SPACS or special acquisition companies are becoming a popular way of raising money. It is a unique and innovative concept that does not seem logical at first glance.
This article answers the question of what a SPAC is and provides the pros and cons of the method as we see it. Read on to get the knowledge you need to answer the questions when someone asks.
Let’s start.
What is a SPAC?
A SPAC is a company that raises money from investors to acquire another company. They are usually listed on a stock exchange and have a board of directors and a management team. Once they’ve raised enough money, they’ll find a business to buy.
SPACs have been around for quite some time, but in 2020 there was a significant SPAC boom. 248 SPACs went public in 2021 and raised a total of $83 billion. In comparison, there were only 59 who went public in 2019 and raised $13 billion.
However, Guy Davis, portfolio manager at GCI Investors, cautions: “The current SPAC craze is likely to be self-correcting and the correction may have already started. As SPACs become less profitable, they will become less popular and the boom will subside. As more and more SPACs compete for deals, the quality of the deals they close must decline and the prices they have to pay rise, meaning more SPACs will ultimately cause losses for investors.”
SPAC history
The first Special Purpose Acquisition Company was founded in 1993 by Bill Ackman, founder of Pershing Square Capital Management. They have since acquired companies such as Hertz Global Holdings Inc., Burger King and Red Roof Inn.
SPACs exist in virtually every industry. They have been used to acquire banking, oil, gas, real estate, retail and technology industries.
SPACs have gained momentum because it can be difficult for a company to go public and raise money if they have no income or profit. A SPAC allows companies to raise money up front and then use that money to acquire another company.
How do they work?
SPACs have two years to find a target company or return the money to investors (including retail and institutional investors). SPAC investors are betting that management can identify target companies with stock prices that are undervalued by the market and buy them at a discount (or cheap) within this time frame. Once this happens, shareholders of both companies would receive SPAC shares in a new entity created with their combined assets — meaning more value for everyone involved if everything goes according to plan. Because companies have significant flexibility regarding their acquisition goals, SPACs are often referred to as “blank check” companies.
That’s different from traditional IPOs, because there’s no roadshow where management meets with potential investors to make their pitch or set an offer price in advance. Instead, the company will issue units made up of common stock and warrants for $11 a unit — meaning they can raise as much money as possible while still having some skin in the game.
Advantages of investing in SPACs
Investing in SPACs has many benefits:
They are easily accessible to many investors as you do not need any special qualifications such as achieving accredited investor status. There are no lock-up periods where you can’t sell your shares of SPAC stock right away, unlike traditional IPOs. You can get some upside potential if management finds an undervalued company worth buying at a discount (and turns profitable once acquired)
Disadvantages of investing in SPACs
There are also some drawbacks to investing in SPACs:
They are highly speculative investments as not much is known about their assets after finding another company or company to buy out. That means the market value is unknown, making it more difficult to determine whether or not they are overpriced and thus risk losing money on the investment. If things go wrong, investors would likely lose everything invested in them later. The management teams of these companies are mostly former CEOs who have stopped running large companies with a lot of experience and expertise. Yet they are now trying something new by buying out smaller companies that need help in one way or another. These can be more risky because their track record isn’t quite as strong or well-established – especially if a takeover doesn’t go well, because then investors would be burned as well. Investing in the stock market is always a risky business no matter what you do, so make sure your portfolio is sufficiently diversified. It would help if you also understand your risk tolerance before putting money into these investments.
Examples of some well-known SPACs
There are a few well-known SPACs that you may have heard of:
Albertsons Companies, Inc. (ABS) is an American supermarket chain formed in 2006 through the merger of Albertsons and Safeway. It became a publicly traded company on July 26, 2006. In 2019, private equity firm Cerberus Capital Management acquired ABS for $68 billion
The Carlyle Group is an American multinational private equity, alternative asset management and financial services company headquartered in Washington, DC. It has more than $200 billion in assets under management on six continents.
KKR & Co. LP is an American global investment firm headquartered in New York City that manages investments across multiple asset classes, including private equity, energy, real estate and hedge funds.
Why would a company choose to invest in a SPAC?
There are a few reasons why a company might choose to invest in a SPAC:
They may feel that their business is no longer growing and want to explore other opportunities outside of their current industry. The company’s management team may feel that they have run out of ideas or growth opportunities within their organization. The company may want to acquire another company but don’t have the time or resources to go through an IPO process, so a SPAC would be a faster way to do it.
What is the process of a SPAC merger?
There are four steps in the process of a SPAC merger:
The SPAC raises money from investors by selling shares in an initial public offering (IPO). The company then uses the fresh capital; to take over another company, which becomes its operating subsidiary. The acquired company is then listed on a major stock exchange after it has gone through regulatory approval processes with the exchange and its financial statements audited by an independent accounting firm.
SPACs use this as leverage against other companies because they can offer more money for acquisitions than private equity firms could typically pay out in cash because of restrictions imposed by regulators on how much debt can go into deal financing structures such as leveraged buyouts (LBOs). †
The company to be acquired will have a management team, which will be responsible for running the company and reporting to the SPAC’s board of directors.
Investors in a SPAC should do their due diligence before investing to ensure that the subsidiary’s management team is experienced and has a good track record. Investors can also benefit from hiring a financial advisor who knows the ins and outs of SPAC investing to help them make a more informed decision.
The quintessential SPAC timeline
Here is a typical timeline for a SPAC:
The company raises money from investors by selling shares through an initial public offering (IPO). The company then uses the capital to acquire another company, which becomes its operating subsidiary. Then the subsidiary is listed.
At present, the SPAC is a publicly traded company and can make acquisitions with the money it raised from its IPO.
The company usually has three years from the IPO to make an acquisition. If no acquisitions are made within that time, it will be closed and the money raised will go back to the investors.
SPAC management structure
One of the critical things investors should look at when investing in a SPAC is the management structure. That’s because the acquired company will have a management team, which will be responsible for running the business and reporting to the SPAC’s board of directors.
It is critical for investors in a SPAC to do their due diligence before investing. Ensure that the subsidiary’s management team is experienced and has a good track record.
SPACs and Reverse Mergers
One of the key advantages SPACs have over private equity firms is that they use their public status to do a reverse merger. The acquired company will go public by merging with SPAC, which is already listed on a major stock exchange.
That is a quick and easy way for the subsidiary to go public without going through an IPO process, which can be time consuming and expensive. The flip side of this structure is that it gives the SPAC’s management team more control over the subsidiary. The SPAC management essentially becomes the majority shareholders in the company, which could be a good thing.
How competent the SPAC’s management team is of utmost importance before investing.
It comes down to
SPACs are an excellent way for investors to gain exposure to the private equity market and a relatively easy way for companies to go public without going through an IPO process.
The most important thing for investors is to do their due diligence before investing and ensure that the subsidiary’s (and SPAC’s) management team is experienced and has a proven track record of success.
This article originally appeared on Wealth of Geeks.
This post What is a SPAC? Are SPACs a Smart Investment Option for 2022?
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