Banking on Manufactured Luck: An Overview of SPACs
Over the past few years, there has been an increase in the emergence of some organisations called SPACs, or Specific Purpose Acquisition Companies over at Wall Street, which has heralded their existence as one of the ‘premier’ financial organisations to exist. This hype around SPACs is not at all unsubstantiated, since they have responsible for raising more than $20 billion over the past year. So, what are SPACs and what is it that they do?
SPACs, or Specific Purpose Acquisition Companies are essentially companies that possess no commercial operations, and are practically formed on the basis of the capital they are able to raise through the presentation of an IPO, with the specific purpose of the acquisition of a pre-existing company. Whenever such companies issue their respective IPO prospectus’s, they do not state the reason for which the IPO is being carried out for, in order to avoid extensive disclosures during the said process.
So, what does all of this mean? SPACs are organisations that essentially raise money through IPOs for the purpose of acquiring a pre-existing company, but do not mention which company it is that they shall be acquiring. Such organisations are typically called “blank check companies”, since investors have absolutely no idea about the company that they are investing in, as well as the company that the SPAC will end up acquiring.
So, what comes next? All the money that is raised through the presentation of an IPO is deposited in an interest-bearing trust account. These funds cannot be used for any purpose by the owners of the SPAC, except for the acquisition of a pre-existing company, or for the repayment of money to their investors in the case of the SPAC’s liquidation. SPACs are usually in existence for a time frame of about two years, in which they are supposed to complete the acquisition of a pre-existing company. But if they fail to do so, the money is returned to the investors of the SPAC.
The above paragraph was pretty much straightforward. However, for the sake of a recap: SPACs are companies that raise money through their IPO, and use the money to acquire a pre-existing company, or return the money to their investors if they are unable to complete an acquisition.
After reading the above few paragraphs, the one question that pops in anyone’s head is that how can people invest such high amounts of money in a company that essentially possesses no plans or strategies for its operations or existence, with its success completely banking on the acquisition of an existing company? Well, the answer lies within the name and reputation of the organisation that is behind the creation and existence of the SPAC.
Over the past few years, SPACs have witnessed an increase in their hype on Wall Street, and have thus attracted renowned organisations like Goldman Sachs, Credit Suisse and even Deutsche Bank. These companies which essentially function that intermediaries for the IPO process act as the underwriters for the SPACs, which thus lend a certain sense of creditworthiness to the company in question.
Since SPACs raise their funds through the process of an IPO, they are required to be listed on at least one stock exchange. Essentially, SPACs are publicly listed shell companies that either acquire or merge with an existing private operating company, to create a new entity that will be traded publicly on the stock exchange by providing a public listing for the private operating company they have merged with or acquired. And since they are not required to state the reason for which they’re raising funds through an IPO, their selling proposition is based on its sponsors’ reputation.
So, what do the investors of a SPAC do? They essentially buy “units” for $10 each. A unit essentially consists of a common, regular stock and also a derivative called a warrant. These warrants allow investors to buy additional shares at specific “exercise” prices, which after the merger, are traded publicly alongside the shares of the company as well.
Furthermore, SPACs can invite PIPEs to invest in their company in order to increase the amount of cash available with them. PIPE, or “private investment in public equity”, are typically organisations like large mutual funds, sovereign wealth funds and pension funds.
SPACs are extremely beneficial for small companies with extremely high growth potential, and are looking to go public. These small companies benefit extremely from the premium (which is usually upwards of 20%) if it is compared to a private equity deal. It also allows them a faster IPO process since the parent company is already listed on the stock exchange, with a lesser amount of worry with regards to the swings in the broader market sentiment.
However, the hype around SPACs are a bit over-exaggerated, since there is a lack of regulation surrounding the particular type of the organisation, as well as the redemption options provided to their shareholders.
As far as the SEC is concerned, the organisation doesn’t have a hard stance against the type of organisation. Since any SPAC has not caused significant harm to an organisation, the SEC is maintaining its distance from the organisation. But if a SPAC is involved in a hostile takeover over the next few years (which I’m pretty sure will happen) which results in a public battle between two major companies, the SEC will be the first one to step in between and call quits.
As for the investors, it is technically in their favour. Since the SPAC is dealing in units of say $10 each, investors are allowed to redeem their shares at any time at which they want to do so. However, they still get to retain the warrant (which is a fraction of the warrant they redeemed) with themselves, which essentially means that they will be basically be left with the cherry on top of the sundae which they returned to the barista. And in a once in a millionth case in which all the investors pull back their money, there will be no SPAC and no subsequent acquisition.
So as to conclude, SPACs have a bright future ahead of themselves, but due to the lack of regulation surrounding the organisations, and also as the structure of the organisation’s working, they may very well be used to initiate hostile takeovers of various organisations that will definitely effect market stability and increase volatility. But as far as seed funding for IPOs goes for private organisations, the presence of SPACs is the best thing that has happened to them, and will continue to be so until some new organisation takes Wall Street by storm.