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).

Conclusion
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. Investing Basics

    5 Tips For Investing In IPOs

    It’s not easy to profit from IPO​s, but the money is there.
  2. Investing Basics

    5 Tips For Investing In IPOs

    Thinking of investing in IPOs? Here are five things to remember before jumping into these murky waters.
  3. Professionals

    Tips on Building a Resume for a Private Equity Job

    Trying to land a job in the coveted private equity sector? Ensure your resume meets the stringent PE job requirements with these important tips.
  4. Active Trading Fundamentals

    The 4 Biggest Private Equity Firms in London

    Discover information about the largest private equity firms that are headquartered in London, ranked by total assets under management.
  5. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  6. Active Trading Fundamentals

    The Biggest Private Equity Firms in San Francisco

    Learn about some of the larger private equity firms with a presence in San Francisco, including KKR, the Blackstone Group and Warburg Pincus.
  7. Active Trading Fundamentals

    The Companies of Peter Theil's Founders Fund

    Learn about the major public companies that Peter Thiel has invested in and companies that are on the verge of going public at multibillion-dollar valuations.
  8. Active Trading Fundamentals

    The Biggest Private Equity Firms in Los Angeles

    Learn why Los Angeles is a thriving market for private equity, and identify the five largest private equity firms operating in the city.
  9. Investing Basics

    If You Had Invested Right After Amazon's IPO

    Find out how much you would have made if you had invested $1,000 during Amazon's IPO, including how the power of the stock split affects investment growth.
  10. Markets

    Trader Joe's Stock Doesn’t Exist. Here’s Why

    Learn about Trader Joe's and how it operates. Understand why Trader Joe's has chosen not to be a public company and why it should remain that way.
RELATED TERMS
  1. Venture Capitalist

    An investor who either provides capital to startup ventures or ...
  2. Roll-Up Merger

    A rollup (also known as a "roll up" or a "roll-up") ...
  3. Volcker Rule

    The Volcker rule separates investment banking, private equity ...
  4. Dog And Pony Show

    A colloquial term that generally refers to a presentation or ...
  5. Form 211

    1. A form that must be completed by a market maker and filed ...
  6. Red Herring

    A preliminary prospectus filed by a company with the Securities ...
RELATED FAQS
  1. 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 >>
  2. What kind of assets can be traded on a secondary market?

    Virtually all types of financial assets and investing instruments are traded on secondary markets, including stocks, bonds, ... Read Full Answer >>
  3. What does residual value represent in a private equity investment?

    It is common to see a private equity investment's net asset value, or NAV, referred to as its residual value, since it represents ... Read Full Answer >>
  4. Why would a company decide to utilize H-shares over A-shares in its IPO?

    A company would decide to utilize H shares over A shares in its initial public offering (IPO) if that company believes it ... Read Full Answer >>
  5. How do I place a buy limit order if I want to buy a stock during an initial public ...

    During an initial public offering, or IPO, a trader may place a buy limit order by choosing "Buy" and "Limit" in the order ... Read Full Answer >>
  6. How much, if any, influence do non-controlling interest shareholders have?

    Non-controlling interest shareholders do not typically have much influence. The level of influence can vary, however, depending ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!