What is a SPAC?

A SPAC, or Special Purpose Acquisition Company, is a publicly traded company created specifically to acquire or merge with an existing private company. Often called a "blank check company," a SPAC raises money through an initial public offering (IPO) before it has any actual business operations or even a specific acquisition target in mind.

The Basics of SPACs

Think of a SPAC as a shell company with a very specific mission: to find and acquire a private company within a set timeframe, typically 18-24 months. The SPAC raises capital from public investors who trust the SPAC's management team (called "sponsors") to find a good acquisition target.

Here's what makes SPACs unique:

• No business operations: At IPO, a SPAC has no commercial operations—it's just a pool of cash looking for a company to buy.
• Trust-based investment: Investors are essentially betting on the SPAC sponsors' expertise and track record.
• Time-limited: SPACs typically have 18-24 months to complete an acquisition or return money to investors.
• Redemption rights: Investors can often get their money back (plus interest) if they don't like the proposed acquisition.

How SPACs Work: The Life Cycle

1. Formation and IPO

A SPAC begins when sponsors (typically experienced investors, executives, or industry experts) create the company and file for an IPO. The sponsors usually invest a small amount of capital in exchange for "founder shares" that represent about 20% of the SPAC's equity.

During the IPO, the SPAC sells units to public investors, typically at $10 per unit. Each unit usually consists of:

• One share of common stock
• A fraction of a warrant (often 1/3 or 1/2) that allows purchasing additional shares at a set price (typically $11.50) in the future

2. The Search Period

After the IPO, the SPAC's cash is placed in a trust account while the sponsors search for a target company to acquire. During this period:

• The money in trust earns interest (typically invested in government securities)
• Sponsors cannot touch the trust money except to complete an acquisition or return it to investors
• The SPAC's shares and warrants trade publicly on stock exchanges
• Sponsors work to identify and negotiate with potential acquisition targets

3. The De-SPAC Transaction

When sponsors find a target, they announce the proposed merger. This triggers several important events:

• Disclosure: Detailed information about the target company is provided to investors
• Shareholder vote: SPAC shareholders vote on whether to approve the merger
• Redemption option: Shareholders can choose to redeem their shares for cash (typically $10 plus interest) rather than participate in the merger
• PIPE financing: Often, additional funding is raised through a Private Investment in Public Equity (PIPE) to ensure adequate capital

4. Completion or Liquidation

If the merger is approved and completed, the private company becomes public, taking over the SPAC's stock exchange listing. If no suitable target is found within the time limit, or if a proposed merger fails, the SPAC liquidates and returns the trust money to investors.

Advantages of SPACs

For Target Companies:

• Faster path to public markets: The process can be completed in 3-6 months versus 12-18 months for a traditional IPO
• Price certainty: The valuation is negotiated upfront with the SPAC sponsors
• Less market risk: The deal terms are set regardless of market volatility
• Expert partners: SPAC sponsors often bring valuable expertise and connections
• Ability to provide projections: Unlike traditional IPOs, companies can share forward-looking statements

For Investors:

• Downside protection: The ability to redeem shares at the IPO price plus interest provides a floor
• Upside potential: Warrants provide additional upside if the merger is successful
• Access to private companies: Opportunity to invest in companies that might not otherwise go public
• Transparency: Detailed disclosures before voting on the merger

Risks and Considerations

Dilution Risk

One of the biggest risks for SPAC investors is dilution. The sponsor's promote (typically 20% of shares), warrants, and PIPE investments can significantly dilute existing shareholders' ownership percentages.

Sponsor Incentives

Sponsors have strong incentives to complete a deal—any deal—because they typically lose their entire investment if no merger occurs. This can lead to overpaying for targets or pursuing suboptimal acquisitions.

Limited Time and Information

The pressure to find a target within the deadline can lead to rushed due diligence. Additionally, investors have limited time to evaluate the proposed merger once it's announced.

Post-Merger Performance

Historical data shows that many SPAC mergers underperform the broader market after the de-SPAC transaction completes, particularly after redemptions and sponsor lockups expire.

The SPAC Boom and Evolution

SPACs experienced explosive growth in 2020 and 2021, with hundreds of SPACs raising billions of dollars. This boom was driven by:

• Low interest rates making yield-seeking investors more willing to take risks
• Market volatility making traditional IPOs less attractive
• High-profile sponsors bringing credibility to the structure
• Success stories of companies like DraftKings and Virgin Galactic going public via SPAC

However, the market has since cooled due to regulatory scrutiny, poor post-merger performance of many SPACs, and rising interest rates. This has led to evolution in SPAC structures, including:

• Lower sponsor promotes
• More investor-friendly terms
• Enhanced disclosure requirements
• New SEC regulations governing SPACs

Key Takeaways

Questions to Ask Before Investing in a SPAC

1. Who are the sponsors? What is their track record and expertise?
2. What are the terms? How much dilution will occur from sponsors and warrants?
3. What's the timeline? How much time remains to find a target?
4. What's the focus? Does the SPAC have a specific industry or geographic focus?
5. What are the redemption terms? When and how can you get your money back?
6. What happens to warrants? Understand the warrant terms and exercise conditions