Special purpose acquisition companies (SPACs), also known as blank check companies, have experienced significant growth recently. In 2019, according to the Harvard Business Review, 59 SPACs were formed with $13B invested. In the first quarter of 2021 alone, the number of SPACs created rose to 295, with a total investment of $96 billion.
This article will provide you with an overview of how a SPAC merger works and how it’s different from a traditional IPO. It also presents important statistics and explains why a SPAC merger can be risky for young and inexperienced investors.
What is a SPAC merger?
A special purpose acquisition company (SPAC) is an entity with no commercial operations that completes an initial public offering (IPO) and becomes a public company. After that, a SPAC acquires or, more frequently, merges with an existing private company, bringing it to the public market. In such a way, an acquisition target avoids the traditional IPO process.
Usually, SPACs don’t provide investors with information about the target companies they will acquire. Moreover, it’s common for a SPAC to be formed before a target firm is even selected.
As a result, a SPAC is often described as a blank check company since investors provide funds to the SPAC without having any knowledge about the details of the merger.
Note: M&A experts often compare SPAC with a reverse triangular merger by M&A experts due to its nature.
SPACs are subject to the U.S. Securities and Exchange Commission (SEC), which controls and investigates the deals and enhances investor protection.
How does a SPAC merger work?
There are three phases of a standard SPAC deal.
1. SPAC formation and IPO
Private equity firms or individuals like former executives form a management team and find a special purpose acquisition company using nominal invested capital, also known as founder shares. This shell company now exists only on paper and has no employees.
The SPAC then goes through an IPO, during which public investors purchase about 80% of the SPAC’s shares, and about 20% of the shares are held by the founders. Normally, the SPAC stock is priced at $10 per unit. This unit consists of one share of common stock and a warrant.
2. SPAC target search
Once a SPAC is founded, it typically has 18–24 months to find a target business and complete a SPAC merger. However, if needed, a SPAC management team is allowed to change the timeframe. Though if a SPAC fails to find and merge with the target, it’s liquidated, and all SPAC investors get their money back.
When a SPAC finds a promising private company, they negotiate the terms of the merger and conduct due diligence, which involves reviewing the target company’s financial statements.
If the SPAC needs additional financing to fund the SPAC deal, it may:
- Seek debt financings, such as loans, registered notes, or private placements
- Offer more common stocks to public shareholders
- Offer institutional investors the right to purchase common stock through private investment in public equity deals
3. De-SPAC merger
A De-SPAC merger occurs when a special purpose acquisition company acquires or merges with a private company. The process normally takes about six to eight weeks and involves:
- Obtaining shareholder approval for a merger by voting (warrant holders normally don’t have voting rights and only whole warrants are exercisable)
- Preparing regulatory documents
- Meeting with prospective shareholders
- Controlling from the SEC
Before the proposed merger is finalized, SPAC’s public shareholders can cash out their IPO proceeds if they want to avoid investing in the target company.
In general, a SPAC IPO may go through several rounds of sourcing and negotiating before a deal is closed.
Note: Learn about other types of mergers and acquisitions, such as vertical and horizontal mergers, in our dedicated article.
The most important SPAC statistics for the past years
Here are seven statistical facts to know about SPAC investments from 2021-2022:
- The US SPAC’s IPO activity considerably decreased in 2022—there were 86 SPAC deals that raised $13.4B compared to 610 deals that raised $160.75B in 2021.
- In Europe, SPAC market activity was lower than in the US. Since 2019, there has been a total of 39 SPAC IPOs, with Luxembourg, the Netherlands, and France being the main three issuer nations.
- The peak of the SPAC boom came in the first quarter of 2021 when SPACs raised capital for 300 IPOs. However, the bubble burst in the second quarter when the SEC announced new accounting rules, which probably led to the decline in SPAC IPOs.
- Digital World Acquisition Corporation was the best-performing SPAC IPO of 2021 in America. It received a return of 430%.
- 27 SPAC deals worth $12.8B were liquidated in 2022. In 2021, however, there was just one liquidated SPAC.
- The leading industries in SPAC deals were high technology, industrials, financials, and healthcare M&A deals.
- Nasdaq was the most popular public stock exchange for SPAC listings, with 71 IPOs in 2022.
Advantages and risks of SPACs
Find out why IPO investors should or should not put their money in special-purpose acquisition companies.
Here are the benefits and investment opportunities that companies and SPAC’s shareholders receive:
- Faster execution
The most significant benefit is that a target company can reach the public markets faster with a SPAC (3–6 months) than with a traditional IPO (12–18 months)
- Stable price
Stable price. In a conventional IPO, the price per share fluctuates depending on the demand and market conditions. Meanwhile, the SPAC sponsors and the target company lock in a fixed price
- Possibility to raise additional capital
When required, SPAC sponsors can raise debt or PIPE funding in addition to their original capital to fund the transaction and to ensure a successful business combination.
- Greater control
A private company that wants to go public has much more control over the SPAC acquisition rather than during a traditional IPO
- Experienced management teams
SPAC sponsors are usually experienced financial and industrial professionals that can offer their management and operations expertise to the target company
Now let’s see what kind of threats SPACs may potentially face:
- Limited timeframe
Even though SPAC sponsors offer help to the target company during the transaction, it’s the target that is obliged to prepare the required financial documents. However, with limited time, it may fail to do so properly
- Less strict due diligence
While a traditional IPO requires conducting extensive due diligence, the SPAC process is less strict. Yet, poorly conducted due diligence in the conditions of a reduced timeframe may lead to incorrectly valued business or even lawsuits
That’s why private companies should be cautious when going public through SPACs. Here’s what Dean Bell, a deal advisory leader at KPMG US, had to say on this subject:
The more a company peels away at a SPAC merger, the more it is likely to find ‘unknown unknowns’ that need to be addressed and resolved at pace. That’s why SPACs are really more suitable for companies that are demonstrating a degree of maturity, and where they have already embedded value creation and operational excellence.
Here are the main points to remember about SPAC companies:
- A SPAC is a company with no business operations formed to raise capital through an initial public offering (IPO), merge with a target company, and take it public.
- Three main stages of a standard SPAC deal include SPAC formation and IPO, SPAC target search, and De-SPAC merger.
- The main advantage of going public through a SPAC is that it takes less time (3–6 months) as compared with the traditional IPO process (12–18 months).
- The main disadvantage of going public through a SPAC is that a target company is limited on time. Thus, when it comes to conducting due diligence and preparing the required documents for the SEC, it may fail to do so properly.
What happens to SPAC shares after a merger?
When the merger is completed, SPAC shares remain listed on the same exchange and trade like any other stock. However, the ticker symbol and company name are changed to reflect the new combined entity.
How long does a SPAC merger take?
A SPAC merge usually takes 18 to 24 months.
How does SPAC merger work?
First, a SPAC raises capital through an initial public offering (IPO). Then, it acquires or merges with an existing private company. After that, the private company becomes a listed public company without having to execute an IPO.
What is a SPAC reverse merger?
In a reverse merger, a private company purchases a public shell company—an organization that has no commercial and business operations but is publicly traded. Afterward, a private entity becomes a public company without having to undergo a traditional IPO.
What happens to stock if the SPAC merger fails?
If a SPAC and a target company don’t merge during the required time, usually 18–24 months, the SPAC is liquidated, and investors receive their funds back.