What is SPAC?
Source: spacinsider.com. *As of May 2021
The traditional IPO process involves too much red-tape and is heavy on regulatory compliance. Hence, many companies are obliged to delay going public and deprive themselves from the benefit of raising money in the public market. Special Purpose Acquisition Company or SPAC makes it possible for companies to go public, without going through the tedious process of registering an IPO with the SEC (Securities and Exchange Commission), which can take anywhere, from 6 months to over a year to complete. Although SPACs have been around for decades as alternative investment vehicles, they have become highly popular in 2020 onwards. The SPAC IPOs accounted for over half of all IPOs in 2020 and 48% of the proceeds raised even amid global markets gripped with pandemics’ uncertainty. So, what is SPAC and how does it work?
SPAC is essentially a shell company (also known as blank-cheque Company) set up by investors, with the sole purpose of raising money through an IPO to eventually acquire another company. Once the SPAC IPO is complete, the SPAC typically has 18 -24 months to complete the merger with the targeted company. While a conventional IPO takes a minimum of 6 to 12 months, listing with a SPAC can be completed in 4 to 5 months.
A SPAC is generally formed by a group of sponsors, highly experienced business executives or fund managers, seasoned investors, private equity firms or venture capitalists. SPACs undergo the typical IPO process, however the sponsors are not obligated to publicly identify companies they are eyeing for an acquisition, to avoid a more grueling process with the SEC. The SPAC is assigned a ticker symbol, and the money invested by shareholders is held in an escrow account, which is usually an interest-bearing trust account. SPACs also issue the warrants along with shares, as part of a unit to attract investors. A warrant provides an investor with the right to buy additional shares at a later date at a fixed price.
SPACs have 18 -24 months to search for a private company to acquire or merge with. oftentimes, sponsors already have the specific company or industry in mind at the outset of SPAC’s formation. After the target company is identified, and a deal negotiated, the “de-SPAC” process begins. This requires few significant approvals and actions, before the actual acquisition/merger is executed.
§ SPAC sponsors must formally announce it and take majority shareholder’s approval to close the deal.
§ At the time of the SPAC IPO, the sponsor often receives 20% of SPAC’s common stock, which is referred to as the “founder’s shares”. Accordingly, at least 20% of the SPAC’s outstanding shares are committed to vote in favor of a transaction.
§ The SPAC is required to offer the investors the right to redeem their public shares for a pro-rata portion of the proceeds held in the trust account, whether their vote is for or against the transaction.
A SPAC can also seek a PIPE (private investment in public equity) deal if it does not have sufficient funds in its trust account and needs to raise additional capital to close a merger transaction.
When the acquisition is completed, the SPAC’s investors can either swap their shares for shares of the acquired company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust. The SPAC sponsors typically get about a 20% stake in the final, merged company. With a SPAC merger, the target company gets listed on the stock exchange. In case a SPAC fails to acquire or merge with a company within the stipulated time period, then the invested money is returned back to the shareholders.
SPAC stocks have existed since 1990, with sponsors focusing on varied industries. While it was not largely practiced earlier, the number of SPAC IPOs has increased steadily since 2013 with 2020 scoring the highest record. Better yet, the first quarter of 2021 has been another record-breaking period, with 298 SPACs raising nearly $88 billion. It has already surpassed the full year 2020 performance that reported a total of 248 SPAC IPOs and raised ~$83 billion. As of March 31, 2021, there were ~430 active public SPACs, holding more than $140 billion in cash seeking merger deals. Around 35% of the SPACs are targeting technology, media and telecom industries. In April 2021, Grab Holdings, Southeast Asia’s most valuable start-up, grabbed the headlines when it announced the largest ever SPAC deal of $40 billion, by partnering with Altimeter Growth Corp.
SPAC deals are largely favored as an alternative to traditional IPOs, due to a mix of cost, pricing and legal factors. While the pricing for a traditional IPO is affected by market volatility and broader investor sentiment, SPAC deals are considered more stable because of up-front pricing, which is negotiated before the transaction closes. Further, there are no direct fees associated with SPAC deals, like payment to investment banks, legal fees and auditing fees. Then, the ultimate benefit of a faster execution. Lastly, SPACs invest in hot sectors like Tech, Health-tech, Electric/Autonomous Vehicles (EV/AV), Augmented/Virtual Reality (AR/VR), Artificial Intelligence (AI), IoT, and the likes.
However, SPACs have their own disadvantages. The SPAC process does not require rigorous financial due diligence, which could lead to potential restatements, incorrectly valued businesses or even lawsuits. Studies found that over 50% of post-merger SPACs experienced poor aftermarket performance. As per the data from Bloomberg, 14 out of 24 companies, that went public by Feb 2021, as a result of SPAC merger, reported depreciation in value as of one month following the merger completion.
The influx of well-versed sponsors, seasoned investors and management teams, resulted in an unprecedented rise in SPAC IPOs in 2020 and the trend seems continuing in 2021. Nonetheless, the recent guideline by the SEC, that classifies SPAC warrants as liabilities instead of equity, is expected to bring a halt in the overheated SPAC space. In case the new regulatory guideline becomes a law, it will require existing SPACs as well as deals in the pipeline to go back and restate their financial results to properly account for warrants, which could slow down the IPO process. This will be a costly matter for the companies as they need to value those warrants each quarter rather than just at the start of the SPAC. Moreover, the valuation of warrants requires complex financial modeling. It is worth noting that there were just 10 SPAC IPOs announced in April 2021, compared to 100 announced in March, according to SPAC Research. While the pace of new SPACs deals may seem to have slowed in the second quarter of 2021, it would be interesting to see if this is just a short-term setback and the SPAC deals will pick-up the pace again.