By Jamie Ho
SPACs have garnered a lot of attention in 2020, and their hype appears to be continuing into 2021. But what exactly are SPACs and what makes them so special?
What Are SPACs and How Do They Work?
SPAC stands for Special Purpose Acquisition Company, otherwise known as a “blank cheque company”. SPACs are companies with no commercial operations, created strictly for the purpose of raising capital through an IPO and then using that capital to acquire existing private companies. Through this process, the acquired private company is taken public. SPACs thus present both an opportunity for investors to bet on a leadership team’s ability to find a good deal, as well as a short-cut alternative route to market for private companies.
In general, SPACs are founded and managed by ‘sponsors’ with expertise and interest in pursuing deals in a specific industry. However, while sponsors may have early acquisition targets in mind, they will not state these targets at the time of the SPAC IPO to avoid extensive disclosures. Investors investing in SPACs thus have no knowledge about the company they will eventually be invested in. This is where the comparison to “writing over a ‘blank cheque’ for the SPAC to fill in” originates from. Instead, investors base their investment decisions on the reputation of the dealmakers and trust that they will carry out an acquisition that will give them good returns in the future.
SPACs turn to underwriters and institutional investors to fundraise prior to an IPO, before opening their shares up to the public. Shares are usually listed at $10 per unit, with an unusual capital structure consisting of:
1. Units
Each unit contains a share of common stock + a fraction of a warrant to purchase more stock at a later date.
The warrant is treated as an additional compensation for early investors.
45 days after the IPO, the shares and warrants contained in each unit can be separated and traded as independent securities.
Prior to the IPO, sponsors typically purchase ‘founder shares’ and warrants equalling 20% of total outstanding shares. This 20% ownership is known as the ‘promote’.
Founder shares and public shares are similar in that they are both converted into public shares post-IPO on a one-to-one basis. However, founder shares also come with anti-dilution provisions and a redemption waiver.
2. PIPEs
PIPE stands for Private Investment in Public Equity, i.e. the selling of publicly-listed SPAC shares to a privately selected group of investors.
When a SPAC has insufficient funds to acquire a target company, a PIPE deal can be used to raise additional capital/ offset previous capital withdrawals.
Raising the required additional capital through private fundraising is more efficient than through secondary offerings due to lower regulatory scrutiny.
However, subsequent PIPEs can dilute the ownership of current shareholders. This is why SPACs tend to include warrants in their units– to compensate early investors whose shares may get diluted.
The funds raised from the IPO are secured in an interest-bearing trust, where it will remain until the SPAC’s management team identifies a company to acquire that shareholders sign off on. If the SPAC fails to acquire a company within the (typically 2 year) deadline, the SPAC will be liquidated and the funds would be returned to investors. Investors are also free to redeem their shares should the SPAC announce a deal that they disagree with (hence the need for PIPE deals at times). The interest generated from the trust in the ad interim is used by the SPAC as working capital (day-to-day operations).
What makes SPAC IPOs and De-SPAC acquisitions so special?
The SPAC process can be broken down into two parts:
The SPAC IPO: The first part is the listing of the SPAC itself, which occurs for the purpose of raising capital. To prevent confusion, we will call this process the ‘SPAC IPO’.
The De-SPAC acquisition: The second part is the SPAC’s acquisition of (and thus effectively IPO of) its selected target company, otherwise known as the ‘De-SPAC acquisition’.
Source: PWC Viewpoint, SPAC Overview and Lifecycle, 25th Jan 2021
An IPO is the stock market launch of a private company’s shares to institutional and retail investors for the first time. A company may choose to go public for a number of reasons:
To raise equity capital.
To gain access to liquid secondary markets.
To create profitable exit channels for private shareholders like founders and PE firms.
To act as a currency for future M&A projects.
There are several ways a company may go public. Below we will compare the process of SPAC IPOs and De-SPAC acquisitions to that of traditional IPOs and reverse takeovers (RTO).
Firstly, SPAC IPOs are significantly quicker than traditional IPOs. This is because SPAC IPOs are subject to less usual regulatory and investor scrutiny compared to a traditional IPO. With limited business risks, no commercial operations, historical finances, or assets to complicate statements and prospectuses, this phase can be completed in as little as 8 weeks. SPAC IPOs also have no need for roadshows or pitch meetings.
Secondly, Investment banks charge lower underwriting fees for SPAC IPOs and De-SPAC acquisitions than for traditional IPOs. While traditional IPOs are usually charged 5-7% of gross IPO proceeds upon closing, SPAC IPOs are only charged 2% of gross IPO proceeds. The remaining 3.5% is only paid to the underwriters if and when the De-SPAC acquisition closes too. If no deal occurs, the underwriters will never receive the deferred charge, and the money will instead be used together with the rest of the trust to redeem public shares.
Lastly, De-SPACing is also less risky for the target company and requires less due diligence as compared to a RTO. A RTO occurs when a private company goes to market via the purchase of shares of a public company. De-SPAC acquisitions are similar to reverse takeovers in that they both merge private and public companies to bypass the lengthy process and intensive regulation of a traditional IPO. However, while the public ‘shell’ in a RTO may have covert debt and legal obligations that pose risks to the company wishing to go public, SPACs cannot use their capital for any purpose other than the acquisition of the target company. This means that companies going public via a De-SPAC acquisition can do so quicker and on a cleaner slate, with lower risks than a company going public via a RTO.
These attributes of heightened efficiency and lowered costs and regulation come together to make SPACs a unique and attractive investment vehicle and route to market for private companies.
In the second part of the article on SPACs, we cover the rise of, risks, rewards and future of SPACs.
Jamie Ho
Jamie is a first year International Relations undergraduate at the London School of Economics. Her articles cover mainly markets and M&A, with a particular interest in political risk.
Disclaimer:
This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. You are advised to perform your own independent checks, research or study.