What Is a Special Purpose Acquisition Company (SPAC)?

A special purpose acquisition company (“SPAC”) is a shell company that is created solely for the purpose of raising money through an initial public offering (“IPO”) to be used to merge and bring public another existing company. SPACs, also known as blank check companies, have been around since the early 1990s but have become wildly popular in recent years, raising record volumes of IPO money and attracting prolific investors. “The average SPAC size has risen from $36 million in 2009 to $324 million in 2021. SPACs generally look to combine with a target company 2-3 times the size of the amount of capital in the trust account.” ¹

SPAC Formation

SPACs are typically formed by an investor or group of investors called a “sponsor” with the intent of targeting transactions in a particular sector where the sponsor has relevant expertise. The sponsor invests a nominal amount, which usually equates to a ~20% interest in the SPAC. The other ~80% is owned by public shareholders and is made available through an IPO. Often, the sponsor will have targets in mind, but they are not disclosed to public shareholders upfront. This is done to avoid extensive disclosure requirements during the IPO and provide the sponsor with flexibility after the funds are raised.

The proceeds from the IPO are deposited in an interest-bearing trust account and can only be accessed in two instances: 1) Execute a merger, or 2) Return money to the investors if the SPAC is liquidated.  SPACs generally have 18-24 months to complete a merger before a forced liquidation.

Once the SPAC identifies a company, the SPAC’s public shareholders vote on the merger. If the transaction is approved, dissenting shareholders still have the option to redeem their shares at cost plus accrued interest. In certain instances, the SPAC may require more capital to complete the transaction and may issue debt or additional shares through a private investment in public equity (“PIPE”) deal.  Once the transaction closes, the target company becomes a public entity.

Advantages of a SPAC

Compared to traditional IPOs, SPACS bring certain advantages to all major stakeholders – the sponsor, the target and the investing public.

1. Provides Price Certainty for the Target

In a traditional IPO, the share price is subject to fluctuations based on the demand for the shares and market conditions during the IPO marketing process. In a SPAC deal, the sponsor and the target negotiate and lock in a price that, once agreed upon, is not subject to change.

2. Allows for Faster Execution

SPAC mergers typically take 3–6 months, whereas an IPO usually takes 12–18 months.

3. Gives Early-Stage Companies Access to Public Markets

U.S. securities laws have different disclosure rules for IPOs and mergers. Companies that go public through an IPO are prohibited from sharing financial projections with potential investors. However, the rules around SPAC mergers are less stringent and allow for the inclusion of financial projections in marketing materials. This provides an opportunity for nascent companies with thin financial history to share projected revenue and income with investors.

4. Democratizes the IPO Process for Retail Investors

In a traditional IPO, the companies and their banks select institutional investors to allocate shares to. As a result, most individual retail investors miss out on the IPO process. In the case of a SPAC, shares trade publicly on the stock exchange, usually months before a deal is announced, allowing retail investors to participate in the process.

5. Offers Companies an Opportunity to Partner with an Experienced Sponsor

Each SPAC deal offers a unique opportunity for a target to go public with the support of an experienced sponsor who brings substantial operational expertise and vast industry experience. In most cases, the sponsor will also assemble a seasoned board of directors to help the target’s management team execute their strategic vision.

Drawbacks of a SPAC

While the SPAC has many benefits compared to a traditional IPO, it is not without risks.

1. Potential for Capital Shortfall

When more public shareholders redeem shares than expected, sponsors may be forced to turn to the debt markets or raise more PIPE financing to make up for the shortfall.

2. Compressed Timeline

While the faster timeline may be advantageous in certain instances, the compressed nature of a SPAC transaction places a substantial burden on the target company’s management team as they prepare required financials and SEC filings and establish public company functions, all while hitting critical growth goals during this timeframe.

3. Light Diligence Requirements

The SPAC process does not require the rigorous due diligence of a traditional IPO, which could lead to restatements, incorrectly valued businesses or even lawsuits.

Rise in Popularity

So far in 2021, 330 SPACs have raised nearly $105 billion. That’s a substantial jump from prior years — in 2020, 248 SPACs raised more than $83 billion, and in 2019, 59 SPACS raised more than $13 billion.² New SPAC issuances dropped off in May and June as regulators proposed laws that would introduce substantial administrative and documentation burden to the SPAC process.  However, experts believe SPACs are here to stay as a preferred method for high-growth companies to enter the public markets in a streamlined fashion.

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1. https://www.thompsoncoburn.com/insights/publications/item/2021-04-14/key-considerations-for-target-companies-in-a-spac-merger

2. ttps://www.cnbc.com/2021/06/02/a-spac-frenzy-this-year-could-lead-to-riskier-deals-heres-why.html