What Is a SPAC: Special Purpose Acquisition Company

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TLDR

A SPAC is a special purpose acquisition company, helping private companies go public without the headaches involved with a traditional IPO. In an IPO, the private company announces that it wants to go public, thus attracting investors to help it do so.
A SPAC, on the other hand, reverses the process. The SPAC first attracts investors, allowing them to pool their money. Then, the SPAC goes public as a shell corporation for the sole purpose of raising funds to buy private companies.
One reason for SPACs’ increasing popularity is that they shortcut the required paperwork needed for a traditional IPO, allowing private companies to go public faster and easier.
SPACs do not have any commercial operations other than to raise money solely to purchase private businesses. This is why it’s easier for the SPAC itself to go public — no business operations to disclose.
Once the SPAC has gone public, the next step is to find a private company that it wants to take public. SPACs are typically sponsored by senior investors or management teams with experience and established track records in buying, selling, and managing companies.
Additionally, the SPAC sponsors are responsible for finding the target company to take public.
On the other hand, SPAC investors cannot know the company they’ll eventually acquire ahead of time. This is why SPACs are often called “blank check companies,” as investors often go into the investment blindly.
Once the SPAC’s sponsors find an investable private company, that company and the SPAC may decide to merge, turning the private company into a public one.
SPACs typically have two years to close the acquisition or be forced to liquidate their funding.
SPACs have many advantages, mainly expediting the deal. Taking a company public through a traditional IPO can often take a couple of years. With a SPAC, the process is shortened to a few months, savings enormous amounts of time, money, and frustration while letting the target company take advantage of higher valuations as a public company faster.
SPACs offer greater control over the deal’s terms with less regulatory scrutiny.
In traditional IPOs, the founders typically lose some business control when they accept private equity money. However, in a SPAC merger, the target company’s founders maintain significant ownership.
SPACs have some potential disadvantages well. Because these deals are subject to less scrutiny than traditional IPOs, there is a wider berth for misrepresenting valuations or investments while attempting to get others to invest in the SPAC. Such misrepresentations can cause conflicts of interest or even fraud.

Special purpose acquisition companies, or SPACs, have been around for almost 30 years. In 1993, investment banker David Nussbaum and attorney David Miller created the SPAC as a way “to give private [investment] firms another way to access everyday investors.”

According to NPR, SPACs have remained obscure over the past couple of decades, existing on the “fringes of the financial world.” However, they are now considered by many to be the hottest trend on Wall Street. Except for a small peak in popularity in 2006-2008, SPACs have started gaining massive popularity in 2019, with approximately 200 SPACs going public in 2020, “raising about $64 million in total funding, nearly as much as all of [2020’s] IPOs combined.”

Numerous companies have recently gone public by merging with a SPAC, such as DraftKings and Opendoor. Other pending SPAC mergers include SoFi, 23andMe, WeWork, and Acorns. With these high-profile companies merging or considering a merger with a SPAC, more small- and mid-level startups are more willing to consider a SPAC merger, as these larger companies have given credibility to the process. The U.S. Securities Exchange Commission (SEC) has become more involved in SPAC regulation over the past few years, adding more credibility to these transactions.

This article will address what SPACs are, how they work, and the differences between a SPAC and an initial public offering (IPO).

What Is a SPAC?

A SPAC is a special purpose acquisition company, helping private companies go public without the headaches involved with a traditional IPO. In an IPO, the private company announces that it wants to go public and attracts investors to help it do so.

A SPAC, on the other hand, reverses the process. The SPAC first attracts investors, allowing them to pool their money. Then, the SPAC goes public as a shell corporation for the sole purpose of raising funds to buy private companies.

Let’s look more specifically at how a SPAC works.

How Does a SPAC Work?

According to PwC, SPACs have become the “preferred way for many experienced management teams and sponsors to take companies public.” One reason for this is that SPACs shortcut the required paperwork needed for a traditional IPO, allowing private companies to go public faster and easier.

SPACs do not have any commercial operations other than to raise money solely to purchase private businesses. SPACs make no products. They don’t sell any goods or services. The only assets that they typically have are the funds raised for acquisition. This is why it’s easier for the SPAC itself to go public — no business operations to disclose.

Once the SPAC has gone public, the next step is to find a private company that it wants to take public. SPACs are typically sponsored by senior investors or management teams with experience and established track records in buying, selling, and managing companies. The SPAC sponsors have “founder shares” in the SPAC, making up about 20 percent of the SPAC’s equity, with the remaining 80 percent or so reserved for public shareholders. Additionally, the SPAC sponsors are responsible for finding the target company to take public.

On the other hand, SPAC investors cannot know the company they’ll eventually acquire ahead of time. This is why SPACs are often called “blank check companies,” as investors often go into the investment blindly.

Once the SPAC’s sponsors find an investable private company, that company and the SPAC may decide to merge, turning the private company into a public one. Then the newly formed public company gets its own stock ticker on a public exchange, such as NASDAQ, faster than if it took the traditional IPO route. The SPAC, on the other hand, is no longer a shell company as it now owns a publicly traded business. Additionally, the SPAC investors now own a portion of the publicly traded business as well.

SPACs typically have two years to close the acquisition or be forced to liquidate their funding. Thus, the SPAC may only disburse funds necessary to complete the acquisition or to return the funds (plus interest) to the investors upon the SPAC’s liquidation.

What are the Advantages of a SPAC?

SPACs have many advantages, chiefly expediting the deal. Taking a company public through a traditional IPO can often take a couple of years. With a SPAC, the process is shortened to a few months, savings enormous amounts of time, money, and frustration while letting the target company take advantage of higher valuations as a public company faster. Additionally, SPACs can often give private companies access to capital more quickly than traditional methods through the liquidity offered in the SPAC IPO.

Because of the expedited timeline for becoming a public company, SPAC IPOs often yield better results within a fixed timeframe, all under the guidance of an experienced partner through the SPAC’s sponsors. In addition, they offer greater control over the deal’s terms with less regulatory scrutiny.

Also, in traditional IPOs, the founders typically lose some business control when they accept private equity money. However, in a SPAC merger, the target company’s founders maintain significant ownership.

Private companies reduce their risk of having market volatility their stock publicly by choosing to work with a SPAC. Finally, in a SPAC merger, the target company can negotiate its own valuation with the SPAC investors.

For the SPAC investors, these mergers “can also mean big bucks for the sponsors who organize them, who are rewarded with a big chunk of equity when they close a deal.” Additionally, once the SPAC sponsor announces the target company, if the investors are skeptical, they can get their money back, making SPACs extraordinarily unique. As such, the SPAC investors have less risk than their sponsors.

Let’s look at some other disadvantages of a SPAC.

What are the Disadvantages of a SPAC?

Although skyrocketing in popularity, SPACS are not without their disadvantages. For example, if the target company does not fit the goals or expectations of the SPAC, the SPAC investors can back out of the deal.

Additionally, because these deals are subject to less scrutiny than traditional IPOs, there is more room to misrepresent valuations or investments while attempting to get others to invest in the SPAC. Such misrepresentations can cause conflicts of interest or even fraud.

Because SPACs close in a shorter amount of time, the deal may not always be best for investors or the target company. For example, “sponsors can make so much money if they complete a SPAC that some critics worry there's an incentive to merge with a mediocre company just to get their payday,” according to NPR.

The shorter time period to closing can also create challenges for the target company, as meeting an “accelerated public company readiness timeline as well as complex accounting and financial reporting/registration requirements that may differ based upon the lifecycle of the SPAC involved.” To add to the time-crunch, the “target company’s management team will need to focus on being ready to operate as a public company within three to five months of signing a letter of intent,” according to PwC.

What is the Difference Between a SPAC and an IPO?

Although we’ve addressed some differences between SPACs and IPOs, let’s summarize them. As quoted in Crunchbase, Don Butler of Thomvest Ventures sums it up nicely by stating, “[y]ou can think of it like: an IPO is basically a company looking for money, while a SPAC is money looking for a company.” However, there’s more to it than that.

The timeline for a SPAC merger may take up to a few months, where a traditional IPO may take up to a couple of years. The underwriting fees for SPACs typically range around 2 percent and 3.5 percent at completion, where underwriting fees for traditional IPOs double at 7 percent.

Also, for SPACs, sponsors can consider a private company’s financial projections up to ten years out, where companies “can share their past financials and talk about a total addressable market size but cannot get into detailed financial projections.”

SPACs have a shortened time limit in which they close the merger, giving investors a shorter time to see a return on their money, saving everyone involved substantial amounts of time and money. Additionally, if SPAC investors have doubts or concerns about the target company, they can get their money back.

For the private company, founders can maintain more control and ownership through a SPAC than the traditional IPO process. SPACs can give private companies access to higher valuations as a publicly traded company faster than through the formal IPO process.

Finally, SPACs have much less regulatory scrutiny than traditional IPOs, contributing to the speed of the deal.

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