SPACs Explained: What are Special Purpose Acquisition Companies (SPACs) & How Do They Work?

A  Special Purpose Acquisition Company (SPAC), often referred to as a "blank check company," is a publicly traded shell corporation established by investors. Its primary purpose is to raise capital through an initial public offering (IPO), with the sole intention of acquiring or merging with an existing private company. This structure offers a streamlined, alternative path to the traditional IPO process, allowing target companies to go public more quickly and efficiently.

TL;DR

• A SPAC is a shell company created to merge with a private business and facilitate its public listing.

• It raises capital through an IPO without initially disclosing any specific acquisition target.

• SPACs typically offer a faster, more flexible alternative compared to traditional IPOs.

• While they provide benefits like speed and access to experienced sponsors, they also involve risks such as investor dilution and increased regulatory scrutiny.

• Although the popularity of SPACs has recently seen a decline, they still hold strategic appeal in certain sectors for companies looking to go public.

How Do Special Purpose Acquisition Companies (SPACs) Work?

1. Formation and Capital Raising (SPAC IPO):

• SPACs are typically launched by experienced sponsors—often institutional investors, private equity firms, or industry veterans.

• These sponsors fund the company's formation costs and manage the SPAC IPO to raise capital from public investors.

• The funds raised are held in a secure trust account, generating interest, until a suitable merger or acquisition opportunity (known as a de-SPAC transaction) is identified.

• Crucially, the SPAC does not have any existing business operations at this stage.

2. Target Search and Merger (De-SPAC Transaction):

• Sponsors are usually given a timeframe of 18 to 24 months to identify, vet, and negotiate a merger with a private company.

• Once a target company is selected and a definitive agreement is reached, the proposed deal is presented to the SPAC's shareholders for a vote.

• If approved, the merger proceeds, allowing the private company to become a publicly traded entity by leveraging the SPAC’s existing stock exchange listing. This final step is known as the de-SPAC transaction.

Pros and Cons of SPACs

Advantages of SPACs

• Speed to Market: A SPAC merger can be completed in months, faster than a traditional IPO.

• Valuation Certainty: Deal terms, including valuation, are agreed upon early.

• Access to Expertise: SPAC sponsors may bring strategic guidance, industry credibility, and connections.

Disadvantages of SPACs 

• Dilution Risk: Sponsors typically retain about 20% equity, reducing the stake of other investors.

• Incentive Misalignment: Sponsors may push deals to meet deadlines, not always in shareholders’ best interest.

• Performance Volatility: Many de-SPACed companies have underperformed post-merger.

• Increased Regulation: Regulatory bodies now scrutinise SPAC transactions more closely due to past issues.

Recent Trends and Market Sentiment

The SPAC market experienced explosive growth during 2020 and 2021, marked by a high volume of new SPAC formations, high-profile mergers, and significant speculative enthusiasm. However, this surge was followed by a notable slowdown. This deceleration can be attributed to several factors, including:

• Increased regulatory scrutiny from bodies like the SEC.

• Increased investor caution following the underwhelming post-merger performance of many de-SPACed companies.

• A general shift in market sentiment away from speculative growth assets.

Despite this decline in overall popularity, SPACs continue to remain a useful and viable tool for certain companies seeking to go public, especially in sectors with inherently long IPO timelines or complex regulatory hurdles. Their strategic appeal persists for specific market conditions. (Source: Fidelity)

Conclusion

SPACs represent a compelling alternative for companies seeking to go public. They offer speed, simplicity, and the benefit of experienced sponsorship. However, they’re not without risks. From dilution to misaligned incentives and stricter oversight, both investors and companies must evaluate SPACs carefully to ensure alignment with their long-term goals.

*Past performance does not reflect future results.