What are Special Purpose Acquisition Companies (SPAC)?

By: Felix Ng & Horace Chow

We often come across the term SPAC when reading Bloomberg or financial times. However, what are SPACs and how does it play its roles in the financial market? SPACs are shell companies, also known as blank check companies with no business operations. Hence, the company does not have any revenue or expense. The sole purpose of SPACs is to raise capital from investors through an IPO, then acquire a fully operating private company using the cash held in trust. Typically, SPAC companies raise funds through common shares with a warrant allowing investors to purchase more shares later on at a specific price. Once that cash held in trust has formed the management team, also known as the Sponsors, a search for a potential company seeking to list their company in the public market will begin. The SPAC company will take the private company public through acquisition using the cash held in trust. If the SPAC company fails to merge or acquire a company within a deadline, the SPAC company will be liquidated, and the fund will be returned to the investors.

There are many Pros and Cons when it comes to SPACs. Through comparison between Traditional IPO and SPAC IPO, the differences become noticeable.

Traditional IPO:

Many steps must be taken before a company is finally IPO and listed on the stock exchange. The company must first begin by selecting an investment bank and hire them for underwriting the IPO. Afterwards, the underwriters investigate the company to understand any underlying potential risks. The company is subject to regulatory and investor scrutiny of its audited financial statements. The IPO team collects all necessary information to proceed, then submit the documentation to the regulatory bodies such as SEC or IIROC. The Investment bank will begin to market the shares to create interest in the IPO company and estimate the demand for the shares. Once the regulatory body has approved the IPO, the investment bank will finalize the IPO price based on the estimated demand for shares and the company’s financial status. The whole process should usually take nearly 6-9 months before being listed on the stock exchange. In addition, the company will also need to hire an investment bank to assist throughout the IPO process.

SPAC Transaction:

As for SPAC transactions, the procedure and timeline are shorter than traditional IPO, with fewer fees. SPAC companies will begin by listing themselves on the stock exchange through an IPO with the sole purpose of raising capital from investors. The collected funds are used to purchase a percentage, usually less than 50%, of a company that is also seeking to IPO on the stock exchange. Once the target company is found, and the merger is announced, shareholders can vote to either go through with the merger or elect to redeem their shares. If the SPAC does not have sufficient funds, it might issue additional shares or debt, such as a PIPE deal. Once shareholders approve of the merger and all regulatory compliance, the target company will become a public entity. Compared to traditional IPO, SPAC IPOs’ procedure is much simpler, allowing the company to be listed in a much shorter time. In addition, the company that is seeking to be listed will save on fees paid to investment banks.

Typical SPAC timeline

As for the disadvantages of SPACs, due to the lack of scrutiny of its financial statements compared to Traditional IPO, investors are more cautious when purchasing shares listed through SPACs. SPAC founders also have an incentive to close any deal including bad deals, because they will generally still make a return just from the company going public, allowing for bad companies to become targeted companies. In correlation, studies have also shown that companies listed through SPACs typically tend to underperform versus the S&P 500.

Highlighted below is an example of a successful and an unsuccessful SPAC transaction.

DraftKings (NASDAQ:DKNG) — 52-wk range ($34.90-$74.38)

As one of the most successful SPACs in history, Draftkings is a digital fantasy sport and sports betting operator that has become a strong growth stock as online gambling regulations loosens in many U.S. states. Diamond Eagle Acquisition, the blank check company’s stock price opened trading at $20.49 after the merger was announced, up from its original $10 offer price in 2019. Wellington, Franklin Templeton, and others have also agreed to invest $300 million upon completion of the merger, which provided retail investors with a strong sense of confidence. Draftkings has exploded to become one of the most successful SPACs because of investors’ optimistic view on sports betting.   

Pershing Square Tontine Holdings (NYSE: PSTH)

Billionaire hedge fund manager Bill Ackman’s SPAC faced scrutiny after his failed SPAC bid for a 10% stake in Universal Music group for $4 billion. Ackman tried to use his SPAC to negotiate a complicated deal but quickly abandoned the deal due to regulatory scrutiny from the SEC. Former SEC commissioner Robert Jackson believes that PSTH isn’t a SPAC at all but is actually an investment company and should be regulated as such. This could affect the entire SPAC industry, making it increasingly harder for companies to become a SPAC. Many critics also believe that the SPAC structure is simply a shortcut around the regulatory requirements involved via the traditional IPO route.