What Is a Special Purpose Acquisition Company (SPAC)?

SPACs are all the rage on Wall Street lately, not to mention the world of celebrities, retired athletes, and even former members of Congress. Although SPACs have been around for many years, their popularity skyrocketed in early 2020, and everyone from the obscure to the world-famous seemed to either be working for a SPAC or angling to start or invest in one.

What is a SPAC?

SPAC is short for special purpose acquisition company, a sort of shell company that doesn’t have its own operations, but rather is created to raise money through the sale of shares in an initial public offering (IPO) and then use the money to buy an existing company. It’s a way for acquired companies to go public more quickly and easily than the usual IPO process.

The creators of the SPAC typically have expertise in a given industry and often have a potential acquisition target in mind. But they don’t usually disclose that information during the SPAC IPO process, so investors don’t know what they’re specifically investing in. That’s why SPACs are sometimes called blank-check companies. The deals themselves are also known as reverse mergers.

The SPAC lifecycle and path to acquisition

The process of creating a SPAC and using it to make an acquisition follows a well-established path.

1. SPAC formation

The people or groups who form the SPAC are called its sponsors. It’s usually a team of well-known and/or well-funded individuals, venture capitalists, hedge funds, private equity firms—and lately sometimes even a celebrity. The group needs strong bona fides, with demonstrated expertise in a given field, to convince investors to put money in a blank-check deal.

2. SPAC IPO

SPACs debut on a stock exchange through the standard IPO process, filing paperwork with the Securities and Exchange Commission (SEC), and signing on underwriters and institutional investors to facilitate the deal. But it’s faster and easier than a traditional company’s IPO process: SPACs don’t run an underlying business, and their only assets are typically a small amount of cash and investments, so there aren’t many details to share. That process is much more complicated for a standard company, because it has to disclose details such as sales, profit, and potential risks to the business so investors can do their due diligence.

Once the SPAC clears this process, it’s assigned a stock ticker by the exchange it will trade on, and it raises capital for the deal through the IPO process.

3. The search for an acquisition

SPACs generally have 24 months to successfully complete a merger or acquisition, though some opt for an 18-month deadline. Most of the shareholders’ money is placed in escrow in an interest-bearing trust account, and those funds can’t be disbursed for anything other than a deal. If the SPAC fails to merge with another company within the two-year deadline, it will be liquidated. According to the SEC, in this case shareholders’ money will be returned to them from the trust on a prorated basis.

4. Finalizing a deal

After SPAC management teams shop around and identify a company they’d like to merge with, a majority of shareholders must vote in favor for the deal to go ahead. If the SPAC doesn’t have enough cash to make the acquisition, it may issue more shares or find other ways to raise additional capital. After the acquisition is completed, the purchased company is listed on a stock exchange with shares available to the public.

SPAC benefits and risks

A SPAC carries certain advantages, but also a number of limitations.

SPAC benefits

The SPAC process offers a few benefits for the SPAC’s sponsors, the acquired companies, and shareholders compared to the traditional IPO process.

• For sponsors, SPACs offer a way to leverage their expertise and reputations to raise capital from all kinds of investors—and to make deals that may not have been possible otherwise.
• Owners of the acquired companies can bring the business public without the long and often arduous process of regulatory disclosures and road shows to make their case to investors.
• Target companies that sell to a SPAC can often get a higher purchase price.
• For investors, it can be comforting to know that if a deal doesn’t come to pass, they’ll get money back.

SPAC risks

• Perhaps the most obvious risk of a SPAC is its blank-check nature. When investors put their money into a SPAC’s IPO, they have no idea which company the SPAC will try to buy, nor the financial details of the prospective deal. Because SPACs require a majority vote from shareholders for approval, a proposed merger could be rejected.
• Some market watchers are skeptical of SPACs, preferring to invest in companies that participate in the traditional regulatory process and financial disclosures.
• The deal-or-no-deal deadline can also be a negative. A merger may never come to pass and the SPAC could be dissolved, forcing the sponsors to hand the money back. And under the pressure of time, the sponsors may pay high prices to ensure an agreement is completed by their deadline—cutting into profit.

Notable SPAC examples

From big names to buzzy startups, plenty of entities have helped bring SPACs into the spotlight. The deal that kicked off the recent trend is Virgin Galactic, Richard Branson’s space tourism company. It was purchased by venture capitalist Chamath Palihapitiya’s SPAC in late 2019, with the SPAC receiving a 49% stake and Virgin Galactic netting $800 million in cash as it went public.

Fantasy sports and betting company DraftKings had a splashy debut via SPAC in April 2020, further fueling interest and cementing the trend. Once a Wall Street trend starts, others tend to follow: Lots of companies in the hot electric-vehicle market have opted for SPACs, for example, including Lordstown Motors and Nikola (though both ran into serious management and financial troubles after their SPAC deals).

SPACs have gone so mainstream that some have recruited celebrities to help attract interest. Athletes Shaquille O’Neal, Serena Williams, and Alex Rodriguez have taken leadership or board positions at SPACs, as has singer Ciara. Even former House Speaker Paul Ryan signed on to head a SPAC.

SPAC FAQs

Why are SPACs so popular right now?

Some on Wall Street once thumbed their noses at SPACs, deeming them best for companies that couldn’t otherwise make a deal or weren’t financially stable enough to execute an IPO. But SPACs became hot in 2020, thanks in large part to the uncertainty surrounding the pandemic and its effect on the economy.

The traditional IPO market can be subject to erratic swings in investor sentiment, both in regards to the broader market and a specific company. SPACs help to cushion companies from that risk in changing sentiment, with the dealmaking happening one-on-one. The participation of prominent figures, like Branson and hedge fund billionaire Bill Ackman, has also helped legitimize SPACs.

Still, the glut of SPACs has sparked calls for increased scrutiny of the deals. For example, the SEC recently proposed changes to accounting rules. Some believe this will cool down the SPAC market.

How to buy SPAC stock

Investors can buy shares of a SPAC before it makes a deal, or after the SPAC and acquisition company are combined. In either case, the shares can be bought and sold on major exchanges like any other stock.

For broader, more diversified exposure to SPACs, investors can also invest in exchange-traded funds (ETFs) that focus on these mergers. According to ETF.com, these include:

• The Defiance Next Gen SPAC Derived ETF (ticker SPAK), an index-based fund that invests in both US-listed SPACs and the post-deal merged companies;
• The SPAC and New Issue ETF (SPCX), an actively managed fund that invests in SPACs before they make a deal;

• The Morgan Creek Exos SPAC Originated ETF (SPXZ), another actively managed fund, albeit one that invests in pre- and post-merger SPACs.

The bottom line

SPAC mergers are a unique alternative to the traditional IPO process. They help SPAC sponsors raise capital and create opportunities for deals that may not have happened otherwise, while allowing the acquired companies to go public more quickly and easily. They also offer investors a chance to get involved in the process by voting on whether a deal can go forward—and the promise that they’ll get their money back, with interest, if a merger never happens. However, SPACs come with risks, namely that investors put money in before they know which company a SPAC will acquire and that the usual IPO regulatory disclosures and road shows are sidestepped.‍