What Is a Special Purpose Acquisition Company (SPAC)?
A special purpose acquisition company (SPAC) is a company without commercial operations and 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 existed for decades, but their popularity has soared in recent years. In 2020, 247 SPACs were created with $80 billion invested, and in 2021, there were a record 613 SPAC IPOs. By comparison, only 59 SPACs came to market in 2019.
- A special purpose acquisition company (SPAC) is formed to raise money through an initial public offering (IPO) to buy another company.
- At the IPO, SPACs do not have business operations or stated targets for acquisition.
- SPAC shares are structured as trust units with a par value of $10 per share.
- Investors in SPACs range from prominent private equity funds and celebrities to the general public.
- SPACs have two years to complete an acquisition or they must return funding to investors.
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How Does a Special Purpose Acquisition Company (SPAC) Work?
SPACs are commonly formed by investors or sponsors with expertise in a particular industry or business sector, and they pursue deals in that area. SPAC founders may have an acquisition target in mind, but they don’t identify that target to avoid disclosures during the IPO process.
Called “blank check companies,” SPACs provide IPO investors with little information prior to investing. SPACs seek underwriters and institutional investors before offering shares to the public. During a 2020–2021 boom period for SPACs, they attracted prominent names such as Goldman Sachs, Credit Suisse, and Deutsche Bank, in addition to retired or semiretired senior executives.
The funds that SPACs raise in an IPO are placed in an interest-bearing trust account that cannot be disbursed except to complete an acquisition. In the event it is unable to complete an acquisition, funds will be returned and the SPAC will ultimately be liquidated.
A SPAC has two years to complete a deal or face liquidation. In some cases, some of the interest earned from the trust can serve as the SPAC’s working capital. After an acquisition, a SPAC is usually listed on one of the major stock exchanges.
In 2019, SPAC IPOs raised $13.6 billion. This was more than four times the $3.5 billion they raised in 2016. Interest in SPACs increased in 2020 and 2021, with as much as $83.4 billion raised in 2020 and $162.5 billion in 2021. As of March 13, 2022, SPACs have raised $9.6 billion.
What Are the Advantages of a SPAC?
SPACs offer advantages for companies planning to go public. The route to public offering using a SPAC may take a few months, while a conventional IPO process can take anywhere from six months to more than a year.
Additionally, the owners of the target company may be able to negotiate a premium price when selling to a SPAC due to the limited time window to commence a deal. Being acquired by or merging with a SPAC that is sponsored by prominent financiers and business executives provides the target company with experienced management and enhanced market visibility.
The popularity of SPACs in 2020 may have been triggered by the global COVID-19 pandemic, as many companies chose to forego conventional IPOs because of market volatility and uncertainty.
What Are the Risks of a SPAC?
An investor in a SPAC IPO trusts that promoters are successful in acquiring or merging with a suitable target company in the future. However, there exists a reduced degree of oversight from regulators and a lack of disclosure from the SPAC, burdening retail investors with the risk that the investment may be overhyped or even fraudulent.
Returns from SPACs may not meet expectations offered during the promotion stage. 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. However, 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 by the end of that year, according to a Renaissance Capital strategist. This downward trend could signal that the SPAC bubble that some market experts had predicted may be bursting.
Former President Donald Trump’s conservative Truth Social app was brought public via a SPAC known as Digital World Acquisition Corp. (DWAC). After initially rising to around $100 per share after the deal was announced in the spring of 2022, DWAC shares were trading sharply lower at just around $18 toward the end of 2022.
One risk to investing in a SPAC is that even if they identify a company to acquire, the deal may not end up going through. According to industry reports, more than 55 supposed SPAC deals worth tens of billions of dollars ended up being terminated in 2022, with an additional 65 SPAC sponsors shutting down entirely.
There are any number of reasons why a SPAC deal might fail.
- The SPAC may not be able to find a suitable acquisition target in time. This can happen if the SPAC’s management team is not able to identify a private company that fits the investment criteria outlined in the SPAC’s prospectus, or if the private company is not interested in being acquired by the SPAC.
- The SPAC’s management team may not be able to negotiate favorable terms for the acquisition, such as the purchase price or the structure of the deal.
- The SPAC may not be able to raise enough capital through the IPO to fund the acquisition. This can happen if there is not enough investor interest in the SPAC, or if market conditions are unfavorable.
- Finally, the SPAC deal can fail if the acquisition is not approved by the SPAC’s shareholders or by regulatory authorities.
Because of how SPACs are structured, investors typically get back the par value of the shares (usually $10 per share) but may lose out if they buy shares at higher prices in anticipation of closing a deal. Indeed, investors are only entitled to the pro rata share of the trust account and not the price at which SPAC shares are bought on the market.
Though popular in recent years, SPACs face new accounting regulations issued by the U.S. Securities and Exchange Commission (SEC) as of April 2021, causing new SPAC filings to plummet in the second quarter from the record levels of 2021’s first quarter.
Many celebrities, including entertainers and professional athletes, became so heavily invested in SPACs that the SEC issued an Investor Alert in March 2021, cautioning investors not to make investment decisions based solely on celebrity involvement.
By early 2022, SPACs decreased in popularity due to increased regulatory oversight and less-than-expected performance.
Real-World Examples of SPACs
Richard Branson’s Virgin Galactic was a high-profile deal involving special purpose acquisition companies. 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 and the largest-ever SPAC: Pershing Square Tontine Holdings, which raised $4 billion in its offering on July 22, 2020. In August 2021, Ackman planned to liquidate the SPAC, but as of 2022, the SPAC has not been liquidated with efforts still under way to find a deal.
How can an individual invest in a special purpose acquisition company (SPAC)?
Most retail investors cannot invest in promising privately held companies. However, SPACs are a way for public investors to now partner with investment professionals and venture capital firms. Exchange-traded funds (ETFs) that invest in SPACs have emerged, and these funds typically include some mix of companies that recently went public by merging with a SPAC and SPACs that are still searching for a target to take public. As with all investments, depending on the specific details of a SPAC investment, there will be different levels of risk.
What are some prominent companies that have gone public through a SPAC?
Some of the best-known companies to have become publicly listed by merging with a SPAC are digital sports entertainment and gaming company DraftKings (DKNG); aerospace and space travel company Virgin Galactic (SPCE); energy storage innovator QuantumScape (QS); and real estate platform Opendoor Technologies (OPEN).
What happens if a SPAC does not merge?
SPACs have a specific time frame in which they need to merge with another company and close a deal. This time frame is usually 18 to 24 months. If a SPAC cannot merge during the allotted time, then it liquidates and all funds are returned to investors.
The Bottom Line
A special purpose acquisition company (SPAC) is a type of investment vehicle that is created with the purpose of raising capital through an initial public offering (IPO) to acquire a private company. SPACs are sometimes called “blank check companies” because they are formed without a specific acquisition target in mind.
Once the SPAC has raised sufficient capital through the IPO, it uses the funds to search for and acquire a private company, which is then taken public through a reverse merger. This allows the private company to access the public markets and raise additional capital without going through the traditional IPO process. While a popular alternative to traditional IPOs, the SPAC market has seemed to sour in recent years.