Special Purpose Acquisition Companies, or SPACs, have become an increasingly popular investment option. If you’re a basketball fan (Steph Curry, NASDAQ: DUNE) or tennis fan (Serena Williams, NYSE:SPFR), there’s a SPAC for you. So too if you’re a business, man (Jay-Z, OTCMKTS:SBVRF). There’s even a Shaq SPAC (NYSE:FRX).
Great, but what is a SPAC?
At its core, a SPAC is a way to pool investor money for the purpose of finding acquisition targets. In this way it is little different from a private equity fund or a REIT (Real Estate Investment Trust). The advantages of structures like this are myriad, but generally they are more efficient because you have one management team investing $100M, instead of 1,000 investors looking to invest $100,000.
So how are SPACs different?
One of the fundamental differences between SPACs and other structures for pooling investor money is that they are registered with the SEC, and thus are open to the public, with very few limits on the types of assets or businesses they can acquire. Unlike a private equity fund, which is a private investment vehicle generally only available to high net-worth individuals or private investment funds, SPACs are offered to retail investors on the day they launch their IPO. There’s also a public market for the SPAC shares throughout the time it is seeking a target company, which means that investors can exit their investment in the SPAC if, for example, their liquidity needs change.
The other fundamental difference is the ability of the SPAC to acquire a wide range of assets or businesses. A REIT is limited to real estate assets, and there are tight regulations on how those assets are held and how the income they generate is distributed to investors. Not so with SPACs. Most SPACs have an industry focus, yet virtually all allow their management teams to acquire targets outside the scope of that initial focus. In the past, SPACs have acquired targets ranging from massive container ships, auto dealerships in China, and even real estate assets.
How does a SPAC work?
A SPAC is formed by a group called the sponsors who typically have experience in mergers and acquisitions, and public company management. The sponsors arrange with an underwriter to launch the SPAC’s IPO. At the IPO, the sponsors put in their “at-risk” capital (the money they lose if the SPAC fails to close a business combination) and the underwriter sells SPAC units to the public. The units are priced at $10.00 each and consist of a share of SPAC common stock and a warrant (sometimes half of a warrant, sometimes two warrants). The units, shares, and warrants are usually listed on an exchange, like Nasdaq. After the IPO, the sponsors will own 20% of the SPAC, plus have warrants to purchase more after a business combination, and the public shareholders will own 80% of the SPAC, plus the warrants included in the units.
The proceeds from the IPO and the at-risk capital are used to pay the IPO expenses, and then 100%-102% of the IPO gross proceeds (or $10.00-10.20 per public share) is placed in a trust account. The SPAC will have a limited time after the IPO (typically 18 months) to complete a business combination, after which it will have to return the money held in trust to investors. At the time the SPAC completes its business combination, it must give the public investors the choice to keep their money in the business or to take their share of the trust out in exchange for surrendering their share of common stock. Shortly after the IPO, investors will be allowed to split the units, and the common stock and warrants can be traded separately. Therefore, even if investors redeem their shares for cash in connection with a business combination, they can still keep the warrant or sell it separately.
Why are SPACs so hot right now?
The current popularity of SPACs comes from a combination of factors, but in our opinion the main driver is twofold: the relative safety of the trust account structure that significantly mitigates the down-side of the investment; combined with advantages of the pooled investor structure that can lead to significant upside returns for investors. Above all, remember that for every A-Rod homerun (NASDAQ:SLAMU), there were lots of at-bats and strikeouts.