SPAC mania has taken hold of public markets.
A special purpose acquisition company (SPAC) is a “blank check” shell corporation designed to take companies public without going through the traditional IPO process.
Though SPACs have been around for decades, the financial
maneuver has recently gained traction as more private companies
eye exit opportunities. The number of SPAC IPOs in 2020 has
already more than doubled compared to 2019 full-year totals.
Right now, SPACs are an attractive offering. The target company is able to go public quickly without much of the volatility associated with a traditional IPO, and investors get access to high-reward investments with limited risk.
Sponsors — the people or companies that launch the SPAC and find the company to acquire — stand to make millions regardless of how the acquisition works out. Nearly anyone can start a SPAC, which is enticing a cross-section of big names including entrepreneur and VC Peter Thiel and baseball exec Billy Beane to get involved.
Hedge fund manager Bill Ackman raised a $4B SPAC in July 2020 — the largest to date — while Social Capital CEO Chamath Palihapitiya has launched 6 SPACs since 2019, and has reportedly reserved 26 public company tickers for SPAC public offerings — from IPOA to IPOZ. (The first 3 of these were used to acquire and debut space company Virgin Galactic, real estate startup OpenDoor, and Medicare Advantage platform Clover Health, respectively.).
A special purpose acquisition company (SPAC) is a public shell company that acquires a private company and takes it public. Also called a “blank check” company, SPACs go public before their acquisition target is identified. The SPAC IPO has been around in its current form since the 1990s, but the surge in popularity is more recent. Already in 2020, SPAC proceeds have tripled the previous record set in 2019.
n the 1990s, the SPAC had a reputation for taking small, immature companies public for a large fee, leading to high levels of company failure and lackluster stock performance at the expense of investors. Regulations enacted in the 2000s helped to bring SPACs back into the spotlight, but the financial maneuver lost traction following some high-profile failures in 2008.
The sponsor — typically a person or team with significant business experience — decides to launch a SPAC. They create a holding company, then complete the normal filings associated with going public — but because the company doesn’t do anything (i.e. it has no operational business), the filing process is fast and easy.
The sponsor then goes on a roadshow, similar to traditional IPOs, to try to find interested investors. The difference here is that they are selling themselves, their team, and their experience, rather than a specific company. Once the sponsor has attracted enough interest, they sell units in the company. Units are typically €10 each, and represent one share of the company and a warrant to buy more shares in the future.
The money raised from the IPO is put into a blind trust, and is untouchable until the shareholders approve the acquisition transaction. The SPAC goes public and trades on an exchange like any other publicly traded company. This is where retail investors get involved — they can purchase shares on the open market, but the future acquisition is still unknown. Instead, these investors are buying on the strength of the sponsor or the promise of a strong future acquisition. The sponsor also receives 20% of the shares of the SPAC as a fee, called a “promote” or “founders shares.”
Once the SPAC is public, the sponsors can begin the hunt for a
target company to acquire. There are no restrictions on the type
of company a SPAC can acquire, though many will highlight a
target industry before IPO. Typically, the sponsors have 2 years
to find and announce an acquisition, or else the SPAC will
dissolve and shareholders will get their money back. When the
sponsors find a company, they then negotiate the terms of the
acquisition with the target company, like purchase price or
company valuation. Following a deal, the “de-SPAC” process
After deciding on the terms of the acquisition, the sponsors must propose the acquisition target to shareholders. The initial shareholders have the opportunity to vote on the acquisition, which gives them some recourse if a sponsor chooses a company they do not like. Even if the acquisition is approved, shareholders can then redeem their shares for their money back. Once the company is approved and all redemptions have been completed, the sponsor can move forward with acquiring the target company. However, the initial SPAC raise usually only covers about 25-35% of the purchase price. Here, the sponsors can ask existing institutional investors (like large funds or private equity firms) or new outside investors for additional money using a Private Investment in Public Equity (PIPE) transaction.
Following the final capital raise, the SPAC can now take the
target company public. Even though the SPAC is already public
and has filed with and been approved, the target company also
needs to gain approval from regulators. In other words, the
target company does not necessarily face fewer regulatory
requirements when going public via a SPAC merger instead of a
traditional IPO — it’s just a shorter timeline. Once approved,
the ticker changes to reflect the name of the acquired company
and it starts trading as a typical public company. For example,
Social Capital’s IPOA SPAC acquired Virgin Galactic in 2019. On
the day of the acquisition, the ticker IPOA stopped trading and
was replaced with SPCE.
There are a few reasons why SPACs have recently experienced a boom in popularity. For one, private companies have been staying private for longer. Many VC-backed companies have had ample access to capital, as large venture firms like SoftBank dole out $100M+ rounds to late-stage private companies, deferring the need to go public. Now, the Covid-19 pandemic has injected uncertainty into the market.
Private companies are reportedly less sure that they’ll be able to raise large rounds in the near future, but still need access to capital. Some are looking to public markets for liquidity. In fact, the general IPO market proceeds in the first 3 quarters of 2020 have already surpassed full-year totals for the past 5 years, even when excluding SPACs, according to the Financial Times. However, given the volatility of public markets, the traditional IPO is less enticing, as companies have less control over how much money they are able to raise. The traditional IPO also takes years to complete, and the pressure to go public is pushing some companies to explore faster alternatives. Sponsors and investors are therefore taking this opportunity to provide companies with that alternative — for a significant fee.
There are a few reasons why private companies would choose to go public via SPAC instead of a traditional IPO. Healthcare D2C startup Hims recently announced that it would go public via a SPAC sponsored by Oaktree Capital Management. It is going public at a $1.6B valuation, and is raising $280M in the transaction. In the decision to go public, Hims considered both a typical IPO and a SPAC. When discussing the process with Axios, Hims CEO Andrew Dudum said.
“We had always expected and prepped for a traditional IPO, but there are a lot of favorable dynamics in the new group of SPACs. There’s greater speed and certainty of a deal, which helps the team stay focused, and we get to partner with an amazing investor like Howard Marks.”
Some companies prefer the SPAC process to the traditional IPO process because of stability, speed, and strategic partnerships, despite the increased costs associated with sponsor fees.
In a typical IPO, the company’s share price is not certain. It is determined by investor appetite and market forces as much as by the company’s underlying business valuation. A company is unsure of how much it will make until the day before its IPO, even though it takes months to go through the IPO process.
Further, the traditional IPO price is determined by the IPO bankers, who make their best guess at what the company is worth in the eyes of investors. However, this is never perfect, meaning that the IPO can be mispriced. If a company’s bankers priced its IPO at $10/share, but then it immediately pops to $15, this means that the company may have been able to sell its shares at a higher price, missing out on more money.
A SPAC transaction is appealing because it avoids price uncertainty altogether. The company management team is able to negotiate an exact purchase price, ensuring that the company doesn’t leave any money on the table, though it pays a price for this certainty — the valuation received may be lower than a company could receive through a traditional IPO, and the sponsor fees add additional costs.
The traditional IPO can take years from start to finish. The SPAC merger process is much faster for the target company, taking as little as 3 to 4 months, according to PwC. This is attractive for companies looking to raise money and go public quickly. However, the time crunch does mean the company has to prepare to be a public company much quicker, despite needing to complete all the same filing requirements as a traditional IPO. This includes financial reporting, SEC oversight, tax preparation, technology upgrades, cybersecurity measures, and more.
Though not every SPAC plans on being a strategic partner to the company it takes public, the strategic SPAC is becoming a more typical pitch for the hotter tech companies that are looking to go public fast. Strategic SPACs use sponsor experience and knowledge as a selling point for potential companies. For example, an electric vehicle company may find a SPAC offering more appealing if the sponsor comprises a team of EV investors or operators, especially if the sponsor plans to take a board seat and work with the company’s management team on post-IPO strategy.
In this way, the strategic SPAC serves a similar purpose as venture capital does to private investment: the company benefits not only from the investment itself, but also from the investor.
A SPAC floats an IPO to raise the required capital to complete an acquisition of a private company. The capital is sourced from retail and institutional investors, and 100% of the money raised in the IPO is held in a trust account. In return for the capital, investors get to own units, with each unit comprising a share of common stock and a warrant to purchase more stock at a later date.
The purchase price per unit of the securities is usually $10.00. After the IPO, the units become separable into shares of common stock and warrants, which can be traded in the public market. The purpose of the warrant is to provide investors with additional compensation for investing in the SPAC.
The founders of the SPAC will purchase founder shares at the onset of the SPAC registration, and pay nominal consideration for the number of shares that results in a 20% ownership stake in the outstanding shares after the completion of the IPO. The shares are intended to compensate the management team, who are not allowed to receive any salary or commission from the company until an acquisition transaction is completed.
The units sold to the public comprise a fraction of a warrant,
which allows the investors to purchase a whole share of common
stock. Depending on the bank issuing the IPO and the size of the
SPAC, one warrant may be excisable for a fraction of a share
(either half, one-third or two-thirds) or a full share of stock.
For example, if a price per unit in the IPO is $10, the warrant may be exercisable at $11.50 per share. The warrants become exercisable either 30 days after the De-SPAC transaction or twelve months after the SPAC IPO.
The public warrants are cash-settled, meaning that the investor must pay the full cost of the warrant in cash to receive a full share of stock. Founder warrants, on the other hand, may be net settled, meaning that they are not required to deliver cash to receive a full share of stock. Instead, they are issued shares of stock with a fair market value equal to the difference between the stock trading price and the warrant strike price.
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