The traditional IPO process involves too much red tape and is heavy on regulatory compliance. Hence, many companies are obliged to delay going public. As a result, they deprive themselves of the benefit of raising money in the public market. Special Purpose Acquisition Company or SPAC makes it possible for companies to go public, without going through the tedious process of registering an IPO with the SEC (Securities and Exchange Commission), which can take anywhere, from 6 months to over a year to complete. Although SPACs have been around for decades as alternative investment vehicles, they have become highly popular since 2020. The SPAC IPOs accounted for over half of all IPOs in 2020 and 48% of the proceeds were raised even amid global markets gripped with pandemics’ uncertainty. So, what is SPAC and how does it work?
What Does SPAC Mean?
It is essentially a shell company (also known as a blank-cheque Company) set up by investors, with the sole purpose of raising money through an IPO to eventually acquire another company. Once the IPO is complete, the SPAC typically has 18 -24 months to complete the merger with the targeted company. While a conventional IPO takes a minimum of 6 to 12 months, a SPAC takes 4 to 5 months.
A SPAC is generally formed by a group of sponsors, highly experienced business executives or fund managers, seasoned investors, private equity firms, or venture capitalists. SPACs undergo the typical IPO process. However, the sponsors do not have to publicly identify target companies to avoid a more grueling SEC process. The SPAC gets a ticker symbol, and the raised capital remains in an escrow account. This is usually an interest-bearing trust account. SPACs also issue the warrants along with shares, as part of a unit to attract investors. A warrant provides an investor with the right to buy additional shares at a later date at a fixed price.
How Do SPACs Work?
SPACs have 18 -24 months to search for a private company to acquire or merge with. Oftentimes, sponsors already have the specific company or industry in mind at the outset of SPAC’s formation. After the SPAC leadership choose the target company and negotiate a deal, the “de-SPAC” process begins. This requires a few significant approvals and actions before executing the actual acquisition/merger.
- SPAC sponsors must formally announce it and take the majority shareholder’s approval to close the deal.
- At the time of the SPAC IPO, the sponsor often receives 20% of SPAC’s common stock or the “founder’s shares”. Accordingly, at least 20% of the SPAC’s outstanding shares go to voting in favor of a transaction.
- The SPAC offers the investors the right to redeem their public shares. Redeeming occurs on a pro-rata basis of the proceeds held in the trust account regardless of their votes.
A SPAC can also seek a PIPE (private investment in public equity) deal if it does not have sufficient funds in its trust account and needs to raise additional capital to close a merger transaction.
After the acquisition’s completion, the SPAC’s investors have two options. They can either swap their shares for shares of the acquired company. Or, they redeem their SPAC shares to get back their original investment. The SPAC sponsors typically get about a 20% stake in the final, merged company. With a SPAC merger, the target company becomes a public entity. In case a SPAC fails to acquire a company within the stipulated time period, then the invested money is returned back to the shareholders.
Is SPAC New to Financial Markets?
SPAC stocks have existed since 1990, with sponsors focusing on varied industries. The number of SPAC IPOs has increased steadily since 2013 with 2020 being a gamechanger. Better yet, 2021 has been another record-breaking year, with 613 SPACs raising nearly $162.5 billion.
In April 2021, Grab Holdings, Southeast Asia’s most valuable start-up, grabbed the headlines when it announced the largest-ever deal of $40 billion, by partnering with Altimeter Growth Corp.
Are they Better than IPOs?
SPAC deals are a better alternative to traditional IPOs, due to a mix of cost, pricing, and legal factors. While market volatility and broader investor sentiment majorly impact the pricing of a traditional IPO, SPAC deals are considered more stable because of up-front pricing. This is due to the reason that this is negotiated before the transaction closes. Further, there are no direct fees, like payment to investment banks, legal fees, and auditing fees. Then, the ultimate benefit of faster execution. Lastly, they invest in hot sectors like Tech, Health-tech, Electric/Autonomous Vehicles (EV/AV), Augmented/Virtual Reality (AR/VR), Artificial Intelligence (AI), IoT, and the like.
However, SPACs have their own disadvantages. The process does not require rigorous financial due diligence, which could lead to potential restatements, incorrectly valued businesses, or even lawsuits. Studies found that over 50% of post-merger SPACs experienced poor aftermarket performance. As per the data from Bloomberg, 14 out of 24 companies, that went public by Feb 2021, as a result of the SPAC merger, reported depreciation in value as of one month following the merger completion.
Regulatory Setbacks for SPACs
The influx of well-versed sponsors, seasoned investors, and management teams resulted in an unprecedented rise in SPAC IPOs in 2020 and 2021. Nonetheless, last year has witnessed some restraints in the SPAC market from SEC, as a measure to save investors. In April 2021, the SEC issued guidelines that warrant issued to the investors should be classified as debt instead of equity. In case the new regulatory guideline becomes a law, it will require existing SPACs as well as pipeline deals to go back and restate their financial results to properly account for warrants. This could slow down the IPO process. This will be a costly matter for the companies as they need to value those warrants each quarter rather than just at the start of the SPAC. Moreover, the valuation of warrants requires complex financial modeling.
In another crackdown, SEC is contemplating the treatment of “redeemable” shares issued by these shells, as temporary equity. Moreover, It is introducing changes in the listing process. SPACs have traditionally listed on Capital Markets, which has a minimum capital requirements and a minimum threshold of 300 shareholders. On the contrary, Global Market has no minimum capital requirement, however, it does require SPACs to have 400 shareholders. While Nasdaq is working to decrease this threshold to 300 shareholders for Global markets, it might take some time to come into effect.
Authored by Ekta Bhatia
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