of the SPAC bubble, as several market observers have forecast.
The conservative Truth Social app that former President Donald Trump developed was made available to the public via Digital World Acquisition Corp. (DWAC), an SPAC. DWAC shares were selling at just under $18 by the end of 2022, initially increasing to around $100 per share upon the deal’s announcement in the spring of 2022.
Unfinished Business
Investing in a SPAC carries some risk since the transaction could not go through even if they find a firm to buy. Industry estimates state that in 2022, over 55 alleged SPAC transactions totaling tens of billions of dollars were ultimately canceled, and another 65 SPAC sponsors were wholly shut down.
A SPAC transaction might go wrong for a variety of reasons.
The SPAC may need more time to locate a good acquisition target. This might happen if the SPAC’s management team is no longer looking for a private company that satisfies the investment criteria outlined in the prospectus or if the private company declines to sell to the SPAC.
The management team of the SPAC may need help to work out advantageous conditions for the acquisition, such as the purchase price or the deal’s structure.
The SPAC won’t be able to generate enough money for the purchase via the IPO. This may occur if there is insufficient investor interest in the SPAC or the market needs to improve.
Finally, the SPAC transaction might fail if regulatory bodies or the SPAC’s shareholders do not approve the purchase.
Due to how SPACs are set up, investors usually get their money back at the par value of the shares, which is $10 per share. However, if they purchase shares at a higher price, expecting a transaction to be completed, they may lose out. Investors do not have the right to receive the market price at which SPAC shares are purchased; instead, they are only entitled to the pro-rata portion of the trust account.
Alerts about Scams
SPACs have recently gained popularity, but as of April 2021, the U.S. Securities and Exchange Commission (SEC) will enforce new accounting standards. As a result, the number of new SPAC filings will decline from record levels in the first quarter of 2021 to a much lower number in the second.
Celebrities, entertainers, and professional athletes invested so significantly in SPACs that the SEC warned investors not to base their investment choices on celebrity participation in an Investor Alert released in March 2021.
Early in 2022, SPACs lost favor due to heightened regulatory scrutiny and underwhelming results.
Actual Case Studies of SPACs
Exceptional purpose acquisition businesses were involved in a high-profile transaction involving Richard Branson’s Virgin Galactic. Before Virgin Galactic’s 2019 offering, venture entrepreneur Chamath Palihapitiya’s SPAC Social Capital Hedosophia Holdings paid $800 million for a 49% share in the business.
Pershing Square Tontine Holdings, the largest SPAC, was sponsored by Pershing Square Capital Management founder Bill Ackman in 2020. On July 22, 2020, the company raised $4 billion at its first public offering. Ackman intended to liquidate the SPAC in August 2021, but as of 2022, negotiations to reach a transaction were still ongoing, and the SPAC had yet to be liquidated.
What is a particular purpose acquisition company (SPAC), and how can an individual invest in one?
The majority of ordinary investors need help to fund promising privately owned businesses. SPACs, however, provide public investors the ability to collaborate with venture capital companies and investment experts. Exchange-traded funds (ETFs) invest in SPACs; these funds usually consist of a combination of SPACs still looking for a target to go public and firms that just went public via a merger with a SPAC. As with any investment, there will be varying degrees of risk based on the particulars of a SPAC investment.
Which well-known businesses have used SPACs to go public?
The digital sports entertainment and gaming company DraftKings (DKNG), the aerospace and space travel company Virgin Galactic (SPCE), the energy storage innovator QuantumScape (QS), and the real estate platform Opendoor Technologies (OPEN) are a few of the most well-known companies that have merged with a SPAC to become publicly listed.
What happens if there is no merger of SPACs?
SPACs have a deadline by which they must complete a contract and combine it with another business. Usually, this period lasts between 18 and 24 months. A SPAC liquidates and returns all cash to investors if it cannot combine within the specified period.
The Final Word
An investment vehicle known as a particular purpose acquisition company (SPAC) is designed to raise money via an initial public offering (IPO) to purchase a private business. The term “blank check companies” is sometimes used for SPACs due to their formation without a particular acquisition objective.
After raising enough money via the IPO, the SPAC utilizes the proceeds to look for and buy a private business, which is reversely merged to become public. By doing this, the private business may raise more money and access public markets without going through the conventional IPO process. The SPAC market has seemed to be souring recently, despite being a well-liked substitute for conventional IPOs.
Conclusion
- An initial public offering (IPO) is how a particular purpose acquisition company (SPAC) raises capital to acquire another business.
- SPACs don’t have any activities or acquisition targets disclosed at the IPO.
- SPAC shares have a par value of $10 per share and are organized as trust units.
- Prominent private equity firms, celebrities, and the general public are among the investors in SPACs.
- SPACs have two years to complete a purchase, or they have to give investors their money back.
