What is a SPAC?

A Special Purpose Acquisition Company (SPAC) is a specialized company for targeted mergers and acquisitions. SPACs are not created as operating companies; their main purpose is to take a particular private company public through its acquisition. Such initial public offering vehicles were popular back in the 1990s but in recent years SPACs made a full comeback. The number of transactions involving SPACs has already exceeded the number of traditional IPOs.

Thanks to Special Purpose Acquisition Companies, a large number of issuers were able to go public. For example, with the help of such a vehicle, Virgin Galactic went public in 2019. The idea of a company for targeted mergers is becoming more popular every year. Sometimes called a “blank check company,” a SPAC is sponsored by a prominent investor through a flotation of its shares. The purpose of a SPAC is to find another company for a merger or acquisition, thereby providing the opportunity to list it on a stock exchange.

Why are SPACs becoming so popular?

The main advantage is that with a SPAC it is possible to avoid significant costs of a regular IPO process. With a traditional public offering, the company has to pay the investment bank, launch a promotional campaign, pay interest, commissions, and bonuses. Moreover, the price per share during an IPO is determined by investment bankers, while using a SPAC allows you to control the offering price.

Another advantage is that a SPAC allows companies to go public without having to have a long financial history or with a business model that is difficult to evaluate based on traditional criteria. When investing in an IPO, market participants do their due diligence on the company’s history and fundamentals, while a SPAC may not meet traditional criteria.

As a rule, during an IPO, companies seek to receive financing in the amount of 20-25% of their total capitalization, while SPACs are absolutely not limited in the amount of funds raised. Often, when the target company and the SPAC shell merge, investors receive a 30-40% stake in the combined company.

SPACs growing popularity is also a reflection of the market trends over the past 10 years. Many companies funded by venture capital remained in private hands for a long time and did not enter the public markets due to the stringent regulatory requirements for IPOs. With growing interest, company capitalizations are also increasing. Ten years ago, the average size was about $600 million. Recently we saw Snowflake go public with a pre-IPO valuation of $60 billion.

SPACs help shift private investor risks to the public market and are an excellent investment vehicle for many venture capitalists.

SPAC IPO stages:

  1. A blank check company is created. (Usually, its shares cost around $10.)
  2. Two years to find a company for the merger.
  3. Investors vote to approve the merger.
  4. Merger and listing.

With this structure, there are two points when you can invest: when the SPAC itself is formed, or you can wait for the merger when the company gets officially listed on an exchange.

When is the best time to invest in a SPAC?

Statistically, one of the best moments to invest is the period between the SPAC’s creation and its merger.

We should also note the excellent profit potential at the stage when the sponsor finds a company for the merger. In the first 3 months after the announcement, the stock can show a return that exceeds the average return on the S&P 500 Index over the same period by 11%, and the Russell 2000 by 15%. After that, SPAC’s profitability may disappoint as statistically, it then underperforms the indices quite often. At that stage, sponsors are primarily the ones who make money.

In conclusion, we would like to emphasize that SPACs provide ample opportunities for potentially interesting companies to get listed on a stock exchange, as well as to gain liquidity in their shares. In their turn, private investors need to be very careful when choosing a SPAC and when to invest in it.