A special purpose acquisition company (SPAC) is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company. Also known as "blank check companies," SPACs have been around for decades, but their popularity has soared in recent years. In 2020, 247 SPACs were created with $80 billion invested, and in just the first quarter of 2021, a record $96 billion was raised from 295 newly formed SPACs. By comparison, only two SPACs came to market in 2010.
How an SPAC Works
SPACs are generally formed by investors or sponsors with expertise in a particular industry or business sector to pursue deals in that area. In creating a SPAC the founders sometimes have at least one acquisition target in mind, but they don't identify that target to avoid extensive disclosures during the IPO process. (This is why they are called "blank check companies." IPO investors typically have no idea about the company in which they will ultimately be investing). SPACs seek underwriters and institutional investors before offering shares to the public.
The funds SPACs raise in an IPO are placed in an interest-bearing trust account. These funds cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated. A SPAC generally has two years to complete a deal or face liquidation. In some cases, some of the interest earned from the trust can serve as the SPAC's working capital. After an acquisition, a SPAC is usually listed on one of the major stock exchanges.
Advantages of SPACs
SPACs offer some significant advantages for companies that have been planning to become publicly listed. Firstly, a company can go public through the SPAC route in a matter of months, while the conventional IPO process is an arduous process that can take anywhere from six months to more than a year. The soaring popularity of SPACs in 2020 may partly be due to their shorter time frame for going public, as many companies chose to forego conventional IPOs because of the market volatility and uncertainty triggered by the global pandemic.
Secondly, the owners of the target company may be able to negotiate a premium price when selling to a SPAC because the latter has a limited time window for making a deal. In addition, being acquired by or merging with a SPAC that is sponsored by prominent financiers and business executives can give the target company experienced management and enhanced market visibility.
Risks of SPACs
An investor in a SPAC IPO is making a leap of faith that its promoters will be successful in acquiring or merging with a suitable target company in the future. The reduced degree of oversight from regulators, coupled with a lack of disclosure from the typical SPAC, means that retail investors run the risk of being saddled with an investment that could be massively overhyped or occasionally even fraudulent.
Returns from SPACs may be well below expectations when the initial hype has worn off. Strategists at Goldman Sachs noted in September 2021 that of the 172 SPACs that had closed a deal since the start of 2020, the median SPAC had outperformed the Russell 3000 index from its IPO to deal announcement; but in the six months after deal closure, the median SPAC had underperformed the Russell 3000 index by 42 percentage points.2 As many as 70% of SPACs that had their IPO in 2021 were trading below their $10 offer price as of Sept. 15, 2021, according to a Renaissance Capital strategist.3 This dismal performance could mean that the SPAC bubble that some market experts had warned about may be in the process of bursting.
SPACs Make a Comeback
SPACs have become very popular in recent years, although new accounting regulations issued by the Securities and Exchange Commission in April 2021 caused new SPAC filings to plummet in the second quarter from the record levels of 2021's first quarter.
SPAC IPOs raised $13.6 billion in 2019, which was more than four times the $3.2 billion they raised in 2016. But SPACs really took off in 2020 and 2021, with as much as $96 billion raised from 295 SPAC IPOs in just the first quarter of 2021, surpassing the previous high of $80 billion from 247 SPACs for all of 2020.
During this boom period for SPACs, they attracted big-name underwriters such as Goldman Sachs, Credit Suisse, and Deutsche Bank, as well as retired or semi-retired senior executives. In addition, so many celebrities including entertainers and professional sportspeople became involved with SPACs that the SEC issued an "Investor Alert" in March 2021 cautioning investors not to make investment decisions related to SPACs based solely on celebrity involvement.
In 2020, SPACs accounted for over 50% of new publicly listed companies in the U.S.
Why Would a Company Go Public Through a SPAC and Not an IPO?
To save time and money. Going public through an IPO is a lengthy process that involves complex regulatory filings and months of negotiations with underwriters and regulators. This can deter a company's plans to become publicly listed, especially during periods of heightened uncertainty (such as the pandemic years of 2020 and 2021), in which the risk of investors giving its IPO a frosty reception is much greater.
By contrast, a company can go public within months if it merges or is acquired by a special purpose acquisition company (SPAC), which as its name suggests, is an entity that exists specifically for the purpose of making such an acquisition. The owners of a target company may also be in a better position to negotiate a favourable price from a SPAC that has a limited time frame for making an acquisition, compared with another buyer like a private-equity firm, which may drive a hard bargain.
What Are Some Well-Known Companies That Have Gone Public Through a SPAC?
Some of the best-known companies to have become publicly listed by merging with a SPAC are: digital sports entertainment and gaming company DraftKings; aerospace and space travel company Virgin Galactic; energy storage innovator QuantumScape; and real estate platform Opendoor Technologies.
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