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What Are SPACs?

May 9, 2022
A SPAC  (Special Purpose Acquisition Company) is a company with no business operations that is formed solely to raise capital through an IPO to purchase another existing company. It does not produce any product or service, and it does not sell anything. Although SPACs have exploded in popularity in the past few years, they have been around since the early 1990s. Formerly, they were often seen as a last resort for businesses that couldn’t raise money on open markets. 
 
How SPACs Work
SPACs are typically created by investors that have expertise in a specific sector with the intent to pursue deals in that business space. By forming a SPAC—also known as a blank check company or a shell company—the creators can have an acquisition target, but they do not need to identify it. This allows them to dodge substantial disclosures during the IPO process. Investors in the IPO do not know what company they are investing in or when their money will be invested. Before offering shares to the public, SPACs look for underwriters and institutional investors.
 
The finances raised in an IPO are put into an interest-bearing trust account. This money can only be spent to complete an acquisition or to give it back to investors in the event that the SPAC must be liquidated. Generally, a SPAC has about a two-year timeframe to close a deal, or it must liquidate, giving investors their money back with interest. Sometimes part of the interest earned from the trust can be used as working capital. After being acquired, a SPAC is often listed on the stock exchange.
 
Being acquired by a SPAC can be advantageous for an owner of a smaller business. Doing so can add up to 20 percent to the sale price versus a typical private equity transaction. Selling to a SPAC can also offer owners a speedier IPO process, with less concern about broader shifts in the market.
 
The Recent SPAC Trend 
SPACs have become more prevalent in the last few years, primarily in the U.S. In 2019, SPAC fundraising reached $13.5 billion for 59 IPOS. That’s more than four times the amount raised in 2016. In 2020, 92 SPACs announced business combinations with a total deal value of $151 billion. They have also been drawing big names in banking and retired execs seeking shorter-term opportunities.
 
There is a sentiment that market volatility from the COVID-19 pandemic has contributed to the popularity of SPACs as of late. SPACs have actually taken a large chunk out of traditional IPOs. Investors are sitting on plenty of capital, and markets have rebounded since the onset of the pandemic. Some of the advantages that a SPAC offers over an IPO include:
 
The deal value is fixed at the start of the process versus at the end
The target company can negotiate its own fixed valuation 
The company can go public and get an influx of capital faster 
There is no lengthy process of filing with the SEC
The due diligence process is not as tedious
Minimum cash is secured at the outset via private investment in public equity
Financial projections can be used to market the acquisition
Existing owners can take out more cash in the deal
Valuation gaps can be overcome through earn-outs
SPACs are not as expensive to execute as IPOs
 
The largest-ever SPAC was formed in 2020. Bill Ackman, the founder of Pershing Square Capital Management, sponsored his own SPAC, Pershing Square Tontine Holdings. It raised $4 billion in its offering.
 
A SPAC that drew a great deal of attention was the 2019 deal by Diamond Eagle Acquisition Corp. As the fifth SPAC sponsored by its management team, it agreed to buy the DraftKings digital gaming company, and SBTech, a provider of sports betting and gaming tech. The common stock price was at $10.17 before the deal was announced. When the transaction closed, the stock was up to $17.50 per share. From closing to January 2021, the stock reached a high of $63.78. 
 
Will the Trend Continue?
In 2020, SPACs generated more than $80 billion in fundraising. Because of the advantages that SPACs offer, the trend is not expected to disappear anytime soon. As of March of this year, SPAC fundraising was up 2000%, raising a whopping $83 billion, putting this year already on track to set a new record for SPACs. 2021 has already surpassed the total SPAC fundraising in 2020. Experts predict SPACs to continue to be formed through 2021 (with a bit of a slowdown) as long as the economy continues to recover. 
 
 
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