A Special Purpose Acquisition Company, or SPAC, is a type of investment fund formed for the sole purpose of acquiring existing companies. The company is able to raise capital through an Initial Public Offering (IPO). This allows retail investors in the stock market to contribute funds and participate in transactions usually reserved for private equity firms such as leveraged buyouts (LBO). These shell companies have no commercial operations of their own. A Special Purpose Acquisition Company is sometimes referred to as a “blank check” company as investors supply the funding solely for the purpose of making an acquisition as and when deemed profitable by the management.
SPACs have existed for a number of years and previously were popular especially before the financial crisis. However increased regulatory attention on the alternative investment industry during this period led to a decline in their use. Recently they have moved back into the mainstream and caught the attentions of the wider investor audience. This has enabled SPAC’s to raise even more funding through an IPO. Funds that can then be used to acquire one or more unspecified businesses consistent with its investment objectives.
In 2019, a record level of investment totaling $13.6bn was raised by these investment vehicles. This was up from $10bn in 2018. More household investment names continue to move into this field. On June 11, 2020, hedge fund magnate Bill Ackman filed for an IPO of a Special Purpose Acquisition Company. Initial reports suggest it may be the largest ever offering of this type. With the 2020 funding level already at $10bn half way through the year, the popularity of this alternative investment appears set to be sustained for some time.
Special Purpose Acquisition Company IPO
Some SPAC’s may have the scope to invest and consume targets across a broad spectrum. However, many SPAC’s are formed by investors or sponsors to focus on a particular area or industry. Personnel involved with the fund will often be experienced executives demonstrate a deep level of expertise in a specific area or business sector. The managers of the fund will be a key selling point and focus of the prospectus when generating investor interest in the fund IPO.
The IPO process for a Special Purpose Acquisition Company is more straightforward than for a typical operating business. The objective of the SPAC is singular and direct and rarely involves complications that may involve issues with the SEC. Although the announcement of an IPO is often the first thing many investors hear, the founders will usually already have identified at least one acquisition target. This target may not be disclosed during the IPO process, therefore investors need to have confidence in the executives whose reputation and experience will help identify profitable targets to acquire.
After the SPAC raises funding in an IPO it is placed in an interest paying trust account until a predetermined period elapses or an acquisition is made. In the event that the planned acquisition is not made, generally in a two year period, or legal formalities are still pending, the SPAC is required to return the funds to the investors. In addition, management often agrees to purchase warrants from the company in a private placement at the time of the offering. These may range from 2% to 10% of the amount being raised in the IPO with the proceeds being placed in the same trust and distributed to public stockholders in the event of liquidation.
Warrants which are attached to the shares issued to investors in the IPO can become detached once trading begins and trade separately in the market. The purpose of the warrant is to provide an additional incentive for investors to supply funds to the Special Purpose Acquisition Company. These may produce a warrant arbitrage trading strategy if prices move out of line.
Acquiring a Target Company
The SPAC management team generally has 18 to 24 months (sometimes longer depending on the company and industry) after the completion of the IPO to identify and complete the acquisition of a target. The fair market value of the target company must judged to be 80% or more of the total assets of the Special Purpose Acquisition Company. Until the deal consummates, management are not allowed to collect salaries. However, following the acquisition, the management team profit from the transaction by being awarded a 20% holding of the common stock in the new company. Investors then receive an equity stake pro rata to their capital contribution.
Advantages and Disadvantages of a Special Purpose Acquisition Company
Advantages of a SPAC
Hedge funds and other financial institutions have become very interested in how they can include SPACs and their mergers & acquisitons strategy. They can also be an attractive option for the owners of a smaller company as the risk factors are lower than for standard reverse mergers. Retail investors may benefit from the diversification opportunities afforded by this type of investment strategy.
SPACs begin their acquisition trail with a clean slate and no previous corporate baggage which may interfere with the buyout. Financing is already in place removing a significant hurdle the majority of which is supplied by a varied and influential institutional base. The subsequent market liquidity attracts more investors as the shares can be traded in the stock market. This also helps them raise investment faster than private equity funds and more than a reverse merger could achieve.
As previously mentioned, the process for the subsequent merger is simpler than it would be to file for a full IPO registration with the SEC. Selling to a Special Purpose Acquisition Company could potentially add up to 20% to the sale price when compared to a private equity deal. This is because the management team of the SPAC typically take seats on the board of directors and continue to add value to the firm as advisors or liaisons to the company’s investors. The guidance and deep experience of the managers help reassure the market leading to less volatile swings in broader market valuations. SPACs also allow the target company’s management to continue running the business. They often sit on the board of directors also allowing them to benefit from future growth of the firm. The company usually retains the target name and registers to trade on a national Stock Exchange such as the NASDAQ or the New York Stock Exchange (NYSE).
Disadvantages of a SPAC
However, despite these benefits, investing in a SPAC does not guarantee success. Within the last 5 years, there have been numerous examples of SPACs that have traded below their initial offering price. As this was during an extended bull market, the relative return is even more stark.
Overpayment for the target and management conflict between the founders and the target management tend to be the biggest factors affecting underperformance. In addition, many Special Purpose Acquisition Companies ended up failing to find suitable targets before their specified time limit runs out.
However, SPACs remain an option for investors to get access to the management team’s superior skills and abilities when locating an ideal acquisition candidate.
