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 an existing company. Also known as “blank check companies,”
What are SPACs?
- A special purpose acquisition company is formed to raise money through an initial public offering to buy another company.
- Basically, a SPAC is a shell company tasked with raising a pool of money from investors hoping to buy a “real” company in the future
- At the time of their IPOs, SPACs have no existing business operations or even stated targets for acquisition.
- Alternative to the typical IPO
- Investors in SPACs can range from well-known private equity funds to the general public.
- SPACs have two years to complete an acquisition or they must return their funds to investors.
How Does a SPAC Work?
- Formed by investors, or sponsors, with expertise in a particular industry or business sector, with the intention of pursuing deals in that area
- 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
- 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
- SPAC generally has two years to complete a deal or face liquidation
- Investors are given a warrant (or purchase) the shares of the acquired company at a specific price in the future
Advantages of SPACs
- SPAC can also offer business owners what is essentially a faster IPO process
- Eliminates the need to do mountains of paperwork, roadshows to raise money and reduce the fees paid to investment bankers to underwrite the deal
Disadvantages of SPACs
- No disclosure to investors what company is being purchased
- SPAC creators take a huge chunk of shares (~20%) for creating the SPAC which in return gets paid by the investors
- 2-year timeline may incentivise the SPAC creator to fund an unattractive business just to close the deal and get their compensation
- Attracts more dodgy companies, because these companies can avoid the rigorous auditing process from regulators
- SPAC returns achieve a -10% from Jan – July 2020, after excluding the large SPACs returns from Draft Kings and Nikola from the same period compared to IPO average of 6.5%
- Highly dependent on the sponsor quality, since there’s no other research points to determine whether a SPAC will be profitable
High Profile SPACs
- 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
- 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
- DraftKings is merging with Diamond Eagle Acquisition Corp. and SBTech for a SPAC