What Is a Special Purpose Acquisition Company (SPAC)?
A special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company. Also known as "blank check companies," SPACs have been around for decades, but their popularity has soared in recent years. In 2020, 247 SPACs were created with $80 billion invested, and in just the first quarter of 2021, a record $96 billion was raised from 295 newly-formed SPACs; in comparison, only two SPACs came to market in 2010.
- A special purpose acquisition company is formed to raise money through an initial public offering to buy another company.
- At the time of their IPOs, SPACs have no existing business operations or even stated targets for acquisition.
- Investors in SPACs can range from well-known private equity funds and celebrities to the general public.
- SPACs have two years to complete an acquisition or they must return their funds to investors.
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How a SPAC Works
SPACs are generally formed by investors, or sponsors, with expertise in a particular industry or business sector, with the intention of pursuing deals in that area. In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don't identify that target to avoid extensive disclosures during the IPO process. (This is why they are called "blank check companies." IPO investors typically have no idea about the company in which they will ultimately be investing). SPACs seek underwriters and institutional investors before offering shares to the public.
The funds SPACs raise in an IPO is placed in an interest-bearing trust account. These funds cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated. A SPAC generally has two years to complete a deal or face liquidation. In some cases, some of the interest earned from the trust can be used as the SPAC's working capital. After an acquisition, a SPAC is usually listed on one of the major stock exchanges.
Advantages of SPACs
SPACs offer some significant advantages for companies that have been planning to become publicly listed. Firstly, a company can go public through the SPAC route in a matter of months, while the conventional IPO process is an arduous process that can take anywhere from six months to more than a year. The soaring popularity of SPACs in 2020 may partly be attributed to their shorter timeframe for going public, as many companies chose to forego conventional IPOs because of the market volatility and uncertainty triggered by the global pandemic.
Secondly, the owners of the target company may be able to negotiate a premium price when selling to a SPAC, as the latter has a limited time window to make a deal. In addition, being acquired by or merging with a SPAC that is sponsored by prominent financiers and business executives can give the target company experienced management and enhanced market visibility.
Risks of SPACs
An investor in a SPAC IPO is making a leap of faith that its promoters will be successful in acquiring or merging with a suitable target company in future. The reduced degree of oversight from regulators, coupled with a lack of disclosure from the typical SPAC, means that retail investors run the risk of being saddled with an investment that could be massively overhyped or occasionally even fraudulent.
Returns from SPACs may be well below expectations once the initial hype has worn off. Strategists at Goldman Sachs noted in September 2021 that of the 172 SPACs that had closed a deal since the start of 2020, the median SPAC had outperformed the Russell 3000 index from its IPO to deal announcement; but in the six months after deal closure, the median SPAC had underperformed the Russell 3000 index by 42 percentage points. As many as 70% of SPACs that had their IPO in 2021 were trading below their $10 offer price as of September 15, 2021, according to a Renaissance Capital strategist. This dismal performance could mean that the SPAC "bubble" that some market experts had warned about may be in the process of bursting.
SPACs Make a Comeback
SPACs have become very popular in recent years, although new accounting regulations issued by the SEC in April 2021 caused new SPAC filings to plummet in the second quarter from the record levels of 2021's first quarter.
SPAC IPOs raised $13.6 billion in 2019, which was more than four times the $3.2 billion they raised in 2016. But SPACs really took off in 2020-21, with as much as $96 billion raised from 295 SPAC IPOs in just the first quarter of 2021, surpassing the previous high of $80 billion from 247 SPACs for all of 2020.
During this boom period for SPACs, they attracted big-name underwriters such as Goldman Sachs, Credit Suisse, and Deutsche Bank, as well as retired or semi-retired senior executives. As well, so many celebrities including entertainers and professional sportspeople became involved with SPACs that the SEC issued an "Investor Alert" in March 2021 cautioning investors not to make investment decisions related to SPACs based solely on celebrity involvement.
In 2020, SPACs accounted for over 50% of new publicly listed companies in the U.S.
Examples of High-Profile SPAC Deals
One of the most high-profile recent deals involving special purpose acquisition companies involved Richard Branson's Virgin Galactic. Venture capitalist Chamath Palihapitiya's SPAC Social Capital Hedosophia Holdings bought a 49% stake in Virgin Galactic for $800 million before listing the company in 2019.
In 2020, Bill Ackman, founder of Pershing Square Capital Management, sponsored his own SPAC, Pershing Square Tontine Holdings, the largest-ever SPAC, raising $4 billion in its offering on July 22. In August 2021, however, reports indicated that Ackman planned to liquidate the SPAC.
Why would a company go public through a SPAC and not an IPO?
To save time and money. Going public through an IPO is a lengthy process that involves complex regulatory filings and months of negotiations with underwriters and regulators. This can be a deterrent to a company's plans to get publicly listed, especially during periods of heightened uncertainty such as the pandemic years of 2020-21, when the risk of investors giving its IPO a frosty reception is much greater. In contrast, a company can go public within months if it merges or is acquired by a special purpose acquisition company (SPAC), which as its name suggests, is an entity that exists specifically for the purpose of making such an acquisition. The owners of a target company may also be in a better position to negotiate a favorable price from a SPAC that has a limited timeframe to make an acquisition, compared with another buyer like a private-equity firm that may drive a hard bargain.