Beginner’s Guide to SPACS

Fri Jan 22, 2021, 02:13 pm | by Charles Munyi | No comments

If you’re looking to cash in on the boom in the so-called blank check companies, you should look before you leap. It’s been a frenzy in SPACs (Special Purpose Acquisition Companies) as companies drift away from the traditional IPO (initial public offering) market. Investors are increasingly using this alternative to take their companies public in a move to attract new investors and probably reduce the time it takes to reach public markets.

In 2020 alone, there were over 50 SPAC offerings — which raised in excess of $21.5 billion. Among the notable companies that used SPACs to go public is Nikola Corp., the electric truck manufacturer — it merged with VectoIQ Acquisition Corp., a SPAC focusing on transportation deals.

Even as the NYSE and NASDAQ look to welcome a swarm of SPAC listings and business mergers, not many investors are familiar with this special breed of IPO stocks. This blog provides the inside scoop on special purpose acquisition companies.

Defining SPACs: What Are They?

A special purpose acquisition company is a public-traded company that initially has zero commercial operations and is formed entirely to raise capital through an initial public offering (IPO). The capital raised is placed in an interest-bearing trust account, after which the SPAC seeks to acquire an already existing privately held company through a merger or acquisition within the specific time frame. The target firm is then taken public through the acquisition.

SPACs are also referred to as shell companies or blank check companies, and they often focus on companies within a specific industry or sector. They’ve recently attracted big-name underwriters and well-connected investors to raise record capital. Some of the recent high-profile SPAC deals include:

  • Richard Branson’s Virgin Galactic Holdings leveraged a SPAC formed by Social Capital Hedosophia Holdings to get its shares onto the public market in 2019. It acquired a 49% stake in Virgin Galactic for $800 million.
  • In April 2020, DraftKings closed on its $3.3 billion SPAC merger with Diamond Eagle Acquisition.
  • Electric truck maker Nikola (NASDAQ: NKLA) also finalized its merger with SPAC VectoIQ Acquisition Corp. in 2020.

The SPACs momentum is far from over — there’s a long line of companies looking to come public through such mergers. A would-be SPAC investor still has a chance to join in the dance.

How Do SPACs Work?

SPACs are formed by sponsors or investors with expertise in a particular sector or industry, with an intent to pursue deals in that area. When creating a SPAC, the founders typically have at least one target company in mind, which remains largely unidentified to avoid extensive disclosures prior to the IPO. So, you’ll have no idea what company you’re putting your money into.

The money raised in a SPAC IPO is placed in an interest-bearing trust account, and can’t be disbursed except when completing an acquisition or returning money to the investors after the SPAC is liquidated. SPACs typically have 2 years to complete the acquisition or face liquidation. In some instances, the interest earned from the trust may be used as the SPAC’s working capital. Upon acquisition, a SPAC is listed on one of the major exchanges.

Compared to operating traditional IPOs, SPAC IPOs may be considerably quicker. The SPAC financial statements in the registration statement are very concise and can be prepared in weeks (compared to several months for a business with previous operations). There are no historical assets to describe financial results to disclose, and the business risk factors are minimal. Basically, the IPO registration statement is just boilerplate language and director biographies.

Companies benefit from SPACs because:

  • SPACs let privately held companies go public faster than through the traditional IPO process.
  • SPACs may facilitate going public during periods of higher market volatility and instability.
  • SPACs provide an additional means through which companies can obtain late-stage growth capital instead of through venture capital or private equity financing. There’s also the opportunity to raise capital via common shares instead of preferred shares that may have unwanted protections and control rights.
  • There’s usually more certainty around a company’s capital raise and valuation compared to a traditional IPO, since the valuation is typically fixed through a privately negotiated merger transaction.
  • SPACs let companies that may not otherwise be marketable via a traditional IPO to go public, like companies with a complicated business history or unprofitable operations.

SPAC sponsor teams often comprise very experienced and accomplished professionals — which gives investors the ability to bet on a robust management team. While SPACs haven’t replaced the traditional IPO, they’ve cemented their place as an alternative because of their ability to provide more efficiency, flexibility, and certainty.

Should I Invest in SPACs?

If you were among the pioneer investors in Social Capital Hedosophia Holdings (NYSE: IPOA) — the SPAC that combined with Virgin Galactic — you’d have grown your investment over 10 times faster than betting on the S&P 500. So, you may view a SPAC as a way to hop in on an IPO; later the SPAC will acquire or merge with a promising company and the stock will start soaring, right? Perhaps.

Since SPACs don’t disclose their acquisition target early in the IPO process, you’re simply putting your trust in the expertise, reputation, and track record of the SPACs founders — and their ability to identify successful companies.

Owing to the risks involved, special purpose acquisition companies may be an exciting way to speculatively bet on markets anticipating explosive growth, like biotechnology, clean energy, or electric vehicles.

Understanding the Risks and Rewards

SPACs aren’t with their fair share of risks. For starters, a SPAC may fail to find a suitable business combination within the specified timeframe, and your money will remain tied up for the entire period. And while you’ll get your money back in the event of a failed acquisition, it can be a huge opportunity cost. With a traditional IPO, you’re sure your investment will get down to work immediately — with a SPAC, that’s not a guarantee.

Critics also say that SPACs undergo less regulatory scrutiny as compared to traditional IPOs which are thoroughly vetted. For an investor, this may pose a heightened risk since you might be going in with limited information since the companies have no operating history. You have to put your faith in the guy heading it up.

So, what should you do if you’re interested in SPACs?

  • Do your homework. Look into the reputation and track record of the team leading the SPAC you’re interested in. Have they led any successful SPACs before? What confirms their ability to translate visions into profits?
  • Pick an industry or sector you strongly believe in. Identifying the right sector can make or break your investment. Keep an eye out on where growth is likely to occur. The industry a SPAC will probably invest in can be learned from public sources, like its SEC registration form.
  • Check the timing. A SPAC may not disclose an acquisition for up to 2 years — there’s a chance the money you invest in a SPAC will lie idle for months. And there’s always a risk of returned money if the acquisition isn’t successful.

Final Thoughts

Investors looking to invest in a SPAC should understand that there’s always no guarantee of success. Historical data shows that SPACs don’t always perform well, with more than half of them trading below their IPO price. As long as the IPO market delivers victories to companies going public, many businesses will stick to that process to generate a buzz.

However, SPACs still remain a way for investors to bet on the leadership team’s ability to identify a smart acquisition. The few potential pitfalls won’t kill the interest of those who are hoping to find the right acquisition at the right price. 

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