SPACs, are rising in popularity as a way for companies to go public – but what exactly is a SPAC, and how does it work?
What is a SPAC?
SPAC stands for Special Purpose Acquisition Company. These are also sometimes referred to as blank check companies, or shell companies.
They are called blank check or shell companies, because they don’t have any existing operations. These are simply companies that are formed with the intention of acquiring another company.
The goal of a SPAC or this shell company is to raise money so that they have enough money to actually buy or acquire an existing private company and merge with it.
Why would people give a SPAC their money?
It seems strange that people would want to invest into a shell company that isn’t really an existing functional company with a product right? And especially if you don’t know what company they are actually trying to acquire.
There are several reasons that SPACs are able to raise money.
Typically they will have reputable sponsors and investors that have specific knowledge in a particular industry. Sometimes this is a celebrity or well known name like Bill Ackman.
When you invest in a SPAC, you don’t know what company they’re going to acquire. So you’re very much investing off the reputation of the sponsors and leadership behind the SPAC.
So the pitch is essentially, “Hi, I’m Bill Ackman. Give me money and I’ll find a unicorn.”
So then, people who look up to Bill Ackman, his investor friends, or people he’s done deals with before are more inclined to put faith in this SPAC because he is leading the whole operation.
Will I get my money back?
So they’re going to raise money this way, and once the SPAC has the amount of money they want, this money goes into an interest bearing trust account.
This acts almost like an escrow account where the money is held. They go out and try to find a company that matches their criteria, until a company is found to buy, the money stays in this account.
They have to acquire a company within a certain timeframe (usually 24 months), otherwise, if they can’t acquire the company and nothing happens, the money is returned to the investors.
How a Company can Go Public
To understand what you get when you buy into a SPAC and why they are becoming so popular, we first have to understand the ways a company can go public. There are three main ways that we’re going to talk about:
- IPO (Initial Public Offering)
- Direct Public Offering
- Through a SPAC
With an IPO, the process that a company has to go through in order to be listed on a stock exchange is really long, really tedious, and very intense.
With an existing company IPO’s require a long underwriting process – if you’ve heard the term underwriting if you’ve ever bought a house, it’s essentially the same concept.
They’re looking at the company’s financial statements, assets, and making sure everything looks okay before that company is actually made available to the public.
But in addition to that, they are trying to generate interest in the company. It usually requires a “roadshow” which is basically traveling around making pitches/promotions to potential investors leading up to an initial public offering (IPO).
Direct Public Offering
A direct public offering is slightly less complicated than an IPO. It involves a company selling securities directly to the public without involving a lot of the middle men like the investment banks.
This is sometimes done if companies that can’t afford underwriting, or just don’t want to deal with the middlemen.
If a company is acquired by a SPAC, this is usually the fastest route to go public.
A SPAC sometimes has a specific company in mind that they’re trying to target and acquire, and sometimes they just go for the best company they’re able to find.
The SPAC (remember, this is an empty shell company) is going to raise money through an IPO or Initial Public Offering.
But, since these SPAC companies don’t have a history, or intense financial statements, it makes the process much much shorter than an established company going through traditional IPO process.
What do you get with a SPAC?
When you buy into a SPAC you are typically buying “units”.
A unit is usually $10/piece, and will later split into common stock and warrants.
Common stock is just a share of the company, and warrants allow you to buy more stock later at a fixed price.
When you buy a unit, the common stock and warrants aren’t always 1-to-1. You aren’t always going to get 1 share and 1 warrant. Sometimes you may only get 1 warrant for every 5 shares you own.
Assuming that the SPAC finds a company to acquire, the companies will merge. It will get a new ticker symbol, or that series of letters that represents a company on the stock market.
Once regulations and paperwork is all checked, the company that they acquired will now be public. There are still approval processes, but SPACs go through much less scrutiny than a traditional IPO.
What are the disadvantages of SPACs?
Because SPACs are under less scrutiny, if there wasn’t enough due diligence done, there’s a chance information can be overlooked like what we saw in the case of Nikola.
What are the advantages of SPACs?
Remember that the investors in the SPAC At that point if an investor wants to purchase more stock, because they have the warrants that guaranteed a fixed price they’d be able to buy it at, they can usually purchase more shares below market value.
If instead you want to cash out, you can do that as well.
Why do companies go public through SPACs?
- Fastest route to going public
- Under less scrutiny than they would be with a traditional IPO
- Companies may not be able to afford underwriting in a traditional IPO