Special Purpose Acquisition Company (SPAC)

Updated on April 8, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Special Purpose Acquisition Company (SPAC) Meaning

A Special Purpose Acquisition Company (SPAC) refers to an entity with no commercial operations but intends to merge with or acquire an existing business. The shell firm created or sponsored by institutional investors and underwriters raises capital to incorporate and go public through an initial public offering (IPO).

Individuals and private equity funds buy special purpose acquisition company stocks or shares without knowing the target business. However, they are solely responsible for assessing the investment risksInvestment RisksInvestment risk is the probability or uncertainty of losses rather than expected profit from investment due to a fall in the fair price of securities such as bonds, stocks, real estate. In addition, each type of investment is prone to some degree of investment or default risk.read more based on how the SPAC performs. A SPAC owns no assets other than cash and sells shares to the general public after being listed on a stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more.

How Special Purpose Acquisition Company (SPAC) Works

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Key Takeaways

  • The special purpose acquisition company definition describes a company with no commercial operations but plans to merge with or buy another company. Institutional investors create it to raise capital and go public through an initial public offering (IPO).
  • Sponsors form the SPAC, investors purchase stocks, and targets are firms the shell company plans to merge with or acquire.
  • The process comprises three stages – incorporation and issuance of founder shares, identification of potential merger or acquisition targets, and completion of the merger or acquisition contract.
  • The U.S. Securities and Exchange Commission (SEC) regulates SPACs, which trade like public companies on a stock exchange.

How Does SPAC Work?

A Special Purpose Acquisition Company enables a firm to go public via mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more or acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more. It is a faster and less expensive method than traditional initial public offeringsInitial Public OfferingsAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more (IPOs). SPAC is referred to as a shell corporationShell CorporationShell corporation refers to a dummy company confined in documents with no physical presence such as offices, and employees. It does not have any active business operation running with no tangible assets and plant, property, or equipment in its possession. In addition, any products and services don’t trade on the stock exchanges.read more because it issues an IPO to raise funds for the deal. It is also known as a blank check firm because it has no business model, product or service, or specified purpose.

Special Purpose Acquisition Company (SPAC) Process

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A group of management professionals called founders or sponsors provide the initial funds to the SPAC in exchange for significant ownership in the target business. Next, the company selects an investment bank to help with the issuance and management of the IPO selling securities at a unit priceUnit PriceUnit Price is a measurement used for indicating the price of particular goods or services to be exchanged with customers or consumers for money. It includes fixed costs, variable costs, overheads, direct labour, and a profit margin for the organization.read more. Finally, investors must find and finalize the deal within 1.5-2 years of raising the capital and profit.

The entire process takes place in three stages – incorporating and issuing founder shares, identifying potential merger or acquisition targets, and concluding merger or acquisition deals. SPACs are regulated by the U.S. Securities and Exchange Commission (SEC) and trade like public companies. As a result, the general public can purchase its shares post-merger or acquisition.

Special Purpose Acquisition Company (SPAC) Process

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Such companies have become valuable assets in the United States, with investors straining to keep up with the market following the COVID-19 pandemic. Moreover, the association of personalities like hedge fund manager Bill Ackman and venture capitalistVenture CapitalistVenture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. read more Chamath Palihapitiya with SPACs makes them a trustworthy option for investors.

The most popular businesses on the special purpose acquisition company list are Palihapitiya’s Social Capital Hedosophia Holdings and Ackman’s Pershing Square Tontine Holdings. While the former purchased a 49% share in the British airline Virgin Galactic in 2019, the latter accumulated the largest fund in 2020, totaling $4 billion.

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SPAC Explanation in Video

 

SPAC Characteristics

These firms are quickly becoming the most effective way to get a company listed on a stock exchange. Here are a few quick points to understand a SPAC better:

SPAC Examples

For a better understanding of the concept, consider the following two examples:

Example #1

Shares of the shell company Digital World Acquisition (DWA) soared by up to 700% in October 2021. It was after the firm announced to merge with and publicly list the social network business TRUTH Social.

After being banned by social media platforms like Facebook and Twitter, former U.S. President Donald Trump decided to launch his app in 2022. However, after the short seller Iceberg Research revealed it bet against DWA, its stock prices dropped by 10.98%.

Example #2

Another special purpose acquisition company example is of the media publication house, Forbes. The company announced in August 2021 that it would merge with the SPCA Magnum Opus Acquisition to go public. The newly formed company will use digital transformation to engage audiences and generate revenues. Forbes will list on the New York Stock Exchange as FRBS once the purchase is completed.

Advantages

A SPAC usually has three stakeholdersStakeholdersA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more – sponsors, investors, and targets. Sponsors create the company, investors buy stocks, and targets are firms that the SPAC wants to merge with or acquire in the future. Let us have a quick look at the benefits it holds for are three stakeholders:

Special Purpose Acquisition Company (SPAC) Advantages

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  • SPAC can help a company go public more quickly than regular IPOs. It is because its evaluation depends on the management team’s reputation.
  • It allows investors to purchase cheaper shares and additional capital under a warrant.
  • Its price is negotiable, unlike the traditional IPO, which is set based on market conditions at the listing.
  • The limited-time to close a deal allows the target company to negotiate a higher price.
  • SPAC has lower marketing costs because it does not require investments to attract investors.
  • It lets businesses access funds in the event of market volatility constraining liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more.
  • Sponsors are specialists and hence can be trusted with crucial business decisions.

Frequently Asked Questions (FAQs)

What is a Special Purpose Acquisition Company?

SPAC is a company formed by institutional investors and underwriters only to raise capital through an IPO to acquire or merge with an existing private business. It has no asset other than cash, nor does it have a clear goal, product, or service. The company pools resource by selling stocks, with each share commonly sold at $10. Once it goes public, the funds raised are preserved in a trust account until the company concludes a deal or fails to do so within two years.

What are the benefits of Special Purpose Acquisition Company (SPAC)?

The benefits of SPAC are:
– Goes public quickly
– Low-priced shares
– Negotiable price
– Access to funds during volatility
– Low marketing costs
– Expert decision-makers
– The additional capital purchase allowed

What are the differences between SPAC and IPO?

The differences are listed in the table below:

SPAC vs IPO

This has been a guide to Special Purpose Acquisition Company and its meaning. Here we discuss how does SPAC work, along with examples, characteristics, and advantages. You may also have a look at the following articles to learn more –

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