SPACS or Special Acquisition Companies are becoming a popular way to raise money. This is a unique and innovative concept that at first glance seems to make no sense.
This article will answer the question of what is SPAC and suggest the pros and cons of the method as we see them. Read on to gain the knowledge you need to answer questions when someone asks.
Let’s start.
What is SPAK?
A SPAC is a company that raises money from investors to acquire another company. They are usually listed on the stock exchange and have a board of directors and a management team. Once they raise enough money, they will find a company to buy.
SPACs have been around for quite some time, but 2020 saw a significant SPAC boom. In 2021, 248 SPACs went public and raised a total of $83 billion. For comparison, in 2019, there were just 59 companies that raised $13 billion.
However, Guy Davies, portfolio manager at GCI Investors, cautions: “The current SPAC craze is likely to be self-correcting and the correction may have already begun. As SPACs become less profitable, they become less popular and the boom fades. As more and more SPACs compete for deals, the quality of the deals they make must go down and the prices they have to pay go up, so more SPACs will eventually result in losses for investors.”
SPAC history
The first special purpose acquisition company was created 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 almost every industry. They have been used to acquire the 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 when it has no revenue or profit. SPAC allows companies to raise money up front and then use that money to acquire another company.
How do they work?
SPAC has two years to find a target company or return money to investors (including retail and institutional investors). SPAC investors are betting that management will be able to identify targeted companies whose shares are undervalued by the market and buy them at a discount (or cheap) within that time frame. Once this happens, the shareholders of both companies will receive SPAC shares in the new entity created with their combined assets, meaning more value for all involved if all goes according to plan. Because companies have considerable flexibility in terms of acquisition purposes, SPACs are often referred to as blank-check companies.
This differs from traditional initial public offerings in that there is no road show where management meets with potential investors to make their presentation or pre-set the offering price. Instead, the company will issue units made up of shares of common stock and warrants at $11 per unit, which means they can raise as much money as possible while still keeping some skin in the game.
Pros of investing in SPAC
There are many pros to investing in a SPAC:
- They are readily available to many investors as you don’t need special qualifications such as becoming an accredited investor.
- There are no lock-up periods where you cannot immediately sell your SPAC shares, unlike traditional IPOs.
- You can get some upside potential if management finds an undervalued business that is worth buying at a discount (and becomes profitable once acquired).
Cons of investing in SPAC
There are also some downsides to investing in a SPAC:
- This is a highly speculative investment as little is known about their assets after they have found another company or business to buy out. This means that the market value is unknown, which makes it difficult to determine whether they are overpriced or not, and therefore there is a risk of losing money when investing. If things go badly, investors will likely lose everything they invested in it later.
- The management teams of these companies tend to be made up of former CEOs who have retired from the management of large corporations with extensive experience and expertise. However, they are now trying something new, buying out smaller businesses that need help one way or another. This can be very risky as their track record isn’t as strong or established yet, especially if the acquisition doesn’t go so well because then investors will get burned too.
- Investing in the stock market is always risky no matter what you do, so make sure your portfolio is sufficiently diversified. It would be helpful if you also understand your risk tolerance before putting money into these investments.
Examples of some well-known SPACs
There are several well-known SPACs that you may have heard of:
Albertsons Companies, Inc. (ABS) is an American supermarket chain formed in 2006 as a result of the merger of Albertsons and Safeway. On July 26, 2006, it became a public company. 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 corporation headquartered in Washington, DC. It manages over $200 billion in assets across six continents.
KKR & Co. LP is an American global investment company headquartered in New York City that manages investments in several asset classes including private equity, energy, real estate and hedge funds.
Why did the company decide to invest in SPAC?
There are several reasons why a company might decide to invest in a SPAC:
- They may feel like their business is no longer growing and want to explore other opportunities outside of their current industry.
- Company management may feel like they are running out of ideas or opportunities to grow within their organization.
- A company may be looking to acquire another business, but doesn’t have the time or resources to go through the IPO process, so a SPAC would be a faster way to do it.
What is the SPAC merger process?
The SPAC merger process consists of four steps:
SPAC raises money from investors by selling shares in an initial public offering (IPO). The company then uses the new capital; acquire another business that will become its operating subsidiary. The acquired company will then be listed on a major stock exchange after going through the exchange’s regulatory approval process and having its financial statements reviewed 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 would normally be able to pay out in cash due to restrictions imposed by regulators on how much debt can be used in transaction financing structures such as leveraged buyouts (LBOs). )
The acquired company will have its own management team that will be responsible for running the business and report to the board of directors at SPAC.
Investors in a SPAC should exercise due diligence before investing to ensure that the subsidiary’s management team is experienced and has a good track record. Investors can also benefit by hiring a financial advisor who knows the ins and outs of investing in a SPAC to help them make a more informed decision.
Typical SPAC chronology
Here is a typical schedule for SPAC:
The company raises money from investors by selling shares in an initial public offering (IPO). The company then uses the capital to acquire another business, which becomes its operating subsidiary. The subsidiary is then listed on the stock exchange.
SPAC is currently a public company and can start making acquisitions using the proceeds from the IPO.
A company usually has three years after an IPO to make an acquisition. If no acquisitions are completed during this period, it dissolves and the money raised is returned to investors.
SPAC Governance Structure
One of the most important things investors should pay attention to when investing in a SPAC is the governance structure. This is because the acquired company will have its own management team that will be responsible for running the business and report to the board of directors at SPAC.
For SPAC investors, it is extremely important to conduct due diligence before investing. Make sure the subsidiary’s management team is experienced and has a good track record.
SPAC and reverse mergers
One of the significant advantages of a SPAC over private equity firms is the use of its public status for a reverse merger. The acquired company goes public by merging with SPAC, which is already listed on a major stock exchange.
This is a quick and easy way for a subsidiary to go public without going through the IPO process, which can take a lot of time and money. The disadvantage of this structure is that it gives the SPAC management team more control over the subsidiary. SPAC management essentially becomes the majority shareholder of the business, which could be a good thing.
How competent the SPAC management team is is of paramount importance before investing.
essence
SPACs are a great way for investors to access the private equity market and a relatively easy way for companies to go public without going through the IPO process.
The key for investors is to do due diligence before investing and make sure that the subsidiary’s (and SPAC’s) management team is experienced and has a proven record of prior success.
This article originally appeared on Wealth of Geeks.