SPAC or Special Purpose Acquisition Company is one of the most unusual legal entity there is. Bearing the rather daunting alias of “black check” companies, these are corporations which raise money for the express purpose of merging or acquiring other companies. Another way to look at it is, these companies go public as a legal entity without any business.
The concept of SPACs have been around for a while but its popularity has exploded in the wake of increasing financial volatility as the Coronavirus situation drags on.
The ins & outs of a SPAC.
SPACs are usually formed by investors/sponsors who are typically domain experts of the industry the investment is supposed to function in. This is evidenced by the recent raising of $ 4 billion by Bill Ackman’s Pershing Square’s Tontine Holdings (PSTH.U : NYSE) among other household names such as Sir Richard Branson’s Virgin Galactic among others.
Before a SPAC is created, the founders are in consensus about the particular business acquisition they are aiming at which is usually not identified to avoid bureaucratic red-tapes during the IPO filing process, thus the interested individuals go blind into the investment.
As the money raised is ultimately through public channels, the amount is placed in an interest-bearing trust account to prevent the disbursal of that amount to anything but to complete an acquisition. Failure to do that typically within a period of two years from the filing of IPO or in case of the SPAC’s liquidation, the money raised will be returned to the original investors.
Sometimes, the interest generated will be used as the SPAC’s working capital and when the acquisition is successful, the SPAC is listed on the stock exchanges.
The Only Business of SPACs.
When we mention that SPACs don’t get into a business before it’s IPO. Technically, the only business they are into is M&A (Merger and Acquisition). So, why will a target company even want to merge with, or acquire a SPAC in order to go public? Here are some reasons why-
1- IPOs involve extensive legal back and forth with regulators and other public authorities which is a severe roadblock in the way of raising capital with efficiency and accuracy.
2- Private corporations who are already in business will undergo severe and extensive inspection by authorities and auditors prior to IPO. This is a huge no no for a lot of companies.
3- Working with a SPAC removes not only the paperwork’s burden from the target company but remove the financial uncertainties of IPO failures as well. This is an especially tough lesson which companies like Uber and WeWork found out the hard way.
Now all that can be summed up in a couple of words. Working with a SPAC is relatively inexpensive, easier for the target company, and a lot quicker than other methods. However, that sure begs the question, Why now?
Understanding The Current Rise of SPACs
We are little more than halfway through the year and according to data released by Renaissance Capital, SPACs have raised upwards of $12 billion in 2020 so far. This doesn’t include the $ 4 Billions raised by billionaire Bill Ackman.
The single reason behind SPACs rising in prominence at such rapid pace this year can be attributed to the incredibly volatile market conditions. Companies going public are actually concerned about the real economy catching up with the stock market scenario. However, the recent signs of market tanking is a massive demotivating agent for CEOs choosing to avoid the riskier IPO in favour of SPAC purely off of the absolute certainty it promises. Needless to say that such investments are incredibly risky and consequently carries a higher margin of return. So, invest in such based on your risk tolerance and research the SPAC team thoroughly before that.