All you wanted to know about SPACs

If you think the Initial Public Offering (IPO) market is too dull for you, then you may wish for SPACs’ entry into India. Today Special-Purpose Acquisition Companies (SPACs) are touted as an alternative to slow and inefficient IPOs.

A SPAC is an empty corporate shell that raises money from investors with the aim of acquiring private businesses by merging them. Essentially, a SPAC takes companies or start-ups public through the back door route. SPACs compete directly with private equity investors and strategic buyers for acquisition candidates. The success of SPACs lies in letting their investors own a piece of highly fancied emerging businesses that can quickly soar in value.

Also known as blank-cheque companies, SPACs have no operations or business plans when they seek investor money. They raise money, then hunt around for merger candidates and hit jackpot if they get lucky with their investments.

SPACs have raised more than $48 billion in the US this year, according to Bloomberg. SPACs have been around since early 2000s, but have witnessed a resurgence of late. Virgin Galactic, a space tourism company founded by Sir Richard Branson, is often credited for kicking off the latest SPAC mania in 2019.

Any company looking to raise money via the IPO route knows the risks of doing it the old-fashioned way. There are many tasks involved — preparing for more disclosures, hiring investment bankers, getting the pricing right and then hoping investors will bite.

Not only do some managements view this process as a big distraction, the time taken to complete it can range from 18 to 24 months. A SPAC disrupts this process in a big way by cutting timelines and reducing risks. It can complete its offer in a matter of months and once done, the target company can simply merge with it.

At the moment, it seems anyone who is a big name in the markets is “sponsoring” a SPAC- famed investor Chamath Palihapitiya, ex-Trump adviser Gary Cohn, basketball star Shaquille O’Neal, Hong Kong tycoon Richard Li and tech entrepreneur Michael Dell.

The people who sponsor SPACs are responsible for raising money and negotiating with target companies. For this service, the fee to the sponsor can be quite stiff. Billionaire Alec Gores turned a $25,000 investment into $80 million in nine months. Former Citigroup banker Michael Klein made $60 million on a similar-sized investment. Such stories are fuelling the SPAC boom.

SPACs offer a new route for high-risk taking individuals to participate in the start-up euphoria. Imagine you are an investor who dabbles in US markets and pays $10 per share to invest in a newly established SPAC. Your money, along with the money of many others like you who bought shares, is deposited in a trust account. Now, the SPAC starts looking for a target company. If the SPAC fails to spot a target within two years, you get back your $10 per share, plus applicable interest.

If the SPAC finds a target company within two years, the target company is merged with the SPAC in exchange for the pool of funds in the trust account. At this point in time, you would need to take a call on whether you wish to become a shareholder in the newly combined company, or request to get your $10 back, plus interest. Many SPACs trade at a premium immediately on listing, and when they merge with promising companies can appreciate further.

Fancy packaging does not make it less risky to write out blank cheques.

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