{"id":511501,"date":"2023-01-12T15:55:04","date_gmt":"2023-01-12T15:55:04","guid":{"rendered":"https:\/\/www.publicfinanceinternational.org\/?p=511501"},"modified":"2023-01-12T15:55:29","modified_gmt":"2023-01-12T15:55:29","slug":"what-is-a-spac-stock","status":"publish","type":"post","link":"https:\/\/www.publicfinanceinternational.org\/what-is-a-spac\/","title":{"rendered":"What is a SPAC Stock"},"content":{"rendered":"\n

A Special Purpose Acquisition Company or SPAC<\/strong> is a corporation that acquires or merges a private company and takes it public within 2 years. Instead of the traditional IPO process that can prolong a timeline, SPACs raise capital for their target companies. <\/p>\n\n\n\n

A SPAC is also referred to as a blank check company as it does not offer any services of its own. Rather, they exist to buy private companies and effectively take them public. Take a closer look at several distinct advantages of a SPAC stock over a traditional IPO and learn its risks in the stock market.<\/p>\n\n\n

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\"Merger<\/figure><\/div>\n<\/div><\/div>\n\n\n\n\n\n\n

Special Purpose Acquisition Companies have captured the attention of investors and financial media. SPACs have existed for decades in various forms\u2013recently gaining prominence in the public investment market. <\/p>\n\n\n\n

When a company decides to go public, it must go through the IPO process. To speed up the IPO process, SPACs have emerged as a cheaper alternative. After becoming a public company, the SPAC merges with a private target company. The SPAC raises the required funds through an IPO and holds it till the desired acquisition is made. <\/p>\n\n\n\n

This means that the only asset a shell company possesses is its IPO. There is a team of institutional investors that buys into the IPO without knowing the acquisition target company of the SPAC stock. The capital is raised through the IPO, and the SPAC\u2019s founders or management team looks for a target company and prepares for an acquisition.<\/p>\n\n\n\n

A History Of SPACs<\/h2>\n\n\n\n

When SPACs first emerged as blank-check corporations in the 1980s, the SPAC framework was flawed. Penny-stock fraud was common in the blank check companies, costing investors more than $2 billion a year. <\/p>\n\n\n\n

These firms were notorious for absconding with investors\u2019 money or engaging in deals that left investors with almost no returns. After the intervention of the U.S. Securities and Exchange Commission, SPAC stocks were thoroughly regulated. For example, blank check IPOs were now held in regulated escrow accounts and could not be used before the merger. <\/p>\n\n\n\n

With a new regulatory framework, the blank check corporations rebranded as SPAC. Until the target company is announced, the investors now have the option to recover their funds from the SPAC stock.<\/p>\n\n\n\n

How Does A SPAC Stock Work?<\/h2>\n\n\n\n

SPACs provide endless financial opportunities for boards of companies and investors. The traditional process of going public through the IPO is rather tricky for a private company.<\/p>\n\n\n\n

Compared to an IPO, the SPAC is less risky for the target company. The costs associated with a traditional IPO are eliminated when a company chooses a merger. Going public with SPAC invites a board of potential investors and high levels of financial statements for the target company.<\/p>\n\n\n\n

According to the Wall Street Journal<\/a>, 2020 witnessed the record-breaking of SPAC acquisitions. Many private companies bypassed the IPO process and chose to go public with SPAC.<\/p>\n\n\n\n

A SPAC Lifecycle<\/h2>\n\n\n\n

In the world of investing, SPAC is a rising trend. Large institutional investors like entrepreneur and VC Peter Thiel and baseball executive Billy Beane got involved. When learning about investing in stocks<\/a>, it is imperative to know the different facets.\u00a0\u00a0<\/p>\n\n\n\n

If you\u2019re still confused about SPAC stocks, here\u2019s everything you need to know about a SPAC lifecycle.\u00a0<\/p>\n\n\n\n

SPAC Formation<\/h3>\n\n\n\n

The initial stage of a Special Purpose Acquisition Company involves a group of sponsors, well-known investors, and private equity firms. Since the SPAC is a shell company, the reputation of its founders is the selling point for acquiring investors.<\/p>\n\n\n\n

The SPAC is founded by a management team using capital from the founding members<\/strong>. In the pre-acquisition stage, the blank check company goes through an initial public offering (IPO) process where 80% of the SPAC\u2019s shares are bought by investors while the remaining is distributed among the founders. To attract reputable investors, founders often hold an interest in a specific field that vouches for their credibility. These sponsors invest in risk capital or nonrefundable payments for the operating expenses of the management team.<\/p>\n\n\n\n

If the sponsors or founders fail to acquire a target company, the SPAC is dissolved, and the money is returned to the SPAC investors. Most investments often come from institutional investors who buy shares before identifying the target company. The combination of the SPAC founders and investors forms the backbone of the shell company.<\/p>\n\n\n\n

SPAC IPO<\/h3>\n\n\n\n

Unlike target companies, SPACs are required to go through the traditional IPO process. During the IPO process, the sponsors often withhold the name of the target company to avoid the complicated process with the U.S. Securities and Exchange Commission (SEC<\/a>).<\/p>\n\n\n\n

When issuing the IPO, the SPAC management team contacts an investment bank to administer the IPO. The investment bank charges 10% of the IPO as the fee charged for their services. The securities sold during an IPO are offered at the unit price (including common stock and warrants).<\/p>\n\n\n\n

Investors receive<\/strong> two kinds of securities: common stock<\/strong> ( $10 per share) and warrants<\/strong> that allow them to buy stocks in the future (at $11.50 per share). Following the IPO, proceeds from the IPO are held in a trust account until the private company is identified as the target acquisition.<\/p>\n\n\n\n

Acquisition Search<\/h3>\n\n\n\n

A Special Purpose Acquisition Company typically has 18 to 24 months to find the target company<\/strong>. The management team searches for a private company that is ready to go public within 2 years.<\/p>\n\n\n\n

The imposed deadline requires the SPAC management team to work diligently to find and acquire a target company. If they cannot acquire the target company, the SPAC is liquidated, and the investors get their money back. During this period, the SPAC stock is traded near its IPO price as the proceeds are held in the escrow account.<\/p>\n\n\n\n

The research process for acquiring a target company involves reviewing the company\u2019s financial statements and corporate structure. After the SPAC acquires a potential target firm, they make a formal announcement. If everything checks out, the SPAC and the target company discuss the terms of the merger.<\/p>\n\n\n\n

Acquiring A Target Company<\/h3>\n\n\n\n

After the SPAC announces the target company, the proxy vote is enforced. At this point, the SPAC shareholders can vote on the target acquisition. The fair market value of the target company needs to have at least 80% or more of the SPAC\u2019s trust assets.<\/p>\n\n\n\n

The SPAC may need to raise more money (issuing more shares) to acquire the private company. Shareholders also decide whether to liquidate their shares in the SPAC or continue with warrants. If most shareholders approve of the acquisition, the target company is listed on the stock exchange.<\/p>\n\n\n\n

There is a certain percentage fixed for the number of shareholders who choose to liquidate their shares. Historically, the percentage is fixed at 20%, but it can be as high as 30%. If the percentage of the shareholders exceeds 50%, the escrow account is closed, and the deal is terminated.<\/p>\n\n\n\n

Merger<\/h3>\n\n\n\n

When a Special Purpose Acquisition Company merges with a private company, the process is called a de-SPAC<\/strong>. After soliciting shareholder approval, the SPAC acquires the target company.<\/p>\n\n\n\n

The de-SPAC process involves heavy oversight from the SEC team that evaluates the financial information of the target company. A form 8-K must be filled with the U.S. Securities and Exchange Commission within four business days of closing the transaction.<\/p>\n\n\n\n

A SPAC may go through several rounds of negotiation with potential investors (like large funds or private equity firms) to raise additional capital. The initial IPO raised only covers about 25%-35% of the purchase price. To raise capital, SPAC sponsors may also resort to new outside investors using a Private Investment In Private Equity (PIPE) transaction.<\/p>\n\n\n\n

Is SPAC Better Than Traditional IPO?<\/h2>\n\n\n\n

Regarding funding and liquidity, SPACs offer specific advantages to target companies. Compared with traditional IPO, the process is less complicated and faster with fewer regulatory demands.<\/p>\n\n\n\n

In a traditional IPO, a private company uses an underwriter to go public on the stock exchange market. When it comes to valuation, traditional IPOs take nine to 12 months with little certainty about the capital raised till the end of the process. Target companies directly cede the valuation process to underwriters who solicit and manage potential investors. Refer to the table below for the main differences between the two groups.<\/p>\n\n\n\n

\n \n\n \n \n \n \n \n \n
\n Difference\u00a0 <\/th>\n \n Traditional IPO <\/th>\n \n SPACs\u00a0 <\/th>\n <\/tr>\n
\n Valuation time\u00a0 <\/td>\n \n 9-12 months\u00a0 <\/td>\n \n Within the first month\u00a0 <\/td>\n <\/tr>\n
\n Pricing\u00a0 <\/td>\n \n Depends upon market conditions\u00a0 <\/td>\n \n Target companies can negotiate the pricing\u00a0 <\/td>\n <\/tr>\n
\n Liquidity\u00a0 <\/td>\n \n No access to liquidity\u00a0 <\/td>\n \n Security in liquidity through the cash raised in IPO\u00a0 <\/td>\n <\/tr>\n
\n Cost\u00a0 <\/td>\n \n It is costlier than SPAC\u00a0 <\/td>\n \n The total costs are comparatively cheaper\u00a0 <\/td>\n <\/tr>\n
\n 5.\u00a0 Valuation yield\u00a0 <\/td>\n \n Conflict of interest between private companies and underwriters which results in lower valuation yield <\/td>\n \n Higher valuation yield as the SPAC sponsors directly communicate with investors\u00a0 <\/td>\n <\/tr>\n <\/table>\n<\/div>