What are SPACs?
A Special Purpose Acquisition Company, commonly referred to as SPAC is essentially a company with no commercial operations, along the lines of a shell company. The purpose of the creation and inception of a SPAC is to raise funds through an IPO, and these funds will be used to acquire a company in the near future.
SPAC’s are usually at the behest of reputable asset management companies or individuals, thereby generating a large amount of capital through the IPO process. SPAC’s are commonly referred to as “blank cheque companies” as they are formed by experts in a particular business or industry, who have a check on the pulse of that particular sector but don’t disclose the final company they want to acquire during the process of an IPO. SPAC’s are becoming increasingly popular during the year, raising $12.10 billion so far in this tumultuous time. They are also starting to garner a lot of attention and traction, with everyone jumping on the bandwagon; big names like Bill Foley, Barry Sternlicht and Bill Ackman.
So how do SPAC’s work?
Suppose I own a company ‘ABC Co.’ that deals with musical instruments. I’m happy with the company’s growth, but I have a bigger picture in my head; I want to expand my business but to do so, I need more finances. So, I approach an investment bank to help me ascertain a price for my shares and start the due diligence and process for a probable IPO. This requires me to pitch my business to a large number of different investors so that an average price can be drawn out.
Obviously, this will be an extremely cumbersome process with none of the investors having any idea about my USP, my business model, or the likes.
On another side, there is an extremely successful financier who has a plethora of experience and has been very successful in the finance world. He decides to want to call it quits and just concentrate on a particular sector. Thanks to his reputation and with the backing of the bank he used to work at, he raises a substantial amount of funds through an IPO under him. Wanting to earn a large return, as well as diversify his funds, ABC Co. company comes within his radar. According to him, they have a viable business plan, a solid set of financial statements, and a high growth prospect. ABC Co. company appeals to him, and he invests the required amount that I need to expand my business (ABC Co.). (if the IPO doesn’t raise enough funds, it could look at other ways to raise the required funds). So now, once ABC Co. has agreed to the deal, ABC Co. becomes a publicly listed company coming under the wing of the financier who is the parent company.
With almost every country looking at a negative growth in the upcoming quarter, everyone has realized that the stock market is extremely volatile and frothy aka the assets of companies dragging up the points in stock exchange are overvalued, leading to the creation of the inevitable bubble. This will result in a lot of liquidity in the stock market because of the oncoming panic sell mode.
The best time to sell into a SPAC would be now. The main advantages of investing in a SPAC are:
Companies don’t want to pitch to investors because of how volatile the stock market is, knowing that valuations in this day and age would not be consistent. SPAC’s would offer them a much better price.
Companies that usually partner with a SPAC, will price their shares at a slightly lower price than if they did partner with an IPO. Mainly because the cost involved getting together with a SPAC is far lower compared to the cost incurred through an IPO.
It requires far less disclosure to create a SPAC as compared to the rudimentary way of an IPO. It bypasses all the requirements, less paperwork involved which would on an average takes a year or even more
This inevitably leads to the process of a SPAC being far quicker, thereby enabling the investors to capitalize on moments in the fluctuating stock exchange.
As of the last few months, barring the last week, prices being quoted are relatively high, in lieu of a bubble being created. This could help a company to raise a large number of funds.
However, there are a few drawbacks:
The fee paid to the SPAC sponsor is higher compared to the typical fee paid to an IPO underwriter.
When an investor invests into a SPAC, they don’t know what the investment may be in. The sponsors could give broad strokes e.g. we’re looking at retail or tech, etc.
The bypass process is a double-edged knife, with the standard vetting process being expedited, solely basing your trust on the intellect of the sponsor of the SPAC.
This would involve investments that need not cater to the shareholder's interests, because it may be subjective, not cater to what each shareholder wants, etc.
Almost 80% of the IPO’s that have happened in the United States is for the reason of raising funds for SPAC’s. However, the same can’t be said for India. SPAC’s are still quite ambiguous, with nothing having been registered in India. There is a dearth of information with regards to the setting up for a SPAC, primarily to safeguard investors from possible fraudulent schemes; the government believes that India’s secondary market is far too premature to host a SPAC fund. However, there have been investments in domestic companies through foreign-based SPACs.
Regardless, the future of SPAC domestically and worldwide looks bright despite the current situation.
Written by Rohann