Recently, U.S cryptocurrency exchange “Bullish” announced it is aiming for a $9 billion listing on the New York Stock Exchange via a merger with Far Peak Acquisition Corporation, a special purpose acquisition company (SPAC).
While many were focusing on what this transaction will mean to the crypto industry, others were asking, what is a SPAC and why should I learn about it? Still, others want to know if it’s an investment strategy that’s here to stay or another Wall Street fad.
What is a Special Purpose Acquisition Company (SPAC)?
According to most legal sources, a special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.
SPACs aren’t new. They have been around for decades, but have recently become more popular because low yields have driven investors to seek alternative ways to increase their capital. Not only have they become popular with sophisticated, high-wealth individuals, but they have also drawn the attention of underwriters who envision a big payday in the form of commissions and fees.
SPAC IPOs have seen a resurgent interest since 2014, with increasing amounts of capital flowing to them.
- 2014: $1.8 billion across 12 SPAC IPOs
- 2015: $3.9 billion across 20 SPAC IPOs
- 2016: $3.5 billion across 13 SPAC IPOs
- 2017: $10.1 billion across 34 SPAC IPOs
- 2018: $10.7 billion across 46 SPAC IPOs
- 2019: $13.6 billion across 59 SPAC IPOs
- 2020: $83.3 billion across 248 SPAC IPO
How is a SPAC Formed?
A SPAC is created, or sponsored, by a team of institutional investors, Wall Street professionals from the world of private equity or hedge funds. They create this entity that has no commercial operations. It makes no products and does not sell anything. In fact, the SPAC’s only assets are typically the money raised in its own IPO, according to the Security and Exchange Commission (SEC).
What’s interesting about a SPAC is that when it raises money, the investors buying into its IPO do not know what the eventual acquisition target company will be. That’s part of its mystique, however, since institutional investors with track records of success can more easily convince other investors to invest in the unknown. Due to this, a SPAC is also often called a “blank check company.”
How Does a SPAC Operate?
After the SPAC is legally created, it now needs cash to create the capital needed to do the acquiring of another company, for example, in the future. Remember, the SPAC is not going to raise money to buy equipment, computers, software, or even pay rent. It needs the money to buy what is often referred to as the “eventual acquisition target company”.
A SPAC will raise the money it needs through its own IPO. CNBC says that SPAC IPOs are usually priced at $10 a share. Once the initial capital is raised, the money goes into an interest-bearing trust account until the SPAC’s founders or management team finds a private company looking to go public through an acquisition.
Legal experts say that once an acquisition is completed (with SPAC shareholders voting to approve the deal), the SPAC’s investors can either swap their shares for shares of the merged company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust. The SPAC sponsors typically get about 20% stake in the final, merged company.
Time is of the Essence
Once SPAC sponsors raise the capital they need to go to work acquiring companies, they can’t sit on the funds forever, even if they are protected by trust and earning interest. SPAC sponsors also have a deadline by which they have to find a suitable deal, typically within about two years of the IPO. Otherwise, the SPAC is liquidated and investors get their money back with interest.
What are the Advantages of a SPAC and Who Benefits?
Owners of smaller companies find selling to a SPAC more profitable because the sale often adds about 20% to the price of the deal compared to a typical private equity deal. Additionally, being acquired by a SPAC can also offer business owners what is essentially a faster IPO process under the guidance of an experienced partner, with less worry about the swings in broader market sentiment.
Business owners are often worried about extreme market volatility or the fear that weak investor sentiment could force the postponement of an IPO. By dealing directly with the SPAC, these worries are essentially eliminated.
Furthermore, a deal with a SPAC can be wrapped up in just a few months versus the traditional process of registering an IPO with the SEC, which can take up to six months.
Basically, the key advantage is a business owner can get his money faster and without a lot of government tape.
Are There Any Pitfalls?
Nothing is guaranteed and SPACs are no exception to that rule. Although they are extremely popular in 2021 for large institutional investors and other billionaire backers, this trend can go away quickly if “something better” comes along.
Other factors that could determine its long-term popularity include the fact that target companies run the risk of having their acquisition rejected by SPAC shareholders. Even the rich get cold feet about a deal. Furthermore, investors are literally going blindly into the investment.
SPACs will probably retain their popularity until the major players decide to let the smaller investors into the game. That’s usually when the rules change and the government regulations get tougher in order to protect undercapitalized investors from losing all their money.
What are Some High-Profile Examples of SPACs?
We don’t know yet how the SPAC for Bullish will play out because it was just announced. But since it involves cryptocurrencies, it will probably become a profitable venture since investors looking to get aboard the craze have been throwing money at the asset class.
High-profile SPACs like DraftKings and Virgin Galactic have performed well for investors, but that hasn’t always been the case with average returns from SPAC mergers completed between 2015 and 2020 falling short of the average post-market return for investors from an IPO.
A noted prominent short-seller of SPACs said, “a business model that incentivizes promoters to do something – anything – with other people’s money is bound to lead to significant value destruction on occasion.”
Like any investment, it pays to do your homework before putting money into a SPAC.