Special purpose acquisition companies (SPACs) have been on the investment scene for years. They started gaining popularity a couple of years back, and the trend seems to be gathering momentum.
Last year alone, over two hundred SPACs issued IPOs, then the trend went into a frenzy this year with $170 billion in capital raised so far.
So, what’s happening on Wall Street? Why the SPAC frenzy? Does the COVID-19 pandemic have anything to do with it?
This article seeks to shed light on the SPAC boom and what’s in it for the sponsor, investor, and companies. Let’s dive in.
What Is a SPAC?
A special purpose acquisition company (SPAC) refers to a shell company mainly set up by large institutional investors or high-value individual investors to raise capital through an IPO, then acquire privately held companies via mergers. Also known as a blank-check company, a SPAC has no operations going on at the time of IPO. Its business plan involves merger acquisitions solely. SPAC IPOs carry a high price-per-share, which averages $10.
The funds raised through the IPO are kept in a trust, and the SPAC sponsors are given a two-year timeline to find and acquire a company. Failure to take up a company within this deadline results in the SPAC’s liquidation, and the investors are refunded their money.
Once a private company merges with a SPAC, it immediately acquires rights to trade publicly, thereby dodging the rigorous IPO process. In most cases, it’s a win-win situation for both sponsors and the merging company. Sponsors receive 20% of the post-acquisition SPAC shares, while the company gets a fast capital raise/injection.
On the other hand, investors don’t have an immediate benefit per se, as they have to wait until the company’s shares rake in a profit in the stock market. As such, they are usually given a choice to opt-out by selling the shares if they don’t like the company being acquired.
Special Purpose Acquisition Companies are gaining momentum on Wall Street.
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As earlier mentioned, SPACs have always been there, but the trend has gained momentum in the past year. In some way, the COVID-19 pandemic has played a role in the surge of SPACs seeking registration.
Companies are shying away from going public owing to high market volatility. Even though some companies have gone ahead to issue IPOs, others prefer the low-risk option that SPAC offers. The pandemic has also shaken many private companies financially. As SPAC acquisition provides fast access to capital, these companies are likely to prefer merger over IPO.
Owing to these reasons, high-value investors are setting up SPACs with the hope of offering companies a convenient means to fund raise and start trading publicly. Most sponsors are eyeing companies in the aerospace, software, and automobile space, but the preference is likely to broaden as more SPACs are set up.
Essentially, SPACs have three key players – sponsors (high-value investors who form the SPAC), investors (shareholders who buy SPAC shares during IPO), and companies (private entities who merge with the SPAC to trade publicly).
Arguably, traditional IPO is still holding its share on Wall Street. So, what’s motivating SPAC players despite other booming investment alternatives? To help us wrap our minds around this, here is a rundown of SPAC benefits.
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- High returns – SPAC sponsors receive 20% of the post-IPO shares. This is a high gain that can translate into millions of dollars.
- Easy investment – Since SPAC is a shell company, there are fewer pre-IPO regulations. Hence, the sponsors raise capital much easier than an ordinary company would.
- Fast capital – A SPAC merger has a load of benefits for companies. One on the list is raising fast-capital, as the merger deal can take less than four months to close. Issuing an IPO, on the other hand, can go for more than a year.
- Expertise and credibility – In most cases, SPAC sponsors are seasoned investors with plenty of business acumen. Merging with a SPAC allows a company to benefit from the sponsors’ leadership. Also, it helps boost the company’s brand credibility.
- Better deal – Owing to the recent surge in SPAC incorporation, the tables have turned as sponsors are now arming themselves with compelling investor presentations and pitch books to woo companies into mergers and beat the two-year deadline. This means that companies can now negotiate with several SPACs for the best deal.
- Easy exit – As SPAC is a shell company, investors buy its shares based on the sponsors’ reputation. Effectively, they assume the sponsors will make profitable investment decisions. But if the SPAC decides to acquire a company the investor doesn’t like, they have an option of redeeming their shares before the acquisition deal is closed.
The Flip Side of SPAC Mergers
No one can tell for sure how long the current SPAC boom will last. There’s a chance there may end up being too many of them in the market and fewer companies seeking mergers. But that’s just an assumption. Could be the market can sufficiently support the demand and supply without resulting in a crash. However, this is still a possibility.
Tight Acquisition Deadline
Another possible threat to the SPAC frenzy is that some sponsors might make poor acquisition choices, leading to loss of investor money. This is especially possible due to the tight acquisition deadlines given.
For instance, if, by any chance, the sponsors fail to identify a good company, they may end up acquiring just any available company to avoid liquidation. Regulations do not task SPACs on the quality of the companies they choose to merge. Hence, investing in them is a high-risk endeavor.
Even though some companies perform impressively well following a merger, reports show that most SPAC investments yield lower returns than IPO.
The SPAC frenzy in Wall Street may not cool off anytime soon. With last year’s SPACs working to beat the two-year company acquisition deadline, we should prepare for some interesting mergers. Hopefully, these mergers will join the likes of Galactic in raking in a good return for the investors. Though some companies still prefer to raise capital through the traditional IPO despite market volatility, SPAC mergers will still be prevalent. Thus, we expect the trend to go on, downsides notwithstanding. Besides, the pros seem to topple the scale for all stakeholders – the sponsor, company, and investor.
Here at Launch Module, we can help you prepare compelling SPAC investor presentations and pitch books to win feasible target companies and maximize shareholders’ wealth. If you’re ready to draft your pitch, talk to us and let us help.
About the author
Leslie Morales is the CEO of Launch Module and a Certified High Performance Coach. Learn more about Leslie and her team on our About Us page.