A few weeks ago I was doom-scrolling Twitter and saw a link to yet-another article about SPACs and thought, “I really need to know more about these things.” My colleague, Kenny, has been casually dropping the term in our team meetings for a while, while talking about research he’s been doing, and I realized it was about time I stopped faking that I knew what he was talking about.
So I did a search and got lots of articles about Space-X, because “SPAC” and Twitter’s sub-par search engine don’t mesh. Sigh.
If you’re looking for a lost shoe, chances are good it’s not in the refrigerator.
So I stopped being lazy and did the smart-researcher thing, which was to go directly to Investopedia. I knew it would have the answer, and who has time to waste? (Well, me apparently, because I fell through the prospect research rabbit hole and spent another two hours learning about SPACs!)
There are lots more resources I’m going to link you to at the end of this article that explain things fairly clearly including a fascinating, detailed, inside-baseball explainer from Bill Gurley, a venture capital deal-maker in Silicon Valley.
But first, I’m going to share the basics.
A SPAC is a Special Purpose Acquisition Company. Anybody can start a SPAC. You can start a SPAC. You don’t need a special license or anything. You just need to be able to raise money. (Hmmmmm)
A SPAC is a publicly-held shell company formed by an investor or group of investors, also known as sponsors. These sponsors usually have knowledge or expertise in a certain industry sector.
The ultimate purpose of a SPAC is to merge that shell with a promising privately-held company in order to take that company public without the hassle or cost of the traditional IPO process.
The sponsors will do a roadshow to institutional investors like family offices and private equity firms to drum up interest in investing in this shell company. You might see a SPAC referred to as a “blank check” company, because investors are essentially putting money toward something that doesn’t exist yet.
The sponsors might (or might not yet) have a few companies in mind that they will approach for a merger, and they’re not supposed to tell the investors even if they know – at this stage anyway (more on that in a minute).
Anyone can invest in a SPAC, too, including you and me. Shares traditionally open at $10 each.
Once there’s enough money in the pot, it goes into a blind trust. The SPAC has 24 months in which to acquire/merge with the target company. If they aren’t able to do that within 24 months, all of the money gets returned to the investors.
Now, once the SPAC sponsors have decided on a company to merge with, they can go back to the institutional investors and tell them (in confidence) about it, and ask if they want to put in more money. This is what is called a PIPE deal – a “private investment in public equities.” It sounds a little sketchy, but institutional investors are not allowed to share this insider information, and they’re not allowed to trade their shares for four months after the merger. Retail investors – you and me – can sell or buy anytime.
Who’s making money, how, and how much?
So let’s say the SPAC merges with a privately-held company. What happens then? Who makes money? How do they make money?
Let’s start with the sponsors. They make money in fees: 2% of the SPAC’s value plus $2 million for administration. Plus any profit off of the sale of shares or increase on money they put in.
The owners of the privately-held company make money when their shares increase in price and/or they sell them. In addition, they save money because the IPO process is expensive, with lawyers and investment banks and lots of other people to pay. By merging with a SPAC, they’ve avoided all of that payout.
The institutional investors make money when their shares of stock increase in price. In addition, when they originally invested they were likely also given a warrant to buy future shares of stock at a discounted price at/after a particular date. Assuming that the share price has gone up, that can make for a tidy profit.
So that’s the overview of SPACs. Don’t miss these articles and resources that fill in more of the gaps:
- Almost everything you need to know about SPACs, by Connie Loizos. TechCrunch
- Going Public Circa 2020; Door #3: The SPAC, by Bill Gurley. Above The Crowd
- The Urge to Reverse Merge, by Andrew Ross Sorkin, Lauren Hirsch, Michael J. de la Merced and Jason Karaian. New York Times
- Will This Old Financial Tool Transform Tech Investing? by Kara Swisher. New York Times
- The Risk And Returns For The Increasingly Popular SPAC Trade by Simon Moore. Forbes
- Resource: SPAC Research. Don’t miss the league tables!