What is a SPAC?
The past few weeks I’ve been asked by many friends what a SPAC is. They’ve been wondering why companies go that route when considering an IPO. Well, that is what this article will clear out for all of us non-smart people. By the end of this article, you should have a better understanding of what a SPAC is. While also understanding why companies go about this route. If you want a good recent example about this check out this article regarding Black Rifle Coffee’s IPO.
How a SPAC works?
Special purpose acquisition companies (SPACs) have become a preferred way for many experienced management teams and sponsors to take companies public. They have become fairly popular in the past 5-10 years. There were 295 newly formed SPACs in the first quarter of 2021 and 247 is formed in all of 2020 last year. Now, compare that to 2010 where there were only 2. Like I said grown in popularity recently. The reason they are popular is that these entities raise capital through an Initial public offering (IPO) for the purpose of acquiring an existing operating company. When that happens the acquired company then becomes a publicly listed company.
For example, Black Rifle Coffee, they are starting a SPAC, SilverBox-Engaged (blank check company), and that company will go public and raise capital. Once it does that it will acquire Black Rifle Coffee and rename itself from SilverBox-Engaged to Black Rifle Coffee. Which will make Black Rifle Coffee a publicly listed company. That is a dumbed-down version of what it is. But that is essentially how it works.
The funds that are raised in the IPO are placed in an interest-bearing trust account. The funds cannot be used unless you use them to complete an acquisition or you are returning the money to investors if the SPAC is liquidated. You generally have two years to complete a deal or face liquidation.
Advantages for a SPAC
There are obviously advantages and disadvantages to going down this route. But here I want to focus on the advantages. One of the main advantages of SPACs is a company can go public through this route in a matter of months. While the conventional IPO process is a super long and stressful process. Which can take up to six months to more than a year. This is why they rose in popularity in 2020. Due to the market volatility because of COVID, most companies wanted to get to become publicly traded sooner. I mean can you blame them?
The second big advantage is that the company to be acquired can request a premium price. This is possible because SPACs have a limited amount of time to make a deal. As mentioned above.
Disadvantages/Risks for a SPAC
Those are pretty awesome advantages I have to admit. But now let’s discuss the risks involved with this route. Because as we know not everything is sunshine and rainbows. With this route, the investor is taking a leap of faith that its promoters will be successful in acquiring said company. SPACs have a reduced degree of oversight from regulators and a lack of disclosure. This means retail investors run the risk of being stuck with an overhyped investment. Or even a fraudulent one.
Which can affect returns, which is the most important thing when it comes to investing. Once the initial hype has worn off so do the returns. Per the strategist at Goldman Sachs noted that 70% of SPACs that had their IPO in 2021 were trading below their $10 offer price as of Sept. 15, 2021. If you are not sure what that means I can break it down for you…it’s not horrible.
This puts into question is there a bubble with SPACs. The experts are saying yes and because of the mass use in the last 2 years that bubble is looking to burst soon. So, be aware of the risks when investing in companies going down the SPAC route.
SPACs are not as complicated as many people make them out to be. The best way to look at them is as another tool in the chest for you to use. They are mainly tools for a company looking to grow and expand. They are necessary for companies that don’t have the resources or the time to wait months or even years to go public. As I have mentioned they have grown in popularity in the past few years, but they are not necessarily common. Hopefully, that clears up what special purpose acquisition companies are. Now, go out there and show all your friends how smart you are.
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