If you are like us, you’re seeing this word “SPAC” quite a bit on LinkedIn and in a number of business journals. And maybe like us, you thought to yourself, “SPAC? Is this something akin to SPVs (special purpose vehicles)?”, and you were left scratching your head on why this is trending all over the news. Well, we thought we would cast off on a small journey into what this phenomenon is about and why it has become such a fashionable acronym for those in the vaunted investment circles.
What is a SPAC?
SPAC is an acronym that stands for special purpose acquisition company. So in a way, yes, it is a form of SPV or special purpose vehicle. Meaning that it is a company established for a specific purpose, namely being to acquire another company. OK, you are probably thinking to yourself, “but that does not seem too controversial and nothing that should be novel about it in any case.” Ah, but here is the rub which makes it such a hot topic for today’s frothy markets. The SPAC is set up to sell shares to investors without it having any operations at all - the investors are sold only on its purpose, i.e. that it will go out and purchase a valuable company in the market. Hence, the moniker “blank check company”. Therefore, one can think of it as a backdoor method to listing a company’s shares to the public without having to go through a standard initial public offering (IPO).
How does a SPAC work?
The idea of the SPAC starts and really revolves around the SPAC management team, which are also called the SPAC sponsors. These are the brains behind the investment and the people who average investors are trusting to do something useful with their hard-earned investment funds. The sponsors will establish the SPAC and go through an IPO process that is much less rigorous than one for normal operating companies. The company they are offering shares for is really a shell that exists with a single purpose, perhaps something like “we will buy a premier sports franchise” or “we will buy an innovating company in the electronic vehicle space”.
Members of the public will then buy shares in this purpose-driven shell company and once all the capital is raised the sponsors will have a limited time to acquire a company that fits the purpose. Normally, that time period is 2 years. In the meantime, the investors will get interest on the money while the sponsors go hunting for that great deal. If the 2 years run out without a deal happening, then the SPAC is liquidated and the cash is returned to the investors. No harm, no foul.
It should be noted that the sponsors are not doing this deal sourcing and execution as an altruistic deed. They are compensated for their sweat by gaining a minority stake in the SPAC, usually around 20%. The remaining 80% of shares are held by the public as mentioned above and at the point of acquiring the target the shares in the SPAC are converted into shares in the target company.
Are SPACs new?
Funnily enough, no, they are not. SPACs in some form or fashion have been around since the 1990s. But they have never been as fashionable as they are today. In 2020, SPACs raised $80 billion in the United States which is almost double the amount raised by SPACs in the preceding 10 year period. There also does not seem to be just an aberrant spike for 2020 involved. In the first two months of 2021, SPACs have raised another $60 billion. So, no this is not just a fad that is going to flame out.
The question is then why are they becoming so popular now? In our opinion, this is for two reasons. One is simply that there is a glut of investment cash in the system that is trying to find a home. As we have seen in the rise of investment apps like Robinhood, there are alot of investors flooding into the market and they want to have a home for their money that will give them a return better than your standard interest-bearing bank account. The second reason is that management teams and investors in operating companies want to find a short-circuited route to the abovementioned investor cash. Usually, that would mean they need to go through a rigorous and invasive IPO process which can be painful and last six months or more. But now with SPACs the money can be raised and the acquisition takes place in a month, at least in theory. And Bob’s your uncle, you are now a stock exchange listed company without having to go through investigatory audits, prance around endless investment roadshows or face embarrassing queries about the company balance sheet.
We hope this introduction was helpful and we were thinking about writing a follow-on from this post which would highlight a number of recent SPAC investments. If that is of interest, write a comment and let us know.
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