SPAC is now seen by many management companies as an alternative to an IPO, with WeWork, BuzzFeed, and Bustle Media Group all looking in that direction. And those are just a few of the companies I just remembered first. SPAC is trending on Wall Street right now, and many are looking at it as a great alternative to an IPO. Let’s break down what SPAC is and what opportunities it offers.
Special Purpose Acquisition Company (SPAC) explained
In essence, it’s a shell company, which is created in order to undergo the IPO process and then acquire or merge with another company. This means that SPAC has no commercial operations, i.e. it doesn’t provide services and doesn’t produce goods. That is, in fact, the only real asset of such companies is the money received at IPO.
You can read the SEC bulletin about SPAC to understand more.
Of course, SPACs existed before, but in the last two years, their popularity has increased dramatically. While only 2 SPACs went public in 2019, 247 SPACs were already established in 2020, and the total investment reached $80 billion. Moreover, in 2021, 295 SPACs were formed, attracting a record $96 billion in investment.
Typically, such companies are created or sponsored by institutional investors who create such umbrella companies for their own purposes.
SPACs are usually created by investors who are recognized in some field, who have a strong reputation. This is largely because the founders do not disclose the purpose of buying or merging SPACs, which means that IPO investors do not know where their money will eventually be invested.
Once the SPAC goes public and raises money, it places it in an interest-bearing trust account. The shares are usually valued at $10 per share. The proceeds can be used solely for acquisitions or to return the money to investors if a decision is made to liquidate the SPAC.
SPACs usually have two years to find a private company. that wants to go public.
What SPAC investors do when they find a private company to acquire?
When the SPAC completes the acquisition, investors can either exchange their shares for shares in the combined company or redeem their SPAC shares to get back their funds and the interest that accrued while the money was in the interest-bearing trust account. SPAC sponsors usually receive about 20-25% of the stock of the merged company.
If the deal is not completed in two years, the investors get their shares back plus interest for the time the money has been in the interest-bearing trust account.
Why have SPACs become so popular right now?
SPACs have been known for decades but were unpopular until 2020 when the pandemic struck and created increased volatility in the markets. Many companies, fearing the possible negative impact of volatility on IPOs opted not to debut, and some chose another way – a merger with a SPAC.
Usually, this process is faster than a traditional IPO because a company acquisition (or merger) can be closed within a few months, compared to an IPO, which can take up to six months.
In addition, because SPAC launches usually involve established investors, it allows the company to raise more money if the target company (whose acquisition or merger is the original target) has a weaker track record. In this way, the company can raise additional funds.
What are SPACs risks?
Despite the advantages described above, SPACs also has disadvantages because investors must actually rely on the SPAC managers to be successful in their acquisition. When investors buy stock, they do not know which company will be the target, as this is usually not disclosed.
This means that there is always a chance that the investment will go into a bloated project or even a fraudulent scam. Also, the return from SPAC may be lower than expected if the initial hype dies down.
I will refer to Goldman Sachs analysts who pointed out that if the 170 SPACs initially analyzed in the IPO showed a median higher than the Russell 3000 index, but over the next six months the median SPAC lagged 42% behind the Russell 3000 index.
Moreover, research indicates that up to 70% of SPACs that went public in 2021 ended up trading below their 10-dollar price (as of Sept. 15, 2021). This means that there is in fact a SPAC bubble in the market that could burst.
Thus, despite the obvious advantages, it makes investing in SPACs more vulnerable for investors than buying shares in traditional IPOs.
This article was written by Vladislav Sheridan with assistance from Bill Wingrave and Wissarion Tsiklauri.
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