BY PAVITRA SINGLA
SPAC stands for Special Purpose Acquisition Company is a publicly listed shell company formed to complete a merger, acquisition, or similar combination with one or more businesses, that is identified after raising money from public investors by way of an IPO and listing, typically on a US stock exchange. It has no commercial operation -it does not make any product or sell anything, the only asset it has is the money raised through its own IPO. Generally, the SPAC is created or initiated by a board of institutional investors or professionals belonging from private equity or hedge funds. When SPAC raises money, investors buying into it are unaware of the final acquisition target company therefore these institutional investors with their track record of success are able to easily convince people to invest in it.
Lifecycle of SPAC
Its life cycle is divided into three parts and illustrated in the diagram accordingly.
Pre-IPO stage (SPAC formation)
SPAC is managed by industry experts who are mostly the sponsors of the same. Sponsor refers to the investors who support the SPAC in its pre-IPO stage and thus become the face of it. They are provided with units rather than shares. This unit consists of one share and one warrant and sometimes with voting rights.
IPO stage
This company goes to market and is traded at a stock exchange. The investors remain unaware of the target acquisition company and rely upon the credibility of sponsors. The money raised through IPO and through sponsors is kept in a trust fund which is interest bounded as it is invested in treasuries. A part of the interest is often used to pay for the functioning cost of SPAC.
Target Search Stage
Sponsors are tasked with finding the target company in a period of 2 years, in failure to do so, the SPAC will be dissolved with the money returned to investors. There is no upper bound on the number of companies acquired by SPAC but rarely more than one company is acquired.
De-SPAC stage
After finding the company which is approved by shareholder vote the SPAC acquires the target (for example, via a consolidation/merger) in a transaction commonly referred to as the De-SPAC transaction. Where additional funds are required at this stage (for the acquisition of target), SPACs could explore raising requisite funds from PIPE investors.
Growing Popularity
SPAC as a financial tool has existed over the decade but has become more popular recently due to extreme market volatility induced by covid. Both the number and volume have risen acutely as seen in the diagram. Besides this, the demand and supply are at play here because the proportion of public companies in the market sphere has decreased over the years and the preference for investing in a public company owing to liquidity premium has increased and SPAC has been able to bring multiple companies into the public market. Also, SPAC offers multiple advantages as elaborated in the next heading.
Advantages to company
Valuation
The target company is able to negotiate its own fixed valuation with the SPAC sponsors and with their new public company stature, they are able to trade at a higher value in the market.
Control
The SPAC process gives a company owner more control over who buys their property, and how much of an interest they can maintain or sell.
Liquidity
SPAC deals are finalized ahead of time and both parties agree on a common valuation thus providing certainty which lacks in traditional IPOs especially during the extremely volatile market situation.
Time
It cuts short the almost 2year long grueling period of registering an IPO with the SEC to just 6 months and saves the company a lot of effort.
Cost
SPAC saves a significant amount of money as they are a lot more economic than traditional IPOs as SPAC pays for most of the costs.
Advantages to Sponsors
Sponsors will receive around 25% to 50% of the SPAC’s founder shares in return for sponsoring the company in its pre-IPO stage and seat on board. The sponsor can choose to redeem back its fund and the only loss they face is that they could have invested the fund somewhere else in the meantime. Additionally, they get to keep the warrants out of the units with them even after redemption.
Advantages to IPO investors
In an event where the investor does not like the target company chosen by sponsors, It can withdraw its share anytime and get a treasury bond in return thus giving them the discretionary power not available with traditional IPOs.
Associated Risks
Limited Time Frame
SPAC has limited time to invest in a company and complete all the processes of finding a target company, negotiating a deal, and complying with all the reporting requirements. While a SPAC IPO requires less time than a traditional IPO, complying with all processes might turn out to be a challenge.
Redemption Risk
The money in the trust account belongs to the investor and if the investor takes it back then the SPAC will be left with insufficient capital to acquire the country, this is called redemption risk. Thus most SPACs are now backstopped or provided insurance against redemption risk by raising capital through PIPE.
ABOUT THE AUTHOR
Pavitra is a second-year Economics student at Kirori Mal College, University of Delhi. He is extremely passionate about economics and its intersection with other disciplines. He is most likely to be found reading, debating, or covering last semester’s syllabus.
Disclaimer: The views expressed in this article are the author’s own and do not necessarily reflect the views of the organization.
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