SPAC – A Blank Check Company

Explained What is SPAC & How Does It Work?

If one were to list down the most popular investment jargons of 2020, we are sure ‘SPAC’ would indisputably be at the helm. But, what is a SPAC you ask?

In today’s blog we delve into understanding the fundamentals of SPAC.

SPAC – A Blank Check Company | What is it?

Introduction

Initial Public Offering (IPO) is an age-old traditional practice of raising sizeable capital. It’s a process through which a privately held company offers its shares to the public and becomes a publicly-traded company on the stock exchange.

However, raising funds through an IPO is no walk in the park. A company has to navigate through a complicated, expensive and laborious process which usually ends up taking 12-18 months. The entire exercise could pose several issues like lower pricing, unfair valuations, under subscription, negative market sentiments, etc.

In 2020, things took a rather unusual turn for the worse and all of mankind suffered the wrath of the COVID-19 pandemic. Under lockdown circumstances, raising fresh capital through an IPO wasn’t a viable option. This was when SPAC became the knight in shining armor and garnered popularity among the masses.

What is Special Purpose Acquisition Company & How Does it Work?

Investopedia defines SPAC as –

“A Special Purpose Acquisition Company is a company with no commercial operations that is formed strictly to raise capital through an IPO for the purpose of acquiring an existing company.”

Basically, a SPAC is a shell company formed by a group of seasoned investors, experienced professionals and private equity funds who act as the sponsors. They are the brains behind this entire operation. If a SPAC aims to raise a USD 1 Billion, these sponsors chip in at least 20% (i.e. USD 200 Million) of the funds and raise the remainder 80% (i.e. USD 800 Million) from institutional and retail investors.

Once the capital has been raised and formalities are complete. The SPAC get listed on the bourses and 85%-100% of the proceeds collected are put into an interest bearing trust account. Now the sponsors get a period of 2 years to find a target private company to acquire with the funds raised. In a rare occurrence, if they fail in doing so the SPAC gets dissolved and the funds are remitted back to the investors.

The beauty of this arrangement is that the target company being acquired merges with the already listed SPAC and goes public at warp speed within 90 days, ergo bypassing the overlong tedious IPO process.

You’re probably cudgeling your brains, thinking which type of company would want to get listed on the bourses through a SPAC. Well, an excerpt from an article by PricewaterhouseCoopers sums it up perfectly –

“Small and mid-sized companies may want to continue to fund development, invest in brand awareness or make acquisitions to continue growing, but they may not be ideal candidates for traditional IPOs. By merging with a SPAC sponsor, existing companies can retain a stake in their business and gain access to liquidity that otherwise would not be available to them.”

Blank Check Companies

SPACs are also known as “Blank Check Companies”, simply because the investors write a blank check to the sponsors of the SPAC and they utilize it for acquiring ownership in the private company they deem fit.

To cite a snippet from thespacguys.com –

“When you invest in a Special Purpose Acquisition Company, you invest in the industry titans or billionaires running it. You’re trusting them to make a killer acquisition and get a deal done. Most SPACs don’t have a predetermined target company.”

Don’t make the mistake of thinking SPACs are a newfangled phenomena. SPACs were invented in 1993 with an aim to provide private firms with an alternate investment vehicle to access everyday investors. Back then, blank check companies were prohibited in the US. As a result SPACs came into existence primarily as an exemption of listing blank check companies. Since then, more than USD 100 Billion have been raised through SPACs.

Despite being around for decades, it was only in 2020 that SPACs picked up steam and rose to popularity, taking Wall Street by storm. Apart from veteran names like Goldman Sachs, TPG Capital and Pershing Square Capital Management; prominent athletes such as Serena Williams and Step Curry have also entered the SPAC game.

Example

ReNew Power Private Limited recently became the first Indian company to get listed on the NASDAQ via a SPAC. Indian start-ups like Walmart-owned Flipkart and Grofers are actively exploring the SPAC route for an indirect listing in the US.

According to data from Goldman Sachs –

“2020 has been the year of the SPAC, with 219 ‘blank-check’ companies raising $73 billion in proceeds year-to-date. High profile companies that have gone public via SPACs include Virgin Galactic, DraftKings, and Nikola, representing a class of ambitious growth names riding the long-term secular trends of space exploration, sports betting, and electric vehicles.”

Comparison SPAC vs IPO Volumes

Advantages of SPAC

• Cost effective and speedy.
• Easy access to capital and flexibility to negotiate deal terms for target company.
• Exit opportunity for promoters and early investors of the target company.
• No listing day surprises, as valuation and pricing are predetermined between the target companies and SPAC sponsor 
• Target company gains access to a robust team of experienced professionals (i.e. SPAC sponsors) as strategic partners with identical visions, thus aiding expansion of operations into new horizons.
• If SPAC investors are uncomfortable with the target company being acquired, they can effortlessly withdraw their capital before the merger closes.

Disadvantages of SPAC

• Promoters may lose control due to excess dilution of stake.
• Accounting complications.
• Target company will need to ensure compliance with regulatory norms and get audited.

Will India join the Special Purpose Acquisition Company Party?

Maybe.

You’d be delighted to know that SEBI has recently formed a panel of experts to scan the viability of introducing a Special Purpose Acquisition Company like structure in India.

That’s all from our side.

The next time you encounter the jargon ‘SPAC’, you’ll know exactly what it means!

P.S. – Do you think a SPAC like structure will prosper in India?

Let us know in the comments below.