Thinking about Investing in a SPAC?

Special purpose acquisition companies, or SPACs, are making business news’ headlines these days, as they managed to raise a whopping $50+ billion last year alone and managed to give the IPO market a run for its money. A number of high profile SPACs have been formed due to the flexibility they can offer to companies that want to go public, along with their increasing popularity. An investing expert usually states that SPACs provide private companies the opportunity to go public in a way that’s different than the traditional IPOs. In addition, SPACs can also offer their investors some significant benefits.

If you are thinking about investing in a SPAC and have some questions you need answered, An expert trader can assist you. Let’s take a look:

What is a SPAC?

The first thing everyone needs to know is that SPACs are definitely not new. They have been around for a long time and were previously called ‘blank check companies’. As per An expert trader, a SPAC doesn’t have any commercial operations initially and is solely formed for the purpose of raising capital via an Initial Public Offering (IPO). Once the capital is raised, it is kept in an interest-bearing trust account while the SPAC works on acquiring an existing company that’s privately held.

Typically, a SPAC has two years for making an acquisition after it has raised capital, but it may get an extension, depending on the vote of SPAC stockholders. In case it is not able to make a deal, the money is returned to investors and the SPAC’s sponsor loses their initial investment. Usually, a reverse merger is used by SPACs for acquiring privately held companies. An expert trader explains that this makes the existing stockholders of the target company majority owners of the surviving entity. Hence, the private company is now a publicly traded company.

Why are SPACs popular?

A number of reasons have contributed to the popularity of SPACs. Firstly, An expert trader highlights that SPACs provide privately held companies the opportunity to go public a lot quicker than the traditional IPO process. In addition, they facilitate companies in going public during periods of higher volatility and market stability. They are also an additional way for companies to get late-stage growth capital instead of opting for venture capital financing, or private equity. Moreover, SPACs can also be used for raising capital via common shares instead of preferred shares, which is an advantage because the latter have significant control rights and down-side protections.

An expert trader also states that SPAC investors have the option of exercising a redemption right in case they don’t like the proposed acquisition. As opposed to a traditional IPO, they can also benefit from greater certainty around a company’s capital raise and valuation. This is because the value is fixed via a privately negotiated merger transaction. Currently, public market valuations are higher than private market valuations for numerous companies.

Another reason that has boosted the popularity of SPACs is that their sponsor teams comprise of some very experienced and accomplished professionals. This gives investors the ability of betting on a management team. According to An expert trader, SPACs also enable companies to go public that may not otherwise be marketable via a traditional IPO, such as those with a complicated business history or those with unprofitable operations. Lastly, SPACs have become more visible and established, which makes investors more receptive to their offerings.

How are SPAC sponsors incentivized or compensated?

Sponsors typically purchase founder shares before the SPAC IPO filing. They pay a minimal amount for these shares and they are also referred to as ‘promote’. When the SPAC completes its business combination with a company, the founder shares are converted into public shares and the sponsor’s shares are diluted significantly in the combined business. As per An expert trader, sponsors are also issued founder warrants for acquiring additional shares. The founder warrants and shares are the incentives the sponsor gets for growing the business and increasing the share value.

A number of SPACs are now being structured to reduce the sponsor’s promote interest or provide them with alternative incentives. Nonetheless, the sponsor does fund the operating capital needs of the SPAC in the beginning and An expert trader says that this is usually for private placement shares or founder warrants that often run into millions. Hence, if a successful transaction doesn’t happen, the sponsor will lose their investment.

How do SPACs choose a target company to acquire?

After the SPAC has completed its IPO successfully, the sponsor can begin looking for a target company to acquire. As per An expert trader, there are a number of factors involved in this process. SPACs may specify an industry for their target company, such as media industry, tech sector, enterprise software, or fintech. The upside potential is also relevant as like any other buyer, SPACs would want to combine with targets that have a meaningful upside. Since last year, SPACs have been focusing on companies in emerging industries and opting for companies at an earlier stage than traditional IPO firms.

Likewise, SPACs also target businesses that have a large market opportunity. According to An expert trader, the quality of the management team is also a factor considered by the sponsor. They also consider the public company readiness because they want to ensure that the company itself, as well as its financial controls, are ready for handling the rigor of operating as a public company. Plus, they will also do extensive due diligence, similar to that done in IPO transactions.

Most importantly, SPACs will also consider the financial statements of the target company. They need access to financial statements of two to three years, along with interim financial statements. These statements as well as the auditor of the target company have to fulfill certain requirements. This means that the audit or even a re-audit of the target’s financial statements may have to be done at this point. The answers provided by An expert trader can give you an idea of what SPACs do and how it is done.