A Special Purpose Acquisition Company (SPAC) is a publicly traded company created specifically to acquire or merge with a private company. SPACs do not have any commercial operations when they go public.
Rather, they use an initial public offering (IPO) to generate money with the intention of purchasing a target company within a predetermined window of time, typically 18 to 24 months.
With this type of business structure, investors can put money into a fund that will be used to buy one or more unnamed companies that will be determined following the initial public offering. As a result, the term “blank-check company” is frequently used in the media to describe this type of shell firm structure.
After the SPAC raises the required funds through an IPO, it holds the money in a trust until it completes the desired acquisition or the predetermined period expires.
Therefore, a SPAC doesn’t conduct any business, does not sell anything and typically only holds the money raised in its own IPO. If the planned acquisition fails or legal formalities remain unresolved, the SPAC must return the funds to investors.
In This Post
How Does a SPAC Work?
Formation and Fundraising:
Sponsors form a SPAC by raising money through an IPO. Experienced business executives often create SPACs, relying on their reputation and expertise to identify profitable acquisition targets.
Since a SPAC is merely a shell company, its founders’ reputation often serves as a key selling point when attracting investors. Founders typically focus on a specific industry when launching a special purpose acquisition company.
Well-connected private investors, such as billionaire Bill Ackman, institutional investors, private equity or hedge funds, and high-profile CEOs like Richard Branson and Donald Trump, can establish a SPAC. These financiers are known as Sponsors.
Founders and sponsors provide the initial capital and, in return, secure a significant stake in the acquired company
Issuing the IPO
When launching an IPO, the SPAC’s management team hires an investment bank to oversee the process. They agree on a service fee, typically around 10% of the IPO proceeds. The IPO prices securities per unit, with each unit representing one or more shares of common stock.
A SPAC’s prospectus primarily highlights the sponsors rather than company history or revenue, as it has no performance record or earnings reports. All IPO proceeds remain in a trust account until the SPAC selects a private company for acquisition.
Acquiring a Target Company
The management team has 18 to 24 months to find a target and finish the purchase after the SPAC has obtained the necessary funds through an IPO. Depending on the business and sector, the time frame may change. At least 80% of the SPAC’s trust assets must equal the target company’s fair market value.
The SPAC is far less risky for the target firm than an IPO. The target business merely needs to agree to pay a set sum of money at a negotiated price to the SPAC in order to complete an acquisition.
On the other hand, the target firm is unsure of the size, price, or even prospective demand if the company chooses to pursue the IPO route.
The founders will benefit from their ownership stake in the new business, which is typically 20% of the common stock, if the SPAC is successful in acquiring the target company. Investors will obtain an equity position based on their capital commitment.
If the SPAC fails to finalize an acquisition within the specified time, it dissolves and returns the IPO proceeds from the trust account to investors.
The management team cannot collect remuneration while operating the SPAC until they complete the transaction. In that case, the founders must cover the initial setup costs out of pocket.
Public Listing:
If approved, the private company becomes publicly traded without undergoing the traditional IPO process.
Benefits of SPAC
Faster Public Listing:
Private companies can go public quickly compared to a traditional IPO.
Lower Costs:
SPACs often have fewer regulatory hurdles and costs than IPOs.
Experienced Sponsors:
Many SPACs are backed by industry experts who guide the acquisition process.
Conclusion
SPACs offer an alternative way for private companies to go public, providing both opportunities and risks for investors. Understanding how SPACs function, their advantages, and their risks can help traders make informed investment decisions. Whether you’re a seasoned investor or a beginner, SPACs are worth watching in today’s evolving financial markets.
Related Term
Reach us on WhatsApp
