Special Purpose Acquisition Company (SPAC)

A Special Purpose Acquisition Company (SPAC) refers to an entity with no commercial operations but intends to merge with or acquire an existing business. The shell firm created or sponsored by institutional investors and underwriters raises capital to incorporate and go public through an initial public offering (IPO).

Individuals and private equity funds buy special purpose acquisition company stocks or shares without knowing the target business. However, they are solely responsible for assessing the investment risks based on how the SPAC performs. A SPAC owns no assets other than cash and sells shares to the general public after being listed on a stock exchange.

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• The special purpose acquisition company definition describes a company with no commercial operations but plans to merge with or buy another company. Institutional investors create it to raise capital and go public through an initial public offering (IPO).
• Sponsors form the SPAC, investors purchase stocks, and targets are firms the shell company plans to merge with or acquire.
• The process comprises three stages - incorporation and issuance of founder shares, identification of potential merger or acquisition targets, and completion of the merger or acquisition contract.
• The U.S. Securities and Exchange Commission (SEC) regulates SPACs, which trade like public companies on a stock exchange.

A Special Purpose Acquisition Company enables a firm to go public via merger or acquisition. It is a faster and less expensive method than traditional initial public offerings (IPOs). SPAC is referred to as a shell corporation because it issues an IPO to raise funds for the deal. It is also known as a blank check firm because it has no business model, product or service, or specified purpose.

A group of management professionals called founders or sponsors provide the initial funds to the SPAC in exchange for significant ownership in the target business. Next, the company selects an investment bank to help with the issuance and management of the IPO selling securities at a unit price. Finally, investors must find and finalize the deal within 1.5-2 years of raising the capital and profit.

The entire process takes place in three stages – incorporating and issuing founder shares, identifying potential merger or acquisition targets, and concluding merger or acquisition deals. SPACs are regulated by the U.S. Securities and Exchange Commission (SEC) and trade like public companies. As a result, the general public can purchase its shares post-merger or acquisition.

Such companies have become valuable assets in the United States, with investors straining to keep up with the market following the COVID-19 pandemic. Moreover, the association of personalities like hedge fund manager Bill Ackman and venture capitalist Chamath Palihapitiya with SPACs makes them a trustworthy option for investors.

The most popular businesses on the special purpose acquisition company list are Palihapitiya's Social Capital Hedosophia Holdings and Ackman's Pershing Square Tontine Holdings. While the former purchased a 49% share in the British airline Virgin Galactic in 2019, the latter accumulated the largest fund in 2020, totaling $4 billion.

These firms are quickly becoming the most effective way to get a company listed on a stock exchange. Here are a few quick points to understand a SPAC better:

• Creates a pool of resources by selling stocks, with each share typically selling for $10.
• Includes a warrant or contract that allows investors to buy a whole share of common stock in cash at a specified price and a later date.
• Places funds raised in a trust account until it finds a target firm for merger or acquisition within two years.
• This account generates interest for use as working capital for the company.
• After the SPAC goes public, it lists on a stock exchange.
• Failure to conclude a deal leads to liquidation of the company and the return of IPO funds to investors and public shareholders.
• The expertise and reputation of sponsors determine the performance of the SPAC.
• Sponsors receive 20% of founder shares in the SPAC at a discounted price. However, it makes it a not-so-profitable deal for public shareholders who purchase the remaining 80% SPAC shares through units at a fixed market price.

For a better understanding of the concept, consider the following two examples:

Example #1

Shares of the shell company Digital World Acquisition (DWA) soared by up to 700% in October 2021. It was after the firm announced to merge with and publicly list the social network business TRUTH Social.

After being banned by social media platforms like Facebook and Twitter, former U.S. President Donald Trump decided to launch his app in 2022. However, after the short seller Iceberg Research revealed it bet against DWA, its stock prices dropped by 10.98%.

Example #2

Another special purpose acquisition company example is of the media publication house, Forbes. The company announced in August 2021 that it would merge with the SPCA Magnum Opus Acquisition to go public. The newly formed company will use digital transformation to engage audiences and generate revenues. Forbes will list on the New York Stock Exchange as FRBS once the purchase is completed.

A SPAC usually has three stakeholders - sponsors, investors, and targets. Sponsors create the company, investors buy stocks, and targets are firms that the SPAC wants to merge with or acquire in the future. Let us have a quick look at the benefits it holds for are three stakeholders:

• SPAC can help a company go public more quickly than regular IPOs. It is because its evaluation depends on the management team's reputation.
• It allows investors to purchase cheaper shares and additional capital under a warrant.
• Its price is negotiable, unlike the traditional IPO, which is set based on market conditions at the listing.
• The limited-time to close a deal allows the target company to negotiate a higher price.
• SPAC has lower marketing costs because it does not require investments to attract investors.
• It lets businesses access funds in the event of market volatility constraining liquidity.
• Sponsors are specialists and hence can be trusted with crucial business decisions.

This has been a guide to Special Purpose Acquisition Company and its meaning. Here we discuss how does SPAC work, along with examples, characteristics, and advantages. You may also have a look at the following articles to learn more –

• Merger and Acquisition Strategy
• Mergers and Acquisitions Types
• Acquisition Premium