- A Special Acquisition Company isn't new, but popular sponsors in the finance industry are using them more frequently to bring private companies to the public markets.
- In this video, we cover everything you need to know before investing in a SPAC.
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The following text is a transcript for our readers who would like to follow along:
What is a SPAC? A SPAC, or Special Purpose Acquisition Corporation is a company that raises money through an IPO for the sole business purpose of acquiring an existing private company at some point in the future. Therefore, bringing that private company to the public markets. This is why people also refer to a SPAC as a "blank check company."
But, how does it work? What does the capital structure look like, and why is it a favorable method for private companies to go public? Well, let's start with how it's created.
A SPAC is formed when either an individual or company, referred to as the sponsor, submits a registration document with the Security Exchange Commission, the SEC. This document is called the S-1, and on this document the sponsor marks this new Corporation as a SPAC. Well, when a SPAC raises money on its IPO day, those funds are placed in an interest bearing trust account. This money cannot be dispersed except to complete an acquisition of the target company, or to return the funds to its shareholders if no acquisition is completed by the closing date. Which is typically 18 to 24 months after the IPO date. Although if it comes down to it, a SPAC can request an extension of the time frame, and then the shareholders could approve or deny that request.
If a SPAC fails to complete a business acquisition by the closing date, and the shareholders don't grant an extension, then the public shares are redeemed for a pro rata portion of the cash in the trust account and returned to the shareholders. Now, if a SPAC does complete a successful acquisition, then the company is usually listed on one of the major stock exchanges. Typically the NASDAQ, or the New York Stock Exchange.
One stipulation of a SPAC acquisition though is that the fair market value, which is the price that the company would sell for in the open market of the target company, must be 80% or more of the SPAC's trust funds. So, if this SPAC had $800 million in its trust account, then the target company would have to have a fair market value of at least $640 million. So, what does the capital structure of a SPAC actually look like anyways? Well,
When investors buy into the IPO of a SPAC, they're usually buying what's called a unit, and either a fraction or the entirety of a warrant. Now, a Unit just stands for one share of common stock plus a warrant, which gives the investor the right to buy a share of stock later at a predetermined price at a specific time. Warrants can sometimes only be worth a half, a third, or two-thirds of a share of stock, depending on what was established when the SPAC was created. You might be asking how is that any different than an option?
Well, a warrant when exercised actually provides additional capital for the company when the shares sold.
Options don't do this since they're just contracts only traded between investors. A SPAC warrant can also be different in the sense that sometimes the structure of a warrant doesn't allow the investor to exercise until specific events are triggered. That can be time, revenue goals, the share price of the existing float, etc. And, an issue that most investors are not aware of, is that when warrants are exercised, or force exercised by the company in some cases, it increases the shares outstanding on the market. Therefore diluting the existing shares being traded.
But, what about the creators of the SPAC? What's in it for them? Well, they typically hold what's called Founder Shares which entitle them to 20% of the common shares in the new company brought to the market. There's usually a lock up period of about one year on these shares, but in some special scenarios that time frame can be shorter. A lock up period protects the interests of the market, preventing these SPAC's from being a get rich quick scheme. But, getting 20% of the common shares is the trade off for the sponsor not being able to receive any salary or commission from all the work they do until the acquisition is completed.
So, why do private companies like going public via a SPAC anyways? Well, there's usually a few advantages such as: gaining the expertise of a sponsor who has brought other companies to the public markets, or skipping the long process and large fees of a traditional IPO. Or, how about this one? SPAC's typically acquire companies at a premium, adding value to the private company for its earliest investors and management team.
So the bottom line, SPAC's are just a company created by people or companies with great reputations. Capital is raised and a private company is brought to the public market through an acquisition. And if the SPAC works correctly, then everyone wins.
If you're interested in SPAC investing opportunities Seeking Alpha has a great free IPO daily newsletter that includes SPAC coverage. And, if you're interested in receiving this free newsletter, click the link below this video right now.
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