How Does a SPAC Work?

Understanding how a SPAC works requires following its journey from inception to merger completion. Each phase has distinct characteristics, regulations, and opportunities for investors. This comprehensive guide walks through the entire SPAC lifecycle, explaining the mechanics, key players, and critical decision points along the way.

Phase 1: SPAC Formation and Structure

The Sponsors

Every SPAC begins with sponsors—experienced executives, investors, or industry experts who create and manage the SPAC. These sponsors typically include:

• Former CEOs or senior executives with industry expertise
• Private equity professionals with acquisition experience
• Investment bankers with capital markets knowledge
• Celebrities or well-known figures who add credibility

Sponsors invest nominal capital (usually $25,000) to purchase "founder shares" or "promote," which typically represents 20% of the SPAC's post-IPO equity. This 20% stake is their primary compensation and incentive.

Initial Capital Structure

The SPAC's initial capitalization includes:

• Founder Shares: 20% of equity owned by sponsors, purchased for minimal investment
• Public Shares: 80% of equity to be sold in the IPO
• Warrants: Additional equity upside attached to units or sold separately
• Forward Purchase Agreements: Commitments from sponsors or third parties to invest at the time of merger

Phase 2: The IPO Process

Filing and Regulatory Review

The SPAC files an S-1 registration statement with the SEC, which includes:

• Detailed biographies of the management team and their track records
• The SPAC's investment strategy and target criteria
• Use of proceeds and trust account terms
• Risk factors specific to blank check companies
• Compensation structure and potential conflicts of interest

IPO Pricing and Structure

Most SPACs follow a standardized IPO structure:

• Unit Price: $10.00 per unit (industry standard)
• Unit Composition: 1 common share + fraction of a warrant (typically 1/3 to 1/2)
• Warrant Strike Price: Usually $11.50 per share
• Trust Account: ~$10.00 per unit goes into trust (IPO proceeds minus underwriting fees)

Trading Mechanics

After the IPO, SPAC securities trade as follows:

• Units: Trade immediately after IPO (ticker: XXXU)
• Separation: After 52 days, units can be split into shares and warrants
• Common Shares: Trade under ticker XXX
• Warrants: Trade under ticker XXXWS or XXXWT

Phase 3: The Search Period

Timeline Pressure

SPACs typically have 18-24 months to complete a business combination. This creates urgency:

• Months 1-6: Building deal pipeline and initial outreach
• Months 6-12: Serious negotiations with potential targets
• Months 12-18: Finalizing deal terms and documentation
• Months 18-24: Completing the merger or seeking extension

Target Identification Process

SPAC sponsors employ various methods to find targets:

• Investment Banking Networks: Leveraging relationships with bankers who know companies considering going public
• Industry Contacts: Using sponsor expertise and connections in specific sectors
• Financial Advisors: Hiring firms to run formal auction processes
• Direct Outreach: Approaching companies that fit the SPAC's criteria

Due Diligence

Once a potential target is identified, the SPAC conducts thorough due diligence:

• Financial audits and quality of earnings analysis
• Legal review of contracts, litigation, and compliance
• Business model evaluation and market analysis
• Management team assessment
• Technology and intellectual property review

Phase 4: The Business Combination (De-SPAC)

Deal Announcement

When a target is selected, the SPAC announces the proposed merger through:

• 8-K Filing: Immediate disclosure of material terms
• Investor Presentation: Detailed deck explaining the target's business and projections
• Press Release: Public announcement with key highlights
• Investor Call: Management teams from both companies present the opportunity

PIPE Financing

Most SPAC deals include a PIPE (Private Investment in Public Equity) to ensure adequate cash:

• Purpose: Replace potential redemptions and provide growth capital
• Investors: Institutional investors, mutual funds, hedge funds
• Terms: Usually at $10/share, sometimes with additional warrants
• Size: Typically $100-500 million, depending on deal size

Proxy Statement and SEC Review

The merger requires extensive documentation:

• Proxy Statement/S-4: Comprehensive document describing the transaction
• SEC Review: Multiple rounds of comments and responses (2-4 months)
• Financial Statements: Audited financials for the target company
• Pro Forma Information: Combined company projections

Phase 5: Shareholder Vote and Redemptions

The Shareholder Meeting

SPAC shareholders vote on the proposed business combination:

• Required Approval: Usually majority of shares voted
• Sponsor Votes: Sponsors typically vote their 20% in favor
• Quorum Requirements: Often 50% of outstanding shares
• Vote Timing: Typically 30-45 days after proxy mailing

Redemption Rights

A critical feature of SPACs is the redemption option:

• Right to Redeem: Shareholders can redeem shares for cash from trust
• Redemption Price: Pro rata share of trust (typically $10+ interest)
• Keep Warrants: Redeeming shareholders often keep their warrants
• Decision Timing: Must elect before the shareholder vote

Minimum Cash Conditions

Most merger agreements include conditions related to available cash:

• Minimum Cash: Target company requires certain cash proceeds
• Maximum Redemptions: Deal may terminate if too many redemptions
• PIPE Backstop: PIPE investors help ensure minimum cash is met

Phase 6: Closing and Post-Merger

Transaction Closing

Upon approval, the merger closes with several simultaneous events:

• Legal Merger: Target company merges into SPAC (or vice versa)
• Name Change: SPAC adopts target company's name
• Ticker Change: New ticker symbol reflecting the operating company
• Board Reconstitution: New board with target company representation
• Capital Infusion: Trust funds and PIPE proceeds delivered to company

Post-Merger Dynamics

After closing, several important changes occur:

• Lock-up Periods: Sponsors and insiders typically locked up for 6-12 months
• Earnout Provisions: Additional shares may be issued based on performance
• Warrant Exercises: Warrants become exercisable 30 days post-merger
• Public Company Requirements: Full SEC reporting and compliance obligations

Alternative Outcomes

SPAC Liquidation

If no deal is completed within the timeframe:

• Automatic Liquidation: SPAC must return funds to shareholders
• Distribution Amount: Pro rata share of trust plus interest
• Sponsor Losses: Sponsors lose their initial investment
• Warrant Expiration: All warrants expire worthless

Extension Mechanisms

SPACs can extend their deadline through:

• Shareholder Vote: Approval to extend by 3-6 months
• Additional Contributions: Sponsors may add funds to trust
• Monthly Extensions: Some SPACs allow month-by-month extensions
• Redemption Rights: Shareholders can usually redeem during extensions

Key Stakeholders and Their Incentives

Practical Timeline Example

Here's a typical SPAC timeline from start to finish: