Special purpose acquisition companies - or SPACs for short - are public shell companies that raise capital from the general investing public for the purposes of completing an acquisition of an operating company, usually a privately-held business. The charters of SPACs may provide an ideal acquisition market space or industry, such as commercial manufacturing or industrial services, which provide a guideline for investors. Others are not limited by any particular type of industry, and the target company may be located in any region, domestically or internationally.

SPACs are regarded as a "blind pool" of capital, as investors do not yet know the operating company that the SPAC managers will ultimately invest their money in. Similarly, SPACs are referred to as blank-check companies - as their investors have given the managers a blank check (along a limited timeframe) with which to make an acquisition. In this article, we'll take a look at the blank checks investors are "writing" for these investments.

All About SPACS
These vehicles are typically sold by way of an initial public offering (IPO), structured as a sale of units consisting of both common stock and "in the money" warrants that can be converted within a previously specified timeframe. For instance, a common share may be initially offered for $6 per unit, and for every common share offered there will be either one or two warrants issued, with each reflecting the right to purchase a common share in four years. As with the common stock, the warrants can be traded after the initial offering period. (To learn more about IPOs, check out our IPO Basics Tutorial.)

SPACs are similar to a reverse merger in that a blank shell company is looking to acquire a standing operating company. Reverse mergers commonly involve a smaller public company merging with a larger private company, with the combined entity treated as a publicly listed corporation.

Publicly traded SPAC securities provide their investors flexibility in exit strategies for their equity investments, and their liquidity is an attractive feature of these shell companies because investors can invest smaller amounts of capital while still taking part in the acquisition market. (Keep reading about this in The Wacky World of M&As.)

SPACs vs. Private Equity funds
Contrast these features to investing in a private equity fund. Typically, the size of the minimum required investment restricts the participants to high net worth individuals and institutional investors only. Additionally, private equity firms typically hold their acquired platform companies for five to seven years. The investors that have equity tied up in these funds often find that their investments are illiquid. If they do wish to pull out their investment, they will typically have to approach a private equity fund of funds - firms that invest directly in buy-out firms, which can be a cumbersome process. (Find out more in Fund Of Funds - High Society For The Little Guy.)

Since SPACs are listed as public securities, they are governed by the Securities and Exchange Commission (SEC). Under the S-1 registration statement, full disclosure is required, such as the blank check company structure, ownership structure, target industries and/or geographic region, risk factors, management team and their biographies. The SEC is believed to be studying whether or not SPACs require special regulations in order to prevent abuses.

Currently, blank check companies are listed as common shares and warranty securities on the OTC bulletin board, Nasdaq and the American Stock Exchange (AMEX), though more stock exchanges may be additional listing and trading venues.

Romancing The Funds
The management team usually has a strong track record, significant M&A and/or industry operating expertise in order to attract a successful public fundraising. Typically, at least 90-95% of the proceeds raised are held in escrow for the purpose of a merger or acquisition within a specified time period. Twelve to 24 months is a common time horizon for management to successfully complete a transaction.

Because of the limited life charters of SPACs, an acquisition must be consummated within a defined period or the entity will be dissolved. The fair market value of the target must exceed 80% of the corporation's net assets. SPACs that are seeking companies with enterprise values north of $200 million can encounter a stiff challenge from other acquirers, such as private equity and strategic acquirers from the public company landscape.

Companies north of the mentioned size range are usually approached by a number of suitors. However, in a competitive M&A landscape, SPACs have the ability to pay higher multiples due to the public source of their capital. Additionally, the management team is typically a group comprised of seasoned executives with a fair amount of finance and operating experience. These skills can be leveraged and utilized by a target company to increase overall enterprise value, post-acquisition. The SPAC route can also be a cheaper way for a private company to go public, as a more traditional IPO alternative can yield more expensive fees for large investment banks and brokerage houses.

Target Must Show Value
Shareholders of these entities have voting and conversion rights, and ill-conceived proposed transactions can be rejected. Thus, management must ensure - despite the relative difficulty in acquiring attractive companies due to the number of possible suitors - that the target company has a reasonable and believable value enhancement proposition moving forward. SPACs have received criticism for what is perceived as unusually favorable compensation for its management members. Management typically receives 20% of the equity of a SPAC on the front end.

Most charters dictate that no compensation is owed to management if it is not able to successfully complete a transaction. Heavy rewards may incline a few managers to steer shareholders toward less than ideal companies in the hope of attaining a 20% stake of the company. Due to potential conflicts of interest, industry norms have formed: a SPAC cannot form a business combination with a target where an insider has a financial stake, in order to protect the interest of all shareholders (an exception is if a fairness opinion is issued by a third party to qualify the deal).

Many investment banks are able to generate handsome fees by creating SPACs. These institutions are familiar with capital raising efforts, and also have a wide and diverse network of industry and intermediary contacts that can aid management in securing an acquisition. This advantage must be balanced by considering such things as the limited forecast and/or directional insight shareholders have on future acquisitions, the unattractiveness of the approval contingency to sellers and the limited research coverage on behalf of potential investors.

Related Articles
  1. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  2. Markets

    The Biggest Private Equity Firms In India

    Learn about the leading private equity firms operating in India and which companies and industries are attracting foreign investment dollars.
  3. Financial Advisors

    Are Alternatives Right for Your Portfolio?

    Alternative investments are increasingly making their way into retail investors' portfolios. Are they a good fit?
  4. Fundamental Analysis

    Top Private Equity Bargains for Your Portfolio

    Investing in private equity firms can lead to long-term profits.
  5. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  6. Stock Analysis

    Match.com IPO: Is it a 'Buy' or Should You Pass?

    Demand for relationships is always high. Now you will have a way to directly invest in the relationship market. But is it priced fairly?
  7. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  8. Stock Analysis

    Toys 'R' Us Stock Doesn’t Exist: Here is Why

    Learn why investors cannot trade stock in toy retailer Toys 'R' Us. This privately traded company could be a hot IPO candidate for the future.
  9. Stock Analysis

    If You Had Invested in Qualcomm Right After Its IPO

    Find out about how much you would have if you had bought 100 shares of Qualcomm during its initial public offering and the amount you would receive in dividends.
  10. Markets

    Why Are Companies Taking Longer To Go Public?

    Learn why private companies are waiting longer to have their IPOs. Understand why it may be more advantageous for a company to stay private.
  1. When did Facebook go public?

    Facebook, Inc. (NASDAQ: FB) went public with its initial public offering (IPO) on May 18, 2012. With a peak market capitalization ... Read Full Answer >>
  2. Do penny stocks trade after hours?

    Penny stocks are common shares of public companies that trade at a low price per share. These companies are normally small, ... Read Full Answer >>
  3. Do hedge funds invest in private companies?

    Hedge funds normally do not invest in private companies because of liquidity concerns. Capital funding for private companies ... Read Full Answer >>
  4. Who do hedge funds lend money to?

    Many traditional lenders and banks are failing to provide loans. In their absence, hedge funds have begun to fill the gap. ... Read Full Answer >>
  5. Can mutual funds invest in private equity?

    Mutual funds can invest in private equity indirectly by buying shares of publicly listed private equity companies, such as ... Read Full Answer >>
  6. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center