SPAC stands for special purpose acquisition company. A SPAC is a company with no commercial operations and is strictly existing to raise capital through an acquisition with an already existing company that is not publicly traded. SPACs are also known as blank check companies and were created in the 90s. With the passage of years, SPACs are becoming even more popular, attracting big-name underwriters and investors while raising big money. In August 2020, more than 50 SPACs have been established in the U.S. which have raised more than $22 billion.
Special purpose acquisition companies are mostly formed by investors, venture capitalists, or sponsors with expertise in particular sectors and are looking to pursue deals in that industry. When building a SPAC company, the founders already had one target for acquisition in mind. However, the founders will not always name that target to avoid extensive disclosures during their Initial Public Offerings (IPOs) process. This is why they are also known as blank check companies. IPO investors do not know what company they are eventually investing in.
IPO: When a company becomes publicly traded or available for trading in the market.
The money SPACs make in an IPO is placed in an interest-bearing trust account. These funds can only be used to complete an acquisition or to return the money to investors if the SPAC is successfully liquidated. The usual time that a SPAC has to complete a merger deal or face liquidation is two years.
Note: SPAC companies tend to change ticker symbols after merging with a company. For example, the latest SPAC merger was announced yesterday between Holicity (HOL) and Astra. Holicity is a SPAC company that will merge with Astra, a space launch company in the second quarter of 2021. It will eventually change its ticker from HOL to ASTR after the completion of this transaction.
In recent years SPACs became very popular and many companies have chosen to go public via a merger instead of a direct Initial public offer (IPO). This is because selling to a SPAC is a more attractive option for owners of smaller companies that are privately held. SPAC mergers can add up to 20% to the sale price compared to a typical private equity deal. Additionally, being acquired by a SPAC gives you faster access to a faster IPO process since you are being guided by an experienced partner.
SPACs IPO fundraising hit a record of $13.6 billion in 2019 which is four times higher compared to $3.2 billion in 2016. Big names such as Goldman Sachs (GS), Credit Suisse, BlackRock (BLK) as well as senior executives have also been attracted to this “shorter-term” opportunity.
Denouncing the phenomenon as a “fad on Wall Street,” Stanford Law School professor Michael Klausner and management consultant Emily Ruan teamed up to explain how a company that sponsors a SPAC IPO gets “a nice return on its investment … essentially for free.” Individual investors who buy into a SPAC, on the other hand, lose an average of 12% of their investment within six months of the IPO.
However, if it wasn’t for IPO SPACs the stock market would not have become as bigger and diverse. Moreover, it can be better for investors to jump in as soon as an announcement is out and for the transaction is completed because after that assuming the market cap concertation companies will start expanding and potentially getting more investors on board. (Meaning price will go even more up).
It is very possible that many SPACs IPOs are joining the market only for the revenues and not for the bigger picture and cause. It is possible that when the next stock market shrink happens, most of them will not survive or will even turn out to be overpriced and investors who bought the stock early will lose money if the stock price falls. A great example can be Nikola (NASDAQ: NKLA).
SPAC investors should be extra cautious of these risks and should wait for a proof of concept from such companies. Do not jump on every SPAC opportunity you hear but choose wisely.
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