What Is a Special Purpose Acquisition Company (SPAC)?

Definition & Examples of a Special Purpose Acquisition Company

A SPAC is a business specifically formed to raise capital. It is typically a shell company that goes through an initial public offering (IPO) then uses the capital it raises to merge with or acquire another company within a specified time frame.

A SPAC is a type of “blank check company,” which is a firm in its development stage that doesn’t have a specific business purpose yet. Many blank check companies are working to either build capital as a startup or merge with another company.

How Does a SPAC Work?

A SPAC is a type of shell company that doesn’t have any business operations at the time of its formation, nor does it own any underlying assets other than cash.

SPACs approach their IPOs differently than most firms. Most companies get up and running, prove their business models, then go through an IPO to help them raise more capital and scale the business. But a SPAC is still a shell company when it goes through its IPO.

A SPAC typically goes through three phases: incorporation, research, and acquisition or merger.

Incorporation and Formation

In the first phase, the company officially incorporates and issues its founder shares. During this phase, the company also prepares and files its S-1, which is the form companies must file with the SEC before their IPOs. The first phase typically lasts at least eight weeks.

Research and Due Diligence

In the second phase, the SPAC identifies target companies for a merger or acquisition. It  researches companies and performs due diligence into the financials of target companies. Once it settles on a target company, the SPAC begins negotiations for a merger or acquisition, and begins lining up its financing. Phase two often lasts more than a year, during which time the SPAC continues its regular periodic SEC filings. During this period, the proceeds from the IPO are maintained in a trust account, much like an escrow account during the process of buying a house.

Acquisition or Merger

Finally, phase three is when the SPAC closes its merger or acquisition deal. It publicly announces the transaction, informs investors about the deal, and gets the sign-off from shareholders. The SPAC must also file an 8-K (known as a Super 8-K) within four days of closing the deal. The 8-K form lets all interested parties know about a significant event—in this case, the significant event is the merger or acquisition. Phase three generally lasts anywhere from three to five months, and the end of this phase marks the end of the SPAC.

Once the transaction closes, investors in the SPAC have the option of becoming shareholders in the combined entity or redeeming their shares. The redemption takes place on a pro-rata share of the aggregate amount in the trust account.

SPACs vs. Traditional IPOs

An initial public offering (IPO) is when a company sells shares to the public for the first time. A company issuing an IPO is often phrased as “going public” since it is transitioning from private ownership to public ownership. While a SPAC goes through an IPO, it looks very different from the traditional IPO process.

Most companies are well-established before going public. They have a product or service and have proven their business models. They use an IPO to scale and grow their business even more. But a SPAC enters into an IPO with no product, service, or business operations. It uses the IPO to raise capital and fund the acquisition of another business.

Pros and Cons of Special Purpose Acquisition Companies

Pros Explained

• Cheaper shares: SPACs typically price their IPOs at $10 per share, which is cheaper than many other companies. As a comparison, Airbnb issued its IPO in 2020 at a price of $68 per share. As a result, these SPAC IPOs might be accessible to more investors.
• Faster than a traditional IPO: Many companies don’t go through an IPO until they’ve been in business for years and have proven business models. It’s a lengthy process. But with a SPAC, a company could issue its IPO and acquire another company all within a year or two.

Cons Explained

• Investors may not know where the money is going: SPACs often have a target company or industry identified at the time of the IPO, but don’t necessarily have to. As a result, investors have to trust management to take the company in the right direction.
• Questionable returns: Shareholders don’t often come out on top when they invest in a SPAC. According to a study of 47 SPACs that acquired firms or merged between January 2019 and October 2020, the median SPAC shareholder returns over the three, six, and twelve months after the merger were -14.5%, -23.8%, and -65.3%, respectively.