From former professional basketball player Shaquille O’Neal to ex-House speaker Paul Ryan and well-known investor Bill Ackman, what do these celebrities have in common? They have all lined up to get their very own SPAC (Special Purpose Acquisition Company), giving rise to their popularity and making them the hottest trend on Wall Street. Indeed, according to The Wall Street Journal (WSJ), SPACs accounted for over 50% of new publicly listed companies in the U.S. alone throughout 2020.
And while they may be known to focus on startup companies and those in biotechnology and green energy among others, they are not exclusively limited to such industries, so much so that many solid, middle-market companies are increasingly becoming prime targets for SPACs. Experiencing a boom in 2020 and continuing to surge in popularity as an alternative route for companies to go public, what exactly is a SPAC?
Here we give you the low-down on these, while we highlight the key differences between SPACs and traditional IPOs.
Why do companies opt to go public?
Before even delving into the differences between SPACs and traditional IPOs, it is important to understand why private companies decide to go public in the first place. One of the most common motives is the fact that doing so is a good way to raise money, which can be used to grow their business, for research and development, marketing purposes or to pay off debt. Other reasons may include:
- Avoid having to raise capital through other avenues like bank loans, private investors or venture capitalists.
- Generate buzz and gain instant publicity.
- Secure better terms with lenders, since businesses that have gone public tend to acquire a certain standing.
What is a SPAC?
A SPAC is a company that is formed strictly to raise capital through an initial public offering so that it can eventually acquire another business or merge with one. Also known as a blank check company since, in essence, it is a shell company that exists only on paper, SPACs have been around for decades, mainly growing in popularity between 2019 and 2020. At the time of their IPO, SPACS have no existing business operations, though the company may have a management team, a bank account and perhaps some startup funding, but nothing more. With no products or services to sell, a SPAC’s only assets are usually the funds raised during its own IPO.
At times, a SPAC is also called a reverse merger, since the SPAC company which makes the purchase, takes on the business and identity of the private company it acquires. For example, in 2019, Diamond Eagle Acquisition Corp was set up and a few months later it went public. Then, it merged with DraftKings and SBTech and eventually, the new company - DraftKings - began trading as a public company when the deal closed.
Typically, SPACs are formed by investors who have expertise in a specific industry and who are looking to pursue deals in that sector. These investors can range from well-known private funds and celebrities to the general public. For instance, some high-profile CEOs like Richard Branson and billionaire Tilman Fertitta have both formed their own SPACs.
How do SPACs work?
While an IPO involves an elaborate and lengthy roadshow whereby companies have to prove their worth to investors before going public, SPACs take a very different approach. Without the need to convince individuals to invest, this means that investors openly give their money upfront, attracting individuals looking to cash in on the IPO’s profits.
As such, the process is just like that of a traditional IPO, however, a key difference between the two is their purpose – whereas private companies go public to fulfil their market-driven purpose, SPACS exist purely so as to purchase a private company and take it public. Having said that, SPACS need to follow the same rules and regulations as other public companies, while they must undergo SEC filings, they must file financial reports and comply to any restrictions on stock trading. Once this process is complete, the blank check company becomes a publicly traded one and sells shares on the stock market to raise capital.
The funds raised during an IPO are placed into an interest-bearing trust account until the SPAC’s management finds the right private company looking to go public through an acquisition. Typically, SPACs have two years to complete an acquisition, otherwise they must return the funds to investors. Once an acquisition is complete, the SPAC’s investors can opt to either swap their shares for shares of the merged company or to redeem their SPAC shares and get back their original investment.
After an acquisition, the shell company disappears into the newly-acquired one, which is then listed on one of the major stock exchanges like the Nasdaq or the New York Stock Exchange (NYSE).
Why do companies opt to go public via a SPAC?
Proponents of SPAC IPOs have claimed that becoming public in this manner has greater benefits compared to traditional IPOs. Here are some reasons why some companies may prefer this route:
Faster timelines: unlike traditional IPOs which make take several months for a private company to become a public one, a merger between a SPAC and its target company can take anywhere between four to six months.
Regulatory oversight: based on the current SPAC structure, companies are allowed to market themselves using more forward-looking projections that traditional IPOs and this may work well particularly for companies that are just at the beginning of their growth stage.
Not much volatility: bearing in mind that the valuation of the private company in a SPAC deal is conducted during private negotiations, this may help avoid the ups and downs of public markets. In contrast, valuations of traditional IPOs can be subject to the mood of the stock market at any given moment.
Less expenses: hiring underwriters or investment bankers can be quite costly. With a SPAC there is no not need to engage this help and therefore, it can be a less expensive alternative to going public.
What is an IPO?
An IPO is essentially the first time a company offers its share of stock to the general public to both institutional and retail investors. A lengthy process that can take several months, the IPO is typically underwritten by one or more investment banks, who also arrange for the shares to be listed on a stock exchange. In fact, the underwriters play a crucial role since they provide several services, including assessing the value of the shares and coming up with the share price, as well as establishing a public market for shares, known as the initial sale. Following the IPO, shares are traded freely in the open market. Traditional IPOs tend to generate quite the buzz in the market, which in turn can drive up share prices.
How do IPOs work?
Once a company has decided to go public, it must disclose specific information in the registration statement. For instance, in the U.S., this statement is known as a Form S-1, which is filed with the Securities and Exchange Commission (SEC). Much of this form contains the prospectus and other important information. The company also appoints underwriters who will assist the business during the IPO process by performing due diligence on the company to verify its financial information, as well as to analyse its business model. At the same time, they may commit sums of money to purchase shares before they’re listed on the public exchange. After an initial block of shares is sold, the IPO price is set, together with a date for the stock to begin trading.
Want to find out more about traditional IPOs and how they work? Have a look at this lengthy guide on initial public offerings.
Why do companies opt to go public via an IPO?
From helping companies raise additional money to generating more publicity, there are many reasons why businesses decide to go public via a traditional IPO. Some of these may include:
- Regulatory certainty: the regulatory requirements for traditional IPOs have been in place for many years, while they are designed to protect investors. In contrast, regulatory requirements for SPACs have changed recently and reportedly, more changes are yet to come in the SEC, which can lead to regulatory uncertainty.
- No sponsor promotion: with SPACs, sponsors can get a 20% stake of the company’s common equity, however, with a traditional IPO this is not a requirement, which makes it an appealing route for those businesses that are not willing to give up this stake.
What are the key differences between SPACs and IPOs?
The table below outlines some stark differences between the two.
|Purpose||Through a SPAC transaction, a private company becomes publicly traded by merging with a listed shell company.||A private company issues new shares and with the help of an underwriter sells them on a public exchange.|
|Timing||Approximately 3 to 4 months.||Anywhere between 6 and 9 months.|
|Process||Due diligence required but carried out by a small team.||Comprehensive preparation that involves the whole organisation. Full SEC review.|
|Pricing||Price could be set early on in the process and may be less volatile.||Price determined at time of the IPO, while the IPO valuation can be volatile.|
The rise of SPACs
SPACs’ rise to popularity has been nothing but spectacular. Although they have been around for several decades, they used to exist as a last resort, particularly for small companies that would have otherwise found it difficult to raise money on the open market. The extreme market volatility, caused in part by the global pandemic, drove some companies to postpone their IPOs out of fear that it would affect their stock’s public debut. Others decided to move ahead but chose an alternate route to a traditional IPO by merging with a SPAC.
In 2019, SPAC IPOs raised $13.6 billion, which was more than four times the $3.2 billion raised in 2016. And once they took off in 2020 and 2021, the 295 SPAC IPOs recorded just in the first quarter of 2021 managed to raised as much as $96 billion, surpassing the previous high of $80 billion from the 247 SPACs that were recorded for all of 2020.
Remarkably, the boom in SPACs have attracted both big-name underwriters like the likes of Goldman Sachs (GS) and Credit Suisse (CS), while many celebrities and professional sportspeople flocking to sponsor one. Some well-known deals include digital sports entertainment and gaming company DraftKings (DKNG), energy storage innovator QuantumScape (QS) and real estate platform Opendoor Technologies (OPEN). But perhaps two of the most high-profile deals involved Richard Branson’s Virgin Galactic (SPCE), which was purchased by venture capitalist Chamath Palihapitiya’s SPAC, Social Capital Hedosophia Holdings, for $800 million before listing the company back in 2019, while the other took place in 2020, when Bill Ackman, founder of Pershing Square Capital Management sponsored his own SPAC, Pershing Square Tontine Holdings (PSTH), one of the largest-ever SPACs, which raised $4 billion in its offering.
Investing in a traditional IPO versus investing in a SPAC
As mentioned earlier on, the buzz that surrounds traditional IPOs has the potential to drive share prices, however, these deals can also be quite volatile since the share price can go over what the company is actually worth. And this is why at times companies that have had successful IPO launches have seen their share price drop once the hype has fizzled out. In contrast, SPACs can offset some volatility by minimising the price uncertainty associated with share prices. Yet, some of the enthusiasm surrounding them has cooled in 2021 due to lacklustre performance by some, as well as regulatory warnings.
Here are some other things to keep in mind when deciding whether to invest in traditional IPOs or SPACs:
- Ease: whether you want to purchase IPO stocks or SPACs, the process is the same. All you need is an account and the ticker symbol.
- Regulations: as mentioned earlier on, bearing in mind that SPACs tend to have more regulatory flexibility when it comes to forward-looking statements, it is important to keep this in mind and always consider the business’ outlook. In contrast, regulatory rules for traditional IPOs are more stable.
Both boasting their merits and shortcomings, whether you decide to invest in a traditional IPO or a SPAC, you must remember to always do your research, look into the company’s performance and business model, as well as the sponsors, key executives and the general overview of the industry it operates in.
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