Denice R. Preston
“I know more people that have a SPAC than have COVID” is a famous phrase among financial professionals today. What’s behind the increase? Do you think a SPAC IPO is the best option for your business?
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What Are SPACs?
SPAC is SPAC is a shell corporation that pools the money of investors before it can decide the best way to use it. The SPAC is public in a short time (only a few months, compared to a traditional IPO that can last for more than one year) because it does not have an operating background to report. Once it is public, the SPAC seeks out a company that is looking to go public, and they join together, known as the de-SPAC-ing deal. Investors in the SPAC now have a real asset.
Why Privates Are Choosing SPACs
Improved public image. In the 1980s SPACs had a questionable reputation for scamming investors. Since then, SPACs have enacted specific measures to protect investors, such as allowing investors to opt-out if they disapprove of the proposed merger. Increased protection of investors and the influx of VCs unhappy with the conventional IPO procedure have led to some of the most prominent names being SPAC sponsors. In October 2019, Virgin Galactic led them in the right direction when it joined the VC of Chamath Palihapitiya’s SPAC. It marked the first occasion a company Wall Street considered legitimate went to market via SPAC. Since then, many success stories have come along, such as DraftKings, which went public via SPAC and yielded 776 percent by March 2021.
Market volatility has increased. The markets have been turbulent. It is reported that the CBOE Volatility Index (VIX) reached its 10-year peak in May 2020. The IPO window seems to be large and wide, only to close into place quickly. The volatility does not go according to the standard IPO procedure, which could be more than one year.
Retail investors who are interested in companies with high growth potential. One significant drawback of a SPAC to investors would be the large stake that the sponsor gets in the deal. This may be double digits. Why should investors be interested in this? Since SPACs provide retail investors with an opportunity of investing in “hot” IPOs with high development and exciting prospects. Direct listings and traditional IPOs aren’t accessible and open to all investors. The year 2020 saw the average first-day IPO return was 41.6 percent, according to The University of Florida’s Ritter.
How a SPAC Works in Practice
SPACs are generally founded by sponsors. A sponsor may be an investor in private equity, a hedge fund management company, or even a group of highly successful operating executives. The sponsor could have a goal, but they cannot legally possess term sheets or contracts to achieve that goal.
When a SPAC IPO is priced and financed in contrast to the traditional public offering, the company doesn’t receive the money. The profits are deposited in a trust account that can pay a small interest.
Then, the sponsor starts to search for, screen, and negotiate with potential acquisition potential buyers. The de-SPACing process begins, and so does the merger of the privately operated company and the publicly traded SPAC. When the letter of intention and the merger documents have been approved, the newly formed business can end the M&A and deposit the money into the trust fund. However, mergers are often accompanied by private investments in public equity (PIPE). Therefore, if a SPAC initially sought to raise $300 million but subsequently found a goal that requires $700 million, the sponsor can get that $400 million through the PIPE process from institutional investors generally at a lower cost.
After the announcement of the target after the target is announced, SPAC shareholders will vote for the purchase. The shareholders who support the deal remain on and eventually become shareholders in the newly formed company. This assumes that the crucial majority, a “yes” vote, is secured to close the deal. Investors who do not agree get their money back. If any SPAC investor “walk away” from the M&A, PIPE financing may help fill in the gaps in the amount of capital the private firm needs.
In this case, three sides have interests to consider: the company going public, the investors in the SPAC, and those who sponsor the SPAC. The discussion will be conducted from the viewpoint of the company going public.
Faster
SPAC transactions are a type of merger. SPAC transactions are one of the types that constitute a merger. It could be reversed, or the union of equals or SPAC owners may dominate the cap table after a transaction. However, since the SPAC was drafted to be filed, supervised, and managed to execute an acquisition, it’s likely to be quicker (and more affordable) than a conventional IPO for the newly acquired company. The standard IPO process could take two to three years from beginning to finish, whereas a SPAC merger takes only approximately three to 4 months.
Lower Banking Fees
Since the funds have already been raised (and put into the trust accounts) and the bank fees could be lower than the traditional IPO’s 7.7%. The discount for underwriting a SPAC IPO is around 5.5 percent, with 2 percent paid on the date when the IPO and the remaining 3.5 percent paid upon the completion of SPAC decommissioning (i.e., the business targeted for acquisition).
Lower Dependence on Market Conditions (IPO Window)
With a SPAC, the capital formation process is separated from the exchange listing process. The funds are already raised and are sitting in an account in trust. If the company that manages the private party, together with its sponsor, could convince shareholders and persuade them to approve the merger. The deal could be concluded regardless of a recession or bear market.
