How Does A SPAC Work?
It might sound a lot like SPAM, but a SPAC may be hitting the kitchen portfolio of your table soon. Thus far (as of March 19th), SPACs had raised more than $87.9 billion dollars which was more than all of 2020 according to data from SPAC research. While the industry is facing a multitude of challenges in keeping up with its meteoric rise, the SPAC industry continues to pump out new offerings every single week of growth companies who often may even be pre-revenue. So, just what is a SPAC and is this something you should be looking at for your portfolio?
A SPAC (known as a Special Purpose Acquisition Company) is essentially a shell company set up by investors with the sole purpose of raising money through an IPO to eventually acquire another company. Some people are calling this an IPO workaround given that it costs much lower to go this route. Sometimes these are called 'blank check' companies because IPO investors don't actually have any idea what they will be investing in when they are set up. They have been around for many decades but have recently gained popularity again which is why you are hearing more about them.
As an example, in 2019 the Diamond Eagle Acquisition Corporation was set up as a SPAC in December. Just a short time after, it announced a merger with DraftKings and a gambling platform called SBTech. When the entire deal closed in April of 2020, DraftKings became a publicly traded company. You are seeing more and more structures set up like including companies like Wheels Up likely to go IPO through a SPAC called Aspirational Brands as a recent and relevant example.
So, let's remember that a SPAC doesn't actually have any commercial operations at all. It doesn't sell anything to the public nor does it manufacture a product. Basically, it ends up being a cash bank to raise assets for its own IPO. Sometimes, the money raised can be in the billions for one individual SPAC. CEO's including Richard Brandon and Tilman Fertitta have formed their own SPAC's as well as large institutional investors.
Investors who participate in a SPAC IPO are often lured into the opportunity to exercise the warrants so they can get more common stock shares once the actual acquisition target is identified and the transaction closes. Typically, the IPO price for a SPAC common stock is $10 a share because all that is sitting in the SPAC is cash. The interesting part to the SPAC's is that the exercise price for the warrants is typically set about 15% or higher than the IPO price. When the IPO is completed, the warrant is spun off and trades separately from the SPAC stock. This is why some smaller or mid-size companies like doing a SPAC vs. Private Equity because they may be able to squeeze more out of the value of their company than just selling privately.
One of the potential drawbacks of SPAC investments is that sponsors usually have a deadline by which they have to find a reasonable deal which is typically two years of the IPO. Of course, many of these SPAC's are set up with a specific company in mind to acquire. If no deal is found, the SPAC money is liquidated, and investors get their money back with interest. This means that you could have your money sitting for two years and make nominal interest.
The reason these have become so popular now is that many companies have fear that market volatility could spoil the public debut of their stock when they do an IPO directly. Thus, merging with a SPAC allows a company to go public and get a capital influx more quickly than it would have with a conventional IPO. A SPAC acquisition can be closed in just a few months versus what can be a very grueling process of registering an IPO with the SEC which can take up to six months or more.
If you are thinking about investing in a SPAC, make sure you do your research and take your time to understand the SPAC's acquisition targets. Pricing can still be very volatile, so these should be considered long-term investments and you could potentially lose all of your money. If you are interested in learning more, set up a service meeting with your current Private CFO® or set up a new meeting with one of experts.