What are SPACs?

What are SPACS? This is a question many investors have been asking considering that the hottest private companies are by-passing traditional listing requirements and merging directly with special purpose acquisition companies.

What are SPACs and why are they hot?

“SPAC” stands for special-purpose acquisition company, essentially a blank-check company who has raised billions of dollars for the sole purpose of merging with private companies. Due to the hurdles that a company may face uplisting through the traditional IPO routes, they’ve turned to SPACs. In 2020, there have been 112 SPACs IPOs and most recently, the hottest stocks such as Nikola, Fisker and Arrival have been given life through SPAC mergers.

Creating a SPAC

What are SPACs and how do you create one? Well, the process of creating a SPAC is similar to filing an IPO. With a traditional IPO, companies often go on a road show to drum up interest in hopes the institutional investors or hedge funds would buy into their public offering. However, with a SPAC, you could say it’s reversed. The hedge funds or institutions are the ones that often connect with other hedge funds or private equity funds to generate interest if they want to raise funds for the sole purpose of being a special purpose acquisition company.

SPACs vs. IPOs

Private companies looking to list on a public exchange may go through traditional routes such as an IPO or may merge through a SPAC, a special purpose acquisition vehicle, already trading publicly. Below, we’ve listed the most common differences between the two.

In 2020, there have been over 165 SPAC IPOs with more than $61.3 billion raised. That’s an dramatic increase from 2019 when there were 59 deals with $13.6 billion raised. So why are so many companies going public through SPACs instead of the traditional route?

Who can create a SPAC?

Almost anyone with the right connections and star power able to raise the funds can create a SPAC.

Example: Jim is a successful entrepreneur with a $2 billion net worth. He decided that he wants to create a SPAC so he contacts his other wealthy friends if they want to help him raise money. His friend Dave asks him, "what are SPACs?" so he proceeds to tell him that the end goal would be to buy a operating, preferably private company. Dave and Jim's friends all decide to pitch in and the SPAC is now worth $1B, ready to purchase an operating company.

After the funds are raised, the money is transferred over to a blind trust until the management team has found their target company. At this time, the investors would receive shares of the SPAC which traditionally have been denominated at $10.

What are SPACs and why are they priced at $10?

You may be wondering why SPACs are priced at $10? There is no correct answer to this but many tend to think is that it makes it easier for accounting. If a SPAC raised $1 billion from 400 investors, each investor would have had to put 2.5M each. In return, they would receive 250,000 shares priced at $10, an even number.

However, keep in mind that there is no set share price on what special purpose acquisition company is to be priced at. Bill Ackman’s Pershing Square launched a $4B SPAC with units priced at $20 each.

What are SPACs and why do the shareholders receive warrants?

In addition to receiving shares of the SPAC, investors may also receive warrants that would entitle them to purchase additional shares of the SPAC in the future. Warrants are typically added as a motivator in order to encourage investors to participate in the fund raising.

How big is the target company?

When a SPAC is formed, roughly 80% of the funds held in trust must be used to acquire a target company. The bigger the SPAC, the greater the value of the target company. However, note that there is no maximum size of the target company but only a minimum. Historically, SPACs have acquired companies that are 2-4 times the size of it’s IPO proceeds.

If the company is bigger than the total funds held in trust, there would need to be more private investments and capital raises. At this point the management team of the SPAC would turn to institutional investors to raise the additional funds.

Referring to Bill Ackman’s $4B SPAC, there have been rumors that it may merge with AirBnB, valued at approximately $30B. However, this is yet to be seen. At a minimum, Bill Ackman’s SPAC will merge with a company valued at 3.2 billion within 18-24 months, the typical lifeline of SPACs. If this doesn’t happen, investors are entitled to their funds back.

Now that you have a brief overview of the subject, you can confidently answer the question if your friends ask you, “what are SPACs?” SPACs have been hot and are here to stay. Many private companies are by-passing the traditional IPO route and listing through SPACs. To see a list of current SPACs, click here.