Adam Jeffery / CNBC
You may have heard the term “SPAC” more and more lately, and you may be wondering what it is. First, what it is not- it is not a Super PAC (Political Action Committee), which is an entity organized for the purpose of raising and spending money to elect and defeat political candidates. The only similarity between Super PACs and SPACs, perhaps, is their ability to circumvent prevailing rules to make certain things easier- surpassing donation limits in the former case, and making it easier to IPO in the latter.
In our case, a SPAC is a special purpose acquisition company, the latest trend to emerge from Wall Street. A SPAC is basically a “blank check” company whereby investors pool their money to purchase private companies. You’ll also see them being referred to in the pejorative as “shell companies.” If the sponsors fail in their efforts to acquire a company(ies) within a certain period of time, usually two years, the SPAC is dissolved and the money is returned to shareholders.
They’ve become popular because they provide a back door to public markets for companies wishing to avoid the traditional IPO process. It’s quite simple and clever actually, and a wonder that the concept is only now becoming a thing.
A SPAC itself is created through the IPO process- the so-called blank check companies account for a fifth of the total money raised in initial public offerings this year, amounting to a total of $23.9 billion.
Once formed, their aim is to then acquire a private company, and upon doing so, automatically make the once-private company public, without needing to go through the usual hoops and hurdles of a traditional IPO. The private companies are also able to negotiate financial terms “behind closed doors and finalized before a deal is announced” as opposed to being beholden to the whims of market conditions as is the case with traditional IPOs, providing yet another benefit to the SPAC method.
The SPAC-path to becoming publicly traded may also be more cost-effective. Banks usually rake in 7% in fees when underwriting a traditional IPO, while with SPACs, banks earn only 2% when the deal is finalized, and only earn an additional 3.5% in fees when a takeover is finalized.
As for investors, SPACs make it possible for the general public to gain exposure to companies that would otherwise remain private, particularly potential tech unicorns and other Silicon Valley outfits.
Some big-name examples of SPAC activity include:
Former Facebook exec Chamath Palihapitiya’s Social Capital Hedosophia (SCH) which in effect merged with the combined Virgin Group/Mubadala Investment Ltd. entity to form Virgin Galactic (SPCE), allowing the two companies to become one and trade under Virgin Galactic’s name on the New York Stock Exchange
Diamond Eagle, which merged with DraftKings in December 2019, effectively taking it public
Bill Ackman’s Pershing Square Tontine Holdings, which recently raised $4 billion, the largest SPAC to date
It appears the primary targets of SPACs are ageing venture capital investments, where the VC firm is ready to exit their position and is looking for an alternative method to a traditional IPO. Ackman’s fund, in fact, is said to be targeting an acquisition of AirBnB, as an example of the type of activity you can expect to see in the SPAC space.
As with any Wall Street trend it is important to keep your guard up and approach with caution. It is in effect an alternative way to invest in companies, but it is certainly not without its risks. SPACs are risky propositions, with half of them expected to fail. If you have a gambling itch and have money you can afford to lose, as with any gamble, then go right ahead and invest in SPACs. However I would not rely on them to serve as the core of one’s investment strategy.