What is a Special Purpose Acquisition Company – SPAC
Are you looking to start a new business? Wondering what business model is right for your needs?
Sure, you can go by intuition, but when it comes to creating a successful business, you will need a lot more.
A Special Purpose Acquisition Company (SPAC) is a publicly listed company that aims to raise capital through an initial public offering (IPO) in order to acquire another business or investment.
This capital is raised through a blind pool which means that as the funds are being raised, the investors are not given a specific goal towards which the funds will be used.
WHEN DOES AN IPO HAPPEN?
An Initial Public Offering is when a company starts to sell off their shares to investors and the general public to raise funds.
It is only after the IPO has been successfully completed that the reason for building up the funds will be released.
Now, IPO’s are more common than you would think.
The capital that is raised by this IPO is then deposited in a trust and kept there until the SPAC decides on a merger or acquisition onto which these funds can be used.
A SPAC usually tends to be specific about what they want to do and will partner up a good businessman or a well-versed executive with an investment bank to pursue these acquisitions within a sector.
Typically, after an IPO is completed, the SPAC will take around two years to find an acquisition target, after which they will be merged into the already existing SPAC to form a newly built public company.
When the money is deposited into the trust, it is usually kept for only a pre-determined amount of time (two years mentioned earlier).
Once this time has passed, and the SPAC has been unable to find an acquisition, the money will be sent back to their investors after the costs of the banks, and the broker fee has been deducted.
A Special Purpose Acquisition Company has been called many names in the past such as Blank Check Companies, Clean Shell Companies, Public Shells, etc.
These companies have been getting famous as of late, as many top businessmen have flocked to companies involved in this, due to how well they can perform.
In 2017, SPAC companies accounted for almost 20% of the IPO’s made that year.
HOW DOES A SPECIAL PURPOSE ACQUISITION COMPANY WORK?
Now that we have a basic idea of what a SPAC company is let’s break it down into smaller sections and explore each individually.
Forming up the Company
A SPAC will usually be formed when a businessman or group has a specific goal of acquiring a certain company from a specific industry or when an experienced person knows he has the necessary skills to look for potential companies to acquire in a particular industry.
These people or person will be the most important aspect of the company as they will be the face of the business to the crowd and the investors.
When the SPAC is formed no one will know about it as it is a newly formed shell company and the only reason people will be interested in it will be because of the person backing the whole project.
Therefore, people are investing in the person running the SPAC rather the company itself.
This is why if a SPAC is going to be formed, they need to make sure that the person heading it is a well reputed and experienced individual with a lot of contacts in the business world.
This person will also introduce a starting capital into the business to get it going in return for a rather large stake in the future acquired company.
The more that this person is involved in the industry that the SPAC is looking into, the easier it will be for them to make it successful.
Issuing an IPO
After the SPAC has decided on their founders and which sector to target, they would want to start raising capital for this venture.
To do this, they will link up the team with an investment bank who can handle the IPO.
They will then decide on the fee that the bank will charge for this service which is usually around 10% of the whole proceedings.
The IPO sold by a SPAC is typically not too expensive and will be sold at a single unit price which will equal to one common share.
Since the SPAC is a newly formed venture, they do not have a financial history or any form of proper security to offer to the bank.
Here again, the founder or businessman they choose to head the venture will be important as the bank will judge the SPAC based on this.
So, they will only proceed with the IPO if they are assured that this person has the necessary qualifications or history to prove that he can be successful.
Once the bank has confirmed and the IPO’s are issued, all the capital will be deposited into a trust account set up by the bank where it will remain for a pre-determined period of time until an acquisition opportunity comes along.
MEANS OF ACQUIRING A TARGET BUSINESS
After the IPO has been completed and the capital raised, the main investor or the founder will spearhead the next part of the proceedings.
Based on their experience, they will look into the industry that they want to work with and start to identify those with the potential to be integrated into the SPAC.
Acquiring smaller businesses can be an easy process due to the number of benefits that the other business would gain such as new capital, experienced management, and well-known names.
Also, when approached, it is usually termed as a “merger” rather than an acquisition so that the other smaller business will be more open to the joining of the two companies.
The new target company should also have a market value of at least 80% of that of the SPAC’s cash value.
Once a new company is acquired and formed, the founder will be given a sizeable stake in that company which is typically 20% but will change depending on their initial investment and which industry they are in.
For those investors who purchased shares, they will receive an equity share that will vary according to their investment level.
The team is usually given only up to two years to find a company and finish off the proceedings or else the IPO will be dissolved, and the capital sent back to the investors.
It is only if the SPAC identifies a target company and successfully acquires it that any members of the team or its investors start to make any money.
The management team is not allowed to draw salaries from this company until the moment that the new company is acquired and formed fully.
BREAKDOWN OF CAPITAL FUNDS
When a Special Purpose Acquisition Company issues their IPO, they are basically offering up the future company in part units that can be purchased by the general public or institutional investors.
Institutional Investors are those companies or groups that will purchase stocks on behalf of other people.
All of the money that is raised is kept in the trust account of the issuing bank, and in return for the money that the investors give the company, they will own “units” of the business each of which has a singular value.
Every one of these units will consist of a small portion of the business’s common stock value as well as the right to purchase or sell this common stock at a later date.
A warrant is also issued along with the public units and the reason the warrant is issued to the investors is as means for them to feel more secure about the purchase and to compensate them a little bit more for deciding to invest in the SPAC.
This will be discussed more a bit further down.
In typical situations, the units that are sold to the investors will be given at a fixed price of $10 per unit.
Once the IPO has been completed, these units can be split into two separate entities – common stock and warrants so that they are able to be traded on the Stock Exchange just like normal shares.
In simpler terms, think of the units as a product that a consumer is purchasing from a business that is launching a new product such as a new pair of wireless earphones.
The product will also come with an additional accessory like a charging pouch (warrant) which is only available to the first-time buyers.
This additional accessory comes as compensation for attending the new product launch, and after the launch is over, this limited accessory will become rare and so can be “traded” or sold at a higher value or kept waiting until the value of the product increases in the future.
The more of this product (unit) that the customer (investor) buys, the more value they can have in the future.
The founders who are involved in the start-up of the SPAC will purchase stocks of the company before the IPO which typically equals to 20% in total.
This is the same with either one founder or multiple as only 20% would be shared between them and the rest will be issued to the public or investors.
The founders’ stock is slightly different from the shares that will be issued on the IPO.
The founders will purchase their stocks at face value which is the original value that is shown on the certificate of these stocks.
This is their form of investment into the SPAC and will be different from the value that is given through the IPO.
The other difference the founders will face is that there will be a vesting schedule set on these shares.
A vesting schedule is a time limit that is set on the shares which state that any value or dividends cannot be derived from the shares that hold until a certain amount of time has passed.
In this case, it would mean the two years that the SPAC can be in operation for until they find a new acquisition.
The reason this is put in place is to avoid the free rider problem that can occur when there are multiple founders or even with just one founder.
The SPAC will not want one founder to invest their money and keep taking dividends from their share value without actually doing any work to make sure that the new business is formed.
This method was introduced after instances where this sort of situations arose previously.
As we spoke about earlier, when the IPO is issued to the public, each investor is able to purchase public units from which a part is given as a warrant to compensate the investor for the purchase.
A warrant, in this case, is basically a right given to the investor to purchase a whole share.
Depending on the bank and the IPO, this warrant may be equal to a small fraction or the full share.
This means that the investor can purchase additional shares at a later date for the same value that the share was given at initially.
In this way, even if the prices of the shares increase on the stock exchange after the IPO, the investor can use the warrant to get the share at a lower cost than what is available on the market.
All public warrants should be cash settled which means that if the investor wants to use the warrant and receive its equivalent share value, they need to settle it in cash.
ADVANTAGES OF A SPECIAL PURPOSE ACQUISITION COMPANY
You can gain different advantages from multiples sides with this form of business. Let’s look at some of them by dividing them into categories.
By investor, we mean the people who will purchase shares from the IPO offered by the SPAC.
- When the IPO is offered for this type of business, they are usually sold at a lower value to the investors as the SPAC is aiming to raise a lot of capital through multiple funds very fast. By giving them a lower value, a lot more investors will be able to purchase stocks from this company and will thus lead to more capital for the SPAC. By investing in such a company, the investor can hope to gain a more favorable profit in the future.
- The investors can invest their money into this venture with a hedged risk as there is a time limit set on the SPAC to find an acquisition company. Failure to do so will not result in the investor losing all his money as the terms dictate that in this case, the SPAC will pay back the money to the investors.
- The value of a SPAC company will not be based on the business itself but the founders who are running it. Therefore, the investors would not need to have kept a constant eye on the ever-changing business market to value it but rather on the people who will be running the SPAC. People, in general, know more about actual people rather than a business and so can actually invest their money on a person rather than a business in this scenario.
- Investors are also given a warrant as part of the unit shares that they purchase from the SPAC. This will allow them to be able to gain a higher profit from the IPO the company offers.
The Target Acquisition
This is the company that the SPAC will target as a potential acquisition to form a new company.
- The target company can be assured that accepting this proposal would come with sure funding for all future business ventures. The IPO will have collected the capital just to be used for the acquisition itself and so all that money would go towards building the future of the new company.
- This merger with an experienced management team and the fact that the founders involved with the initial SPAC will be well reputed and well-known names in the business industry will be highly beneficial for the target company. They will be entering into an agreement with these people which will give them more recognition and new and important experience in handling their type of business.
- If the target company is a private business, then they have the added advantage of becoming a publicly listed company without the expenses and documentation that usually follow this process such as underwriting fees and the whole public process involved with turning into a public company.
Special Purpose Acquisition Company and Founders
So, is an SPAC the right choice for you as a founder? Let’s take a look.
- The individual or group that was trying to acquire a certain company in an industry will be able to go about it in a public fashion showing the new company all the benefits that they can receive from such a venture. In the process, they are able to raise capital for the venture and also gain public support for the formation of the new company.
- Founders who are usually confident about their skills in acquiring a new company are the people who will end up starting up or joining with a SPAC. The founders themselves will get a healthy stake in the new company of 20% which can be a high profit-making average in the future. The SPAC will also benefit from a confident founder joining the venture as they can be assured that they have the best team working on it with the best chance of success.
Problems of a Special Purpose Acquisition Company.
Now, it’s not that the SPAC can solve all your business worries.
The answer to whether it is the right choice for you will depend on your business goals, including how much capital you have to run your business.
Here is a look at a few of the things that you need to consider.
- There is no guarantee that the venture will work even after the IPO is complete. The end of the two years after this period would mean that the whole thing would be dissolved and the money will have to be returned.
- Finding reputed and hard-working founders as well an enthusiastic financial institution for a SPAC can be very challenging and time – consuming.
- The team does not get paid any salary or value for their share in the SPAC until the deal with the acquired company has been complete
When it comes to creating a SPAC, ask yourself if it’s the right business model for you.
There are different choices, and having the right management approach is perhaps the first thing that you need to know to guide you the right way.
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