The Great SPAC Deluge

What do Bill Ackman, Serena Williams, and Paul Ryan have in common? Would it help if I added in Shaq, Ciara, and former astronaut Scott Kelly? No? Here’s the answer: each is a founder of a special purpose acquisition company, or SPAC.

A SPAC is a shell company that lists on a public stock exchange with the stated purpose of acquiring a private company, thus allowing them to go public without going through the traditional IPO process.

Recognizable companies like DraftKings, Virgin Galactic, and OpenDoor have embraced SPACs to access public markets. In fact, few trends in the financial markets have been more pronounced than the recent “SPAC boom.” As of mid-March 2021, 296 SPACs have raised $96.4 billion in the US, overtaking last year’s records of 248 SPACs raising $83.4 billion. For comparison, the seven years preceding 2020 saw all of 194 SPACs raise $45 billion.

For much of their decades-long history, SPACs were the exclusive province of financiers, lawyers, and academics. But a combination of political, social, and technological developments has made them more attractive to investors and entrepreneurs. Adding more fuel to their resurgence are the unprecedented levels of capital pursuing private companies and mounting frustrations with the traditional IPO.

How do SPACs work?

We can break this entire process down into three broad phases: (1) SPAC formation, (2) Target company search, and (3) de-SPACing. First, a “Sponsor” raises capital by taking an empty holding company (the SPAC) public through an IPO. The Sponsor is an individual or team that raises funds by trading on little more than its reputation and generalized plans.

Armed with money and SPAC stock, the Sponsor then searches for a real, “target” company to buy. But the clock is ticking. Not only are the gross proceeds from the IPO locked up “in trust” until the Sponsor identifies a target company, but they only have 18-24 months to consummate a merger or else the SPAC dissolves and returns the proceeds.

Finally, de-SPACing refers to the SPAC merging with the target company. This last leg comes when the Sponsor identifies a target company and negotiates an acquisition. Once completed, they present the deal to the SPAC’s shareholders for a vote. While rejection is possible, the shareholders have a powerful incentive to approve, regardless of their feelings on the combination itself. That’s because they can always redeem their shares for their pro-rata amount of the funds held in trust. Upon the deal’s approval, the de-SPACing occurs, whereby the target company merges into the SPAC and becomes public.

How do SPACs differ from traditional IPO?

Until 2020, traditional IPO’s enjoyed an uninterrupted run as the go-to route to the public markets. But recently, SPACs have been outpacing them at a rate of 4:1. Whether SPACs will persist as an alternative remains to be seen, but their recent proliferation has highlighted some key distinctions between the two models. Below are some of the most salient.

Speed

There is little comparison between the two where it comes to the time to go public. For a traditional IPO, the entire process–from pre-planning to public trading–can take about two years. Of this, they can expect to dedicate six to eight months to SEC engagement alone. A SPAC can get SEC approval and start listing in as little as two months. De-SPACing, which is the only part of the process that involves the private company, can take about five months.

Regulatory scrutiny

Before they allow a company to access public markets, regulators seek to ensure that all information needed to make an informed investment decision is available. For traditional IPO’s, transparency is the name of the game. But to call this an audit would be like your doctor referring to a colonoscopy as a checkup. Through this process, the SEC turns the wannabe public company inside out. The back and forth over revisions to the company’s initial registration form, the S-1—which details its business operations, financial condition, and use of proceeds, and alone can take as much as five months—typifies this trial by ordeal.

To the entrepreneur who sees this as more an exercise in tedium than one of earnest due diligence, the SPAC offers an abbreviated regulatory approval process. Being little more than an empty shell company at its outset, the SEC demands a much less detailed S-1. On the de-SPACing end, the SEC treats the combination more like a merger than an IPO. This substitutes certain audited disclosures for the burdensome back and forth discussed above.

Investor scrutiny

As the IPO approaches, the company’s attention shifts to courting investors. Through the “IPO roadshow,” the company pitches the most desirable, well-resourced investors, and supplies them with the information they need in order to feel comfortable subscribing. While many view the roadshow as the regulatory component’s fun counterpart, motivated investors take this opportunity to dig in and offer candid, if not merciless, observations that directly influence the amount of money the company will ultimately be able to raise.

SPACs open at a uniform share price that seldom fluctuates before they announce a merger. Since you’re investing in a shell company with no operations to speak of, it wouldn’t make sense to wrangle over a share price. Instead, most SPACs open at $10/share, with each investor granted a proportional share of warrants. These warrants allow investors to buy additional shares of stock at a (hopefully favorable) price if certain future milestones occur. There is also a role reversal when it comes time to de-SPAC. The private company becomes the beneficiary of the SPAC’s self-imposed spending deadline, which gives them leverage to negotiate favorable terms.

Conclusion

The difference between the traditional IPO and SPAC lies in the journey and not the destination. However, regardless of where you choose to put your money, you would be wise to listen to the SEC when they say, “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.”

Sources

3 Comments

wnm5012

Apr 03, 2021

Thanks for this! I had never heard of a SPAC before reading.

I am curious as to how the SEC will deal with this new trend. It seems like a loophole to get around registration. I also wonder what circumstances exists that would make a business choose a SPAC over a registration exemption. It sounds most investors would be savvy, so finding accredited investors wouldn't be that hard.

Great article!

lauren.shelby123

Apr 01, 2021

This is a great post! Your introduction did a great job of drawing the reader in. The structure of your post also made SPACs easier to understand. It was very helpful to compare SPACs to IPOs after you laid out what they were and how they work. Well Done!

Zoe Matherne

Mar 31, 2021

Great job making SPACs accessible to the lay-reader. This article gives a high-level view of SPACs, particularly how they work and how they are different from traditional IPOs, which is where someone should start when examining SPACs. Specifically, I liked how you broke the SPAC process into three discrete phases. That really simplifies the process. I also liked how you explained the differences between a SPAC and a traditional IPO with headers to clearly delineate the differences.

Also some great turns-of-phrases in there!

-Zoe