What is a SPAC deal?
A Special Purpose Acquisition Company (SPAC) is a way for a company to publicly list themselves - it is in essence, a shell company which is set up to raise money through an IPO in order to eventually acquire another company.
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| Photo by Scott Graham on Unsplash |
A SPAC company is formed and goes public as a SPAC. Later on, the it can announce a merger with a private company (e.g. Company X) - when the merger deal is closed, Company X will become a publicly traded company.
The Special Purpose Acquisition Company has no operations, no products and no services. In general, the only assets a SPAC has is the money raised in its own IPO and it is typically created by, sponsored by, a team of institutional investors.
The money that is raised by the IPO, the cash goes into an interest yielding trust until the management team finds a private company that wants to go public via an acquisition.
Once the acquisition is complete the SPAC investors can have a choice: exchange their shares for shares of the merged company or redeem their shares back for the original investment plus interest.
Criticisms of SPAC
People buying into the IPO do not know what the eventual acquisition company will be - hence the name "blank check company". Institutional investors with a strong reputation and track record of success typically have an easier time convincing people to invest into the unknown.
This means though that investors are going in blind on their investments - this is seen as a casino approach to investing by many in the field.
The SPAC sponsors who have the responsibility of finding an acquisition within a couple of years are not incentivized in striking a good value deal and so can end up overpaying for a company.
Why are SPAC deals growing in popularity?
Renaissance Capital found that the average returns from SPAC mergers completed between 2015 and 2020 under performed the average post-market return for investors from an IPO.
Although SPACs have been around for a while, the 2020 pandemic drove up their popularity. During times of uncertainty companies generally wish to postpone the IPO to avoid the market volatility at the time ruining their stocks public debut.
A traditional IPO can be a comparatively lengthy and involved process, taking up to six months just to register with the SEC. A SPAC acquisition on the other hand can be closed in just a few months allowing a company to go public and get an influx of capital much quicker than through a conventional IPO.
This article is not advice and has not been prepared in accordance with legal requirements designed to promote the independence of investment research – no recommendations are given in the buying, selling or holding of any investments. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.