It wasn’t too long ago that there was an order to the universe when companies wanted to go public, and the traditional initial public offering was at the top of the list.
Ranking near the bottom – the province of often-questionable listings – was an investment vehicle called the special purpose acquisition company, or SPAC. Its approach seemed to flip the process on its ear, by first creating the shell company, then going out and finding acquisitions to fill out its portfolio.
For an increasing number of firms, the SPAC has become the favored way to go public.
But as the equity markets have gyrated in recent years and some IPOs have endured wild price swings, companies looking to go public have sought alternatives.
For an increasing number of firms, the special purpose acquisition company has become the favored way to go public. SPACs are on pace for a record year of fundraising and have helped to sustain the initial public offering market even during the COVID-19 pandemic.
In what should otherwise be a challenging IPO environment given fragile economic and financial conditions, SPAC transactions have grown as the once-soured perception of these investment vehicles has turned more positive in recent years.
SPAC transaction volume is on course for a record year…
Public alternative to private equity investing
SPACs, also referred to as “blank-check companies,” are shell companies with no assets or operations at the onset and are established for the sole purpose of acquiring another company that is yet to be identified.
SPACs effectively flip the conventional order of establishing a private business and then taking it public.
The blank-check company takes in money from investors through an initial public offering in hopes that its management will identify a target company, usually within a period of two to three years.
Once a target is acquired, the SPAC effectively transforms from a shell company into an operating company by merging the target company into the SPAC. Such reverse mergers effectively flip the conventional order of establishing a private business and then taking it public.
SPACs typically issue a combination of shares and warrants. In the event that an acquisition is completed, the warrants may provide some upside for investors if the post-merger share price performance is favorable.
The completion of the merger requires the approval of the SPAC stockholders. Even if a merger is approved, dissenting stockholders may have the opportunity to cash out and get their money back.
If the sponsors of the SPAC are unable to find a suitable target in the set time period, the SPAC will return money to investors and fold. These features give SPAC investors some protection on the downside while also allowing for potential upside.
The early history of SPACs is tainted with cases of fraudulent schemes. Over the years, listing rules have been improved to offer more protection for investors and curb market abuses. But the real driving force behind the recent surge has been the high profile and quality of players now choosing to participate in this market. This has helped SPACs gain acceptance and attract a lot of interest.
Last year’s public listing of Richard Branson’s Virgin Galactic via acquisition by a SPAC was one example of a highly visible transaction which demonstrated that well-known companies have come to accept SPACs as a viable option for going public.
More recently, the hedge fund manager Bill Ackman of Pershing Square Capital Management filed for an IPO of a blank-check company that may end up being the largest SPAC ever created, with a target to raise as much as $3 billion.
In addition to high-profile target companies and asset management companies participating in SPACs, the deal-making activity has also attracted high-quality firms in the form of top-tier investment banks, attorneys and accountants advising on these transactions. Reputable leaders in business and finance are taking up roles on the management teams of SPACs in yet another sign that SPACs have indeed gone mainstream.
Prospects for SPACs
Will the current SPAC momentum endure?
SPACs have enjoyed a similar burst in the past, only to falter in the wake of a recession. SPAC volume hit fever pitch in 2007, but a large number of deals ended up being withdrawn as closing on potential targets within the expected timelines proved difficult in the Great Recession.
But the sharp market decline in March has not been followed by a wave of withdrawn deals and a prolonged period of retrenchment. On the contrary, the pipeline of pending SPAC initial public offerings has accelerated to establish 2020 as a record-breaking year for SPAC volume in dollar terms.
For the time being, the current crisis does not seem to be slowing down the amount of capital flowing into SPACs. This can be expected to continue.
Special purpose acquisition companies have emerged as an accepted alternative for accessing public markets and as a result have attracted record of amounts of cash even in the aftermath of COVID-19.
For private companies, especially those operating in the middle market, SPACs might provide them with the opportunity to go public faster versus the traditional path to an IPO.
Barring any significant reversal of the emerging economic and stock market recovery, this trend seems set to continue and may be worth exploring both for investors and for companies looking to go public.
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