While special purpose acquisition companies (SPACs) have been around since the 1990s, they’ve become increasingly popular due to market destabilization caused by the COVID-19 pandemic. In fact, the approximately 200 SPACs that conducted initial public offerings (IPOs) in 2020 raised around $64 billion dollars.
In the past, SPACs were last-ditch efforts for companies that wanted to go public but couldn’t raise IPO funds on the open market. But today, SPAC investment or acquisition can be an extremely savvy business move. In this blog, we’ll answer “what does SPAC stand for” and provide the information you need about SPAC vs. IPO to help you make the best decisions for your business
What Is a SPAC?
A special purpose acquisition company is formed to raise capital through an IPO to acquire an unspecified business. Also known as an initial business combination, SPAC acquisitions are typically structured like reverse mergers. In other words, the target company merges with (or into) the SPAC or one of its subsidiaries.
Because they don’t have commercial business operations, SPACs are also known as blank check or shell companies. Instead, their only assets are the funds raised during their IPO. The management team who forms the SPAC (known as its sponsors) often has an acquisition target or industry in mind. However, they aren’t required to share this information on the IPO prospectus.
Sponsors include private equity firms, venture capitalists, and high-profile investors who fund the IPO in exchange for founder’s shares, which typically make up a 20% stake in the merged company. After securing institutional investors and underwriters, sponsors offer shares to the general public. Non-founder shares are typically $10 each and come with some voting rights, but public shareholders don’t have input into electing SPAC directors.
Each SPAC shareholder unit includes a share of common stock and a fraction of a warrant, which gives initial investors the ability to buy more fixed-price stock at a later date. This price is often a premium to the current stock price at the time the warrant is issued. Warrant holders typically don’t have voting rights, and the exercise price of whole warrants is at least 15% of the IPO price.
The rules governing SPAC investment warrants vary significantly based on factors like:
- How many shares the investor has the right to purchase
- The price at which and period during when the shares may be purchased
- The circumstances under which the SPAC can redeem the warrants
- When the warrants will expire
Once the IPO is complete, warrants are spun off and traded separately from the original SPAC stock.
The SPAC Lifecycle: From Formation to De-SPAC
There are four main stages of the SPAC lifecycle: formation, IPO, target acquisition, and de-SPAC.
1. SPAC Formation
The sponsor starts by forming the SPAC and completing all of the Securities & Exchange Commission (SEC) filings necessary to go public. This process is quicker and easier than traditional IPO filings since the SPAC has very little historical financial data. The sponsors then go on a small-scale roadshow to find interested investors by emphasizing their expertise and the valuable potential of the future acquisition target.
Once they’ve attracted enough interest in the SPAC (and its unidentified target), they begin selling shares. At least 85% of the capital raised is escrowed in an interest-bearing blind trust to be used only during the future acquisition of the target company.
2. SPAC IPO
At this point, the SPAC goes public and begins trading openly on the major stock exchanges. Retail investors may begin purchasing shares, but they’re taking a gamble since they don’t know the target. The sponsor also receives their 20% of the SPAC’s shares in the form of a promote (founder’s shares).
3. Target Identification & SPAC Acquisition
Once the SPAC goes public, the sponsors have two years to locate and announce an acquisition target. If this process isn’t completed in time, the SPAC is dissolved and shareholders get their money back. Once the sponsors locate a target business, they negotiate items like purchase price and company valuation.
4. Merger with Target & De-SPAC
Once agreeable terms are reached, the sponsors present the target company to initial shareholders, who can vote for or against the acquisition. Shareholders may either swap their SPAC units for those of the merged company or redeem them to recoup their original investment (plus interest). Once the target is approved and all redemptions are complete, the SPAC can move forward with the acquisition.
At this point, the SPAC takes the target company public, as long as the acquired business has also gained regulator approval. The SPAC’s stock ticker then changes to reflect the name of the acquired business, and it begins trading like any other public company.
SEC Reporting Compliance for SPACs
There are several important reporting requirements and regulations to keep in mind if you decide to pursue a special purpose acquisition company. According to the U.S. Securities & Exchange Commission, SPAC founders must:
- Comply with recurring SEC filing requirements (including Forms 10-Q and 10-K), regardless of your limited business operations.
- Compile and present the effects of a potential acquisition and any related pro forma disclosures in a Super 8-K. This includes everything you’d see on a Form 10 registration statement, which is used for businesses that go public in ways other than a traditional IPO.
- File your Super 8-K within four business days of closing on your acquisition.
- File a proxy statement (or joint registration and proxy statement via Form S-4) if you intend to register new securities as part of your SPAC merger.
Benefits of SPAC Transactions
There are many positives associated with SPAC investment for sponsors, shareholders, and their acquired businesses.
Benefits for SPACs
- SPACs streamline the IPO process due to their limited business risk and lack of significant operating history.
- Acquiring an existing public company provides SPACs with an immediate influx of capital, rather than having to wait six months to a year (or more) with a traditional IPO.
- SPACs protect sponsors from the market volatility and uncertainty produced by the global COVID-19 pandemic. While IPO share prices are wholly dependent on market conditions at their listing date, SPAC sponsors can negotiate an exact purchase price ahead of time.
- Sponsors can raise additional capital through private investment in public equity (PIPE), which ensures merger completion even if some initial investors redeem their shares.
- SPACs typically involve lower marketing costs than traditional IPOs since sponsors don’t have to spend the time or money on extensive roadshows. Keep in mind that you will need a roadshow if you pursue PIPE during acquisition or de-SPAC.
Benefits for Target Companies
- Target companies may be able to raise their sales price because sponsors only have a finite period of time to make an acquisition.
- Merging with a prominent SPAC may provide target businesses with experienced management and improved market visibility they may not have access to otherwise.
- SPAC targets may qualify for SEC reporting accommodations that are provided to smaller reporting companies (SRCs) or emerging growth companies (EGCs), which can reduce the time and effort necessary to complete the merger.
Risks of SPAC Transactions
There are also several major risks to be aware of if you decide to form a special purpose acquisition company or are considering SPAC acquisition.
Risks for SPACs
- Sponsors must ensure complete SEC compliance throughout the IPO process, even though they haven’t identified a target company yet. Failure to comply negates many of the benefits associated with SPACs because the sponsor would have to provide the target’s financials.
- Depending on the SPAC’s lifecycle, accounting and financial reporting and registration requirements may be very complicated.
- The sponsors and underwriters who manage SPACs are highly-incentivized to identify a target within the two-year period due to their significant ownership stakes. This can significantly increase the likelihood of insider trading, fraud, or misuse of funds.
- SPACs require much narrower due diligence than traditional IPOs, which can lead to negative consequences like incorrectly-valued targets, potential restatements, and legal action.
Risks for Target Companies
- Acquisition targets may receive valuations well below market value, and sponsor fees tack on additional costs.
- The acquisition target may be rejected by SPAC stakeholders during the voting process.
- Management must be ready to operate publicly within 3-5 months of signing a letter of intent, which is a much shorter timeline than a traditional IPO. It requires the same amount of preparation, due diligence, prospectus drafting, and SEC engagement and oversight, though.