Everything You Need to Know about SPACs

SPACs, or special purpose acquisition companies, have grown in popularity exponentially in the past few years, especially in the US markets. Although SPACs are not new, it could be said that they were brought back to the attention of the world by venture capitalist Chamath Palihapitiya, whose SPAC, Social Capital Hedosophia Holdings, bought a 49% stake in Richard Branson’s Virgin Galactic for 800 million USD before listing the company in 2019. Till date, this probably remains one of the most high-profile SPAC deals ever.

SPACs were especially active last year in the US. A total of USD 83.04 billion was raised by SPACs in 2020. Bill Ackman, founder of Pershing Square Capital Management, sponsored the largest-ever SPAC that raised 4 billion USD in its IPO on July 22, 2020. SPAC deals in the year 2021 are set to surpass 2020 as it has been reported that within the first quarter of 2021, more than USD 84 billion has been raised.

Some of the higher profile SPAC deals that have been announced in 2021 so far includes the merger of Benson Hill with Star Peak Corp II. Benson Hill is an operator of a platform that uses machine learning, simulations and genetics to optimize plant growth, while Star Peak II is the second SPAC backed by alternative capital funds management firm, Magnetar Capital. The firm’s first SPAC, Star Peak Corp, was used to take clean-energy storage firm Stem Inc. public.

SoftBank Group Corp-backed Better HoldCo recently announced that it will go public through a merger with Aurora Acquisition Corp, a SPAC sponsored by investment firm Novator Capital. The startup has reportedly been valued at 7.7 billion USD for the merger. As per the terms of the deal, SoftBank will invest USD 1.5 billion, while Novator’s SPAC Aurora Acquisition Corp will invest USD 200 million. The merger will provide USD 778 million in proceeds for Better.

The technicalities of a SPAC:

A SPAC is often thought of as a “blank cheque company” and is typically used as an alternative mode for a private limited company to go public.

A SPAC raises money through the IPO process with the understanding that the money raised will be used at a later date to merge with an existing private company and take it public. Simply put, when shareholders buy into a SPAC IPO, they are trusting the management to find a worthwhile business, rather than buy into an existing business. Hence the moniker of a “blank cheque company”.

When the SPAC management identifies the target company and announces the merger, shareholders have the option of either accepting the stock in the new company or redeem their shares at the original price of the offering.

SPACs have gained traction of late. Here’s why.

A private company usually goes public through an IPO when they are ready to expand, the aim being to raise funds from retail investors and improve liquidity. The concept of IPO technically dates back to 1602. Over the years however in almost all jurisdictions, regulatory requirements of IPOs have become stricter – primarily to safeguard shareholders’ interests and to reduce financial corruption.

Consequently, smaller private companies often find the process of going public through an IPO:

• lengthy, cost-intensive and paperwork-heavy;
• subject to stringent regulatory requirements; and
• uncertain, as there is always a possibility of the IPO being undersubscribed.

The SPAC route bypasses all that. Once a SPAC and the target company have reached a financial agreement, the merger takes a few months, at the most, as against the 12-18 months required in a traditional IPO. Naturally, it costs less for the company being acquired as well. This makes the SPAC route a faster, easier way to go public for the smaller private companies.

Compared to an IPO, the SPAC route is much less risky for the company being acquired as well: the company signs a deal with the SPAC for a fixed amount of money, i.e. the money raised by the SPAC through its IPO, at a pre-negotiated price and that’s that. There is no risk of the IPO being unacceptable to retail investors and being undersubscribed.

This however means that it is riskier for a SPAC to acquire a smaller company. To compensate for this risk, a SPAC often gets a bigger discount than regular IPO investors.

How the SPAC route works:

The fund-raising procedure for a SPAC is the same as an IPO, except the business of the SPAC is not yet defined and it has no commercial operations. The money raised in the IPO is placed in an interest-bearing trust account until the SPAC management decides which company/ies it wants to acquire. A SPAC usually has a time limit of two years to acquire a target company, failing which it has to dissolve and give the shareholders their money back. During this time, as the target company is not known to any of the investors, the share prices do not fluctuate either way.

The funds held in the trust cannot be disbursed or used in any manner except to acquire a company or to return the money to the investors if the SPAC is liquidated.

How the acquisition identification process works:

For a private company to go public via a SPAC, the SPAC has to be convinced that the said company is worth taking public. So, the basics of fund-raising remain the same – the company has to convince the SPAC management about the business’ mettle, scalability, profitability etc. The difference lies in the fact that the target company needs to convince just one investor, i.e. the SPAC management, rather than multiple retail investors.

The identified target company (or multiple companies) must be valued at a minimum of approximately 80% of the funds in the SPAC trust, but there is no maximum target size. It is quite typical for SPACs to acquire companies that are many times its IPO proceeds, primarily to reduce the dilutive impact of the founder shares and warrants.

If the target company is valued higher than the funds available with the SPAC, the balance money is often raised through PIPE deals.

“Private Investments in Public Equities” or PIPE deals get tacked onto SPACs once the target company has been identified. At this stage, institutional investors often get preferential treatment over retail investors. Institutional investors of the SPAC (and sometimes new institutional investors that have not invested in the SPAC) are often given information about the acquisition target under confidentiality agreements before the announcement is made public, to help them decide if they want to provide further financing via PIPE transactions. Since retail investors are not given the same opportunity, this makes some industry observers wary of SPACs.

Pros and cons of the SPAC route from an Investor’s POV:

SPACs are currently being enthusiastically adopted by institutional investors and family offices, mainly for their time and cost effectiveness. While it is unlikely that this high volume of SPAC deals will sustain for a prolonged period, it is equally unlikely that the SPAC trend will fizzle out any time soon.

Essentially, it boils down to the following points of consideration:

Still in two minds if investing in a SPAC is the right way to go? Reach out to our expert financial advisors today and we shall be happy to help! Xanara’s extensive global network coupled with our holistic approach to building wealth means that you can entrust your asset & wealth management to us, with complete peace of mind.

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