Special Purpose Acquisition Company (SPAC)

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Private equity is embracing the SPAC

Many private companies thinking of going public want to know if merging with a SPAC would be preferable to an IPO. The short answer: It depends. While a private company may find certain advantages in a SPAC merger—such as speed and a guaranteed price—it has its own challenges. One of the greatest of these is finding the best-fit SPAC sponsor in a sea of possibilities.

Special purpose acquisition companies (SPACs) have become a preferred way for many experienced management teams and sponsors to take companies public. A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing operating company.

What happens when a SPAC acquires a company?

Once acquired, the founders will profit from their stake in the new company, usually 20% of the common stock, while the investors receive an equity interest according to their capital contribution. SPACs continue to gain popularity as a potential liquidity option for many companies. The SPAC merger process with a target company may be completed in as little as three to four months, which is substantially shorter than a typical traditional IPO timeline. Accordingly, a target company must accelerate public company readiness well in advance of any SPAC merger. Further, given the compressed timeline of a SPAC merger, project management is essential in order to reduce execution costs, increase project efficiencies, and provide working group participants with enhanced accountability and transparency.

What happens when a SPAC acquires a company?

Once acquired, the founders will profit from their stake in the new company, usually 20% of the common stock, while the investors receive an equity interest according to their capital contribution.

What is the purpose of a special purpose acquisition company?

A special purpose acquisition company (SPAC) is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company.

SPACs versus IPOs?

In an IPO, a private company issues new shares and, with the help of an underwriter, sells them on a public exchange. In a SPAC transaction, the private company becomes publicly traded by merging with a listed shell company—the special-purpose acquisition company (SPAC).

Going public with a SPAC—pros 

The main advantages of going public with a SPAC merger over an IPO are:

  • Faster execution than an IPO: A SPAC merger usually occurs in 3–6 months on average, while an IPO usually takes 12–18 months.
  • Upfront price discovery: Your IPO price depends on market conditions at the time of listing, whereas you negotiate the pricing with the SPAC before the transaction closes—which is much more advantageous in a volatile market.
  • Possibility of raising additional capital: SPAC sponsors will raise debt or PIPE (private investment in public equity) funding in addition to their original capital to not only fund the transaction but also to fuel growth for the combined company. This backstop debt and equity are intended to ensure a completed transaction even if some SPAC investors redeem their shares.
  • Lower costs of marketing: A SPAC merger doesn’t need to generate interest from investors in public exchanges with an extensive roadshow (although raising PIPE involves targeted roadshows).
  • Access to operational expertise: SPAC sponsors often are experienced financial and industrial professionals. They can tap into their network of contacts to offer management expertise or take on a role themselves on the board.

Going public with a SPAC—cons 

The main risks of going public with a SPAC merger over an IPO are:

  • Shareholding dilution: SPAC sponsors usually own a 20 percent stake in the SPAC through founder shares or “promote,” as well as warrants to purchase more shares. SPAC sponsors also benefit from an earnout component, allowing them to receive more shares when the stock price achieves a specified target over a certain time frame which could lead to further dilution.
  • Capital shortfall from potential redemption: Initial SPAC investors may redeem their shares. If redemptions exceed expectations, then cash availability becomes uncertain and forces SPACs to raise PIPE financing to fill the resulting shortfall.
  • Compressed timeline for public company readiness: Although the SPAC sponsor may offer help during the merger process, the target company usually takes the brunt of preparing for required financials in the SEC filings and establishing public company functions, such as investor relations and internal controls, under a much shorter deadline than in an IPO.2
  • Financial diligence performed at narrower scope: The SPAC process does not require the rigorous due diligence of a traditional IPO, which could lead to potential restatements, incorrectly valued businesses or even lawsuits.
  • Lack of underwriting and comfort letter: In a traditional IPO, the underwriter makes sure all regulatory requirements are met but because a SPAC is already public, the target company doesn’t have an underwriter.