My friend Tim Tim just asked me a very popular question in the investing world (and accordingly the investment banking world) – What is a SPAC?
SPAC issuance has previously been somewhat of a fad – a few major ones and then radio silence and then a few major ones again. However in 2020, SPACs have become extremely popular with both SPAC deal count and dollar volume going through the roof.
A few of the most prominent ones have been in hot sectors such as technology and healthcare, as well as certain ones with more niche focus in ESG and consumer.
There has become a celebrity component to SPACs lately, further driving interest from both finance and non-finance folk alike. The Boston Red Sox and Liverpool FC are looking for an exit via a SPAC and finance royalty such as Bill Ackman are getting into the SPAC trend as well (Pershing Square Tontine Holdings).
Major companies that have gone public through SPACs include trading darlings Nikola and DraftKings.
What is a Special Purpose Acquisition Company (SPAC)?
A Special Purpose Acquisition Company (SPAC) is a company with capital/cash formed to merge or acquire a company or an asset. Another way to look at these blank cheque companies is as a publicly listed search fund. The SPAC management team will look for a company to acquire within a defined mandate and once the acquisition is made the SPAC basically becomes the acquired company – publicly listed.
The acquisition or transaction is known as an initial business combination (IBC).
As a simplification, SPACs will IPO, with net proceeds placed into a trust account with an acquisition within the SPAC’s mandate to be completed by a predetermined timeline usually no longer than two years. Should no transaction occur, the remaining funds will be liquidated and redistributed back to investors.
SPACs will generally look for corporates larger than the SPAC funds raised. The gap is plugged by private investment in public equity.
SPAC Valuation and Investing
SPACs will usually IPO for $10 which gives investors a share of common equity and a fractional warrant. If the IBC does not occur, the shareholder can redeem their shares and get back the value held in trust. If a deal is put forward and the shareholder disapproves, they can redeem for cash. The share price generally will not move much until the acquisition, where the investors can decide what to do.
What is Causing the Popularity of SPACs to Rise in 2020?
Private companies like SPAC takeovers because the certainty of pricing (more like M&A) versus an IPO which is underwritten by investment banks in an agency deal (as opposed to a bought deal which comes with a deeper discount – by comparison M&A fees are much lower than IPO fees where fully underwritten deals can be 4% of capital raised). IPOs also need to be underpriced (explained elsewhere in our website and other corporate finance literature) whereas SPACs do not need to be priced to perfection with the risk of failure or leaving money on the table.
This does not mean that SPACs are cheaper for the ultimate investor – it just means more money for the company being taken out.
Additionally, much of the regulatory work is done bringing the SPAC public – so this provides an easier exit with less regulatory disclosures and scrutiny for the private company looking to go public. This is less taxing on management time and attention. SPACs can be put together in a truncated timeline (and investment bankers with boilerplate templates can slap one together and charge fees quickly) of a few months while IPOs can take years.
As with M&A, SPACs provide a total exit versus an IPO which is partial. SPACs also come with a sponsor that is able to offer expertise and potential revenue or cost synergies for the business whereas an IPO typically does not.
For SPAC sponsors, there are options that will certainly be in-the-money if the SPAC is successful with its IBC. This means they will have the right to purchase 20% off the company at below market prices should the SPAC go public – hence why it is a favored vehicle for prominent buy side firms. Returns for sponsors can be astronomical.
SPACs are also great vehicles for a liquidity event for private equity sponsors.