What is a Special Purpose Acquisition Company (SPAC)?
A special purpose acquisition company (SPAC) is a corporation formed to raise investment capital through an initial public offering (IPO). Such a business structure allows investors to contribute money towards a fund, which is then used to acquire one or more unspecified businesses to be identified after the IPO. Therefore, this shell firm structure is often called a “blank-check company” in popular media.
When the SPAC raises the required funds through an IPO, the money is held in a trust until a predetermined period elapses or the desired acquisition is made. If the planned acquisition is not made or legal formalities are still pending, the SPAC must return the funds to the investors after deducting bank and broker fees.
How Does a Special Purpose Acquisition Company Work?
A special purpose acquisition company is formed by experienced business executives who are confident that their reputation and experience will help them identify a profitable company to acquire. Since the SPAC is only a shell company, the founders become the selling point when sourcing funds from investors.
The founders provide the starting capital for the company, and they stand to benefit from a sizeable stake in the acquired company. The founders often hold an interest in a specific industry when starting a special purpose acquisition company.
Issuing the IPO
When issuing the IPO, the management team of the SPAC contracts an investment bank to handle the IPO. The investment bank and the company’s management agree on a fee to be charged for the service, usually about 10% of the IPO proceeds. The securities sold during an IPO are offered at a unit price, representing one or more common stock shares.
The prospectus of the SPAC mainly focuses on the sponsors and less on company history and revenues since the SPAC lacks performance history or revenue reports. All proceeds from the IPO are held in a trust account until a private company is identified as an acquisition target.
Acquiring a Target Company
After the SPAC has raised the required capital through an IPO, the management team has 18 to 24 months to identify a target and complete the acquisition. The period may vary depending on the company and industry. The fair market value of the target company must be 80% or more of the SPAC’s trust assets.
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.
If the predetermined period lapses before an acquisition is completed, the SPAC is dissolved, and the IPO proceeds held in the trust account are returned to the investors. When running the SPAC, the management team cannot collect salaries until the deal is completed.
SPAC Capital Structure
A SPAC floats an IPO to raise the required capital to complete an acquisition of a private company. The capital is sourced from retail and institutional investors, and 100% of the money raised in the IPO is held in a trust account. In return for the capital, investors get to own units, with each unit comprising a share of common stock and a warrant to purchase more stock later.
The purchase price per unit of the securities is usually $10.00. After the IPO, the units become separable into shares of common stock and warrants, which can be traded in the public market. The purpose of the warrant is to provide investors with additional compensation for investing in the SPAC.
The founders of the SPAC will purchase founder shares at the onset of the SPAC registration and pay nominal consideration for the number of shares, which results in a 20% ownership stake in the outstanding shares after the completion of the IPO. The shares are intended to compensate the management team, who cannot receive any salary or commission from the company until an acquisition transaction is completed.
The units sold to the public comprise a fraction of a warrant, allowing investors to purchase a whole share of common stock. Depending on the bank issuing the IPO and the size of the SPAC, one warrant may be excisable for a fraction of a share (either half, one-third or two-thirds) or a full share of stock.
For example, if a price per unit in the IPO is $10, the warrant may be exercisable at $11.50 per share. The warrants become exercisable either 30 days after the De-SPAC transaction or twelve months after the SPAC IPO.
The public warrants are cash-settled, meaning that the investor must pay the total cost of the warrant in cash to receive a full share of stock. On the other hand, Founder warrants may be net settled, meaning that they are not required to deliver cash to receive a full share of stock. Instead, they are issued shares of stock with a fair market value equal to the difference between the stock trading price and the warrant strike price.