Special Purpose Acquisition Company (SPAC)
A company that was established only for the purpose of obtaining capital
A company that was established only for the purpose of obtaining capital through an initial public offering (IPO), purchasing, or combining with another business is known as a special purpose acquisition company (SPAC).
They are sometimes known as "blank check firms" and have been operating for decades but have seen a surge in popularity in recent years.
In 2020, 247 were established with an investment of $80 billion, while 613 SPAC IPOs were recorded in 2021. Only 59 were launched to the market in 2019.
Investors or sponsors with experience in a particular industry or business area typically organize these to seek acquisitions in that sector.
The founders of a Special Purpose Acquisition Company may have at least one acquisition target in mind when forming the company, but they may not reveal that intention in order to avoid huge disclosures during the IPO process.
This is why they're known as "blank check businesses." Investors in initial public offerings often have no prior knowledge of the firm in which they will be investing. Before selling shares to the general public, they look for underwriters and institutional investors.
They invest the money they raise in an IPO in an interest-bearing trust account. If the company is liquidated, these monies can only be used to complete a purchase or to repay money to investors.
They usually have two years to execute a transaction before it is liquidated. In some situations, a portion of the trust's interest can be used to fund its operations. They are normally listed on one of the main stock markets once it has been acquired.
A faster track to public markets
Companies that want to go public might use them to make the process easier. They are founded by a sponsor-which might be anybody from a private equity firm to a former corporate executive-who collaborates with an underwriter to take the blank-check business public.
The SPAC raises money through a public stock offering and trades on an exchange in order to select a target firm with whom to combine. When a merger is completed, the SPAC inherits the target company's identity and ticker.
The capacity to talk about the future and make forecasts, which is restricted in the typical IPO process, is one of the primary benefits for target companies-and effectively, SPACs. This is a particularly appealing prospect for SPACs looking for disruptors and innovators.
The absence of need for roadshows (a crucial element of the traditional IPO process), which normally consist of many meetings with institutional investors and are aimed at acquiring cash, is also of importance to target firms.
They allow a sponsor to obtain funds in one vehicle, making the process of matching with a target firm a little easier.
They also provide direct access to emerging firms for private investors, which has previously been reserved for larger institutions and hedge funds. There's also the appealing aspect of affordability.
Investors may usually acquire one unit of a blank-check corporation for $10, which includes a common share and a portion of a warrant (which gives the right to buy more shares at a specified price in the future).
The SPAC's cash is invested in Treasury bills until it finds a target firm, at which point it is spent to complete the merger process. Fee arrangements vary, but the sponsor often holds a 20% ownership position.
After banking fees, the cost to public investors at the time of the SPAC's IPO, and/or a merger with a target firm, the expenses connected with SPACs may sometimes be substantially greater than standard IPOs.
Despite the fact that they provide a more efficient path to public markets, they do come with a set of hazards that investors should be aware of.
Many people have experienced substantial periods of volatility throughout their lives, with much of it owing to the enthusiasm around a sponsor (whether it a celebrity or a well-known private equity company) or the hoopla surrounding a possible merger.
Some of these share prices have tripled in value in a matter of days or weeks in both circumstances, only to quickly fall back to-or, in some cases, below-their IPO pricing.
Because of the paucity of information related to them, rapid and severe price changes require special vigilance.
Price action cannot be related to any fundamentals (such as earnings streams) until a merger is finalized since they are solely aggregators of cash.
This is one of the main reasons for the poor success of numerous Special Purpose Acquisition Companies, and it emphasizes the need to do due diligence on sponsors and the target industry of interest.
Another risk to consider is their inability to locate a merger target, which would force it to liquidate. They have two years to complete a merger; if they don't, they collapse, and investors receive a pro-rata part of its total worth.
This, together with the impossibility of new Special Purpose Acquisition Companies entering a crowded market, is a growing issue.
Finally, the regulatory environment may continue to be a source of difficulty in the future. The Securities and Exchange Commission (SEC) has increased its emphasis on Special Purpose Acquisition Companies as speculative trading activity has increased over the past year.
The SEC announced new proposed advice for them in March 2022, aiming at improving investor safety. Transparency and accountability are at the heart of the plans.
Under the proposed plan, Special Purpose Acquisition Company sponsors would be required to provide extra transaction disclosures; underwriters would face higher responsibility; special purpose acquisition companies' capacity to make long-term forecasts about future performance would be limited.
Before the advent of this plan, the Special Purpose Acquisition Company market was deteriorating to some extent.
In an April 2021 report, the SEC suggested that warrants will be treated differently, as liabilities rather than equities. This alone prompted over 100 of them to restate previous financial accounts, putting a halt to a fresh issue.
In addition to hazards, the performance of Special Purpose Acquisition Companies is a major concern for investors.
As previously stated, issuance has already seen a boom-bust cycle. As you can see in the table below, they grew in popularity in 2020, and given the flurry of issuance, so did their proportion of overall IPO activity (both in terms of total transaction value and number of businesses).
Special Purpose Acquisition Company value amounted to half of the entire IPO value in the United States by February 2021, when activity peaked. Their market share has dropped to roughly 10% as of April 2022.
The performance of the company has mainly mirrored that of the issuing activities.
Several speculative pockets of the market gained traction in the second half of 2020 for various reasons.
Ample liquidity (thanks to both fiscal and monetary aid) in the aftermath of the pandemic, increased interest in day trading, and an incredibly quick recovery in stocks from the S&P 500's low on March 23rd, 2020, were some of the reasons.
Special Purpose Acquisition Companies across the board-as assessed by the ISPAC Index-had doubled in value by February 2021, based on performance since the middle of 2020 (when many frothy parts of the market began to surge).
The pinnacle in the excitement, however, appears to be behind us, as gains for the ISPAC Index have entirely faded and turned into substantial drops, as seen in the next figure.
The performance of firms in the De-SPAC Index has been much worse, with their value falling by 75% from its high in 2021 to early May 2022.
Given the large number of firms that have gone the traditional way, it's a little more difficult to track traditional IPO performance over time.
The Renaissance IPO Index, which dates back to 2009 and gauges the performance of younger IPOs, is another option.
The index has risen almost 250 percent since its inception, which is rather outstanding. However, as indicated by strong drawdowns in 2015-2016 (-36%), 2020 (-38%), 2021 (-29%), and 2022 (-29%), the run has not been without turbulence (-45 percent).
Rise of Special Purpose Acquisition Company
They have grown in popularity in recent years, despite the fact that new accounting standards announced by the Securities and Exchange Commission in April 2021 led new Special Purpose Acquisition Company filings to drop in the second quarter of 2021 from record highs in the first quarter.
These IPOs raised $13.6 billion in 2019, more than four times their 2016 total of $3.5 billion. On the other hand, they took off in 2020 and 2021, raising as much as $83.4 billion in 2020 and $162.5 billion in 2021. They have raised $9.6 billion as of March 13, 2022.
Special Purpose Acquisition Companies attracted big-name underwriters like Goldman Sachs, Credit Suisse, and Deutsche Bank, as well as retired or semi-retired senior executives during this boom time.
In March 2021, the SEC issued an "Investor Alert" because so many celebrities, including artists and professional athletes, were associated with them.
It advised investors not to base their investment in these companies' decisions primarily on celebrity engagement.
To save money and time. Taking a company public through an initial public offering is a lengthy process that requires complicated regulatory filings and months of negotiations with underwriters and regulators.
This can hinder a company's ambitions to go public, particularly during times of increased uncertainty (such as the pandemic years of 2020 and 2021), when the danger of investors rejecting its IPO is significantly higher.
In contrast, if a firm merges or is bought by a special purpose acquisition company, which is an organization that exists only for the purpose of completing such an acquisition, it can become public within months.
In comparison to another bidder, such as a private equity firm, who may drive a hard bargain, the owners of a target company may be in a stronger position to negotiate a fair price from a SPAC that has a restricted time period for executing an acquisition.
Digital sports entertainment and gambling firm DraftKings, aerospace and space travel company Virgin Galactic, energy storage inventor QuantumScape, and real estate platform Opendoor Technologies are just a few of the well-known companies that have been publicly listed after merging with a Special Purpose Acquisition Company.
They must combine with another firm and conclude a contract within a certain time. This period normally lasts between 18 and 24 months.
If they fail to combine within the time limit, it liquidates and returns all cash to investors.
A Special Purpose Acquisition Company warrant entitles you to buy common shares at a certain price. Let's assume you purchase a warrant for $12 at a 1:1 ratio.
As a result, one warrant is equivalent to one share. You can exercise your right to acquire the stock for $12 if the stock price rises to $20 following the merger. This results in an immediate gain of $8.
Make sure you read the prospectus of the Special Purpose Acquisition Company to learn about your rights as an investor.
The ideal approach in this case, according to history, is to acquire Special Purpose Acquisition Companies after they've disclosed a merger target but before the merger is completed.
Investing in a pre-merger Special Purpose Acquisition Company when you don't know what stock you're buying is like driving in dense fog or a nasty snowfall; you may have a general sense of where you're heading, but you can't be certain.
And it's possible that you'll wind up with poor outcomes.
Shares of common stock immediately convert to the new entity when a merger is completed. Investors also have the choice of:
1. Make use of their warrants
2. Make a withdrawal
Everything You Need To Master M&A Modeling
To Help You Thrive in the Most Prestigious Jobs on Wall Street.
Researched and authored by Tanay Gehi | Linkedin
Reviewed and Edited by Aditya Salunke I LinkedIn
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