Special Purpose Acquisition Companies

By Jamie Johnson

What is a Special Purpose Acquisition Company (SPAC)?

A SPAC is a new company that is incorporated to find businesses to acquire. Acquisitions are typically made by the shell company merging with an existing company. SPACs raise capital through an initial price offering (IPO) on the stock market. They are also referred to as “blank cheque companies”.

How a SPAC is created

A SPAC starts as a company founded by a group of managers and is often incorporated in a jurisdiction that is tax efficient.

A SPAC will then search for underwriters before placing an IPO. The IPO funds are then put in a trust account so that the funds cannot be used other than for acquisitions and for returning money to investors. There may be exemptions to this rule, which allows withdrawals from the trust. Such exemptions include carrying out a shareholder-approved acquisition and repurchasing a shareholder’s shares.

Investors and the founders will then have a share of the equity of the company, which will allow them to receive returns on their investment.

How founders’ rights are restricted

The founders usually enter into a three-year arrangement that limits their ability to transfer or dispose of their rights in the SPACs. Suppose a SPAC does not find a suitable target by the deadline. In that case, it is dissolved, and any proceeds are given to shareholders. The deadline for the acquisition will be mainly determined by what investors are willing to put up with.

Traditionally, none of the founders or affiliates receive salaries, management fees or finders’ fees before the SPAC’s acquisitions.

Shareholders’ protections

There are three primary shareholder protections to be cognisant of: votes on acquisitions, rights for their shares to be repurchased and the cash requirements of the SPAC.

Cash can only be released if a majority of shareholders approve of the acquisition. Assuming that most of the share capital was distributed through the IPO, this ensures that investors will have a significant say over where their money is invested.

Investors also have the right to have their shares repurchased. Thus, if they are outvoted, they can always just liquidate their shares in return for a percentage of the trust fund.

Finally, SPACs need to have sufficient cash in the trust fund to meet the working capital requirements that it has as a result of being a listed vehicle. Thus, investors have guarantees that there will always be some capital if they need it.

Why SPACs exist

From the perspective of SPAC founders, it makes sense to create a SPAC to have access to a wide range of potential investors. In addition, if the SPAC is valued highly, it can be a cheaper way of raising capital.

From the perspective of investors, SPACs can be an attractive way of getting returns on their money. If the SPAC has an effective management team, investors trust that they will see strong returns on their initial investment.

The disadvantages of SPACs

From the perspective of SPAC founders, a SPAC could find itself disadvantaged in the market because of the need to get shareholder approval for an acquisition. At best, this will delay a deal that the SPAC founders want to carry out. At worst, it will mean that the SPAC will miss out on opportunities it should have taken.

From the perspectives of investors, SPACs can be very risky vehicles. If the SPAC does not invest before its set deadline, their money may simply be returned with no or negative returns. SPACs could also make poor decisions, which would risk investors’ capital. It should be noted that the majority of SPACs do poorly, and their equity is valued below its valuation at IPO (Financial Times).

The considerations behind a private firm merging with a SPAC

There are three main reasons why private firms agree to merge with a SPAC: it is less costly than doing an IPO, it avoids time-consuming regulatory commitments, and it hedges against market volatility.

Private firms save the expense of underwriting fees by merging with a SPAC as opposed to carrying out an IPO.

Private firms also avoid having to spend the time producing a prospectus that is approved by the FCA or SEC.

Finally, many firms are happy to merge with a SPAC to avoid the risks of listing. Given the current stock market volatility, a smaller firm can never be sure about how much it will raise from an IPO.

Nonetheless, the considerations above may be outweighed by the risk of the new investor taking the company in a direction that its directors do not want.

Why SPACs are increasing in popularity

2020 is a record-breaking year for SPACs. As of the 15th of September, 82 SPACs have gone public in 2020 and have raised $31 billion (MarketWatch).

The reason they have become more popular is because of an excess of investor capital in 2020. This means that investors have been more willing to allocate money to ventures that were previously seen as risky. SPACs allow these investors to make lucrative returns from merger and acquisition processes.

It should be noted, however, that this is not necessarily a permanent trend. SPACs were popular before the global financial crisis and fell after it (MarketWatch).

Case studies

The launch of “one” – (August 2020) Kevin Hartz created SPAC called “one”, which raised $200 million to acquire a tech start-up. Investors trusted Kevin Hartz because of his experience in investing in Airbnb and Uber at an early stage.

Creation of Pershing Square Tontine Holdings Ltd. – (July 2020) Bill Ackman and Pershing Square raised $4 billion through this IPO. This means that the SPAC has had the largest IPO to date. In addition to this money raised, Pershing Square has agreed to purchase $1 billion to $3 billion extra units in the SPAC through a forward purchase agreement. Thus, the SPAC will have at least $5 billion to invest.

Akazoo Accounting Fraud – (May 2020) it was found that Akazoo’s management team engaged in a multi-year fraud. Akazoo is a music streaming app, which provides a subscription service for users to listen to songs online and offline. The SPAC Modern Media Acquisition Corp (Modern Media) merged with Akazoo to generate returns for investors. This case study shows the potential risks of SPACs.