SPAC – Special Purpose Acquisition Company

Special Purpose Acquisition Companies [SPACs] are one of the most attractive asset classes at the moment and have enjoyed great popularity among investors in recent years. With declining dividend payments and persistently low interest rates, more and more investors are turning to alternative investment opportunities such as SPACs, but what is this hype all about?

SPACs are shell companies with no operations and no assets that are formed solely to raise capital through an initial public offering (IPO) in order to subsequently acquire or merge with an operating company. A management group – called sponsors – decides to form a publicly traded SPAC. In the SPAC IPO, shares with warrants are sold to investors to raise the necessary capital. Because SPAC shares are traded like ordinary shares, investors can continue to buy or sell them at market rates after listing. The funds raised through the IPO are subsequently held in trust for the acquisition of the target company and are usually invested in safe assets including a moderate interest rate. The structure of SPACs thus allows investors to put their money into funds without knowing how it will be used, hence the term “blank check companies”.

With the goal of a merger or acquisition, the management of the SPAC will actively search for a private company with great potential. Typically, a time frame of 18-24 months is agreed upon for this purpose, in which the management group must complete the M&A transaction. If they fail to meet the deadline, the SPAC is dissolved, and investors are entitled to a refund of their original investment. On the other hand, if a target company is identified and acquired, the SPAC and the company merge to form a publicly traded company, bypassing the traditional IPO. The investors themselves must approve the acquisition with a majority of usually 60 to 80 percent. Investors who do not agree usually still have the option of redeeming their shares.

So why does a company want to go public via a SPAC? On the one hand, it is seen as an opportunity to take advantage of the inflow of capital from the public market, while at the same time circumventing the regulatory hurdles and dangers of a traditional IPO. Thus, the issuing costs are lower and the risk of a high price discount at the IPO is eliminated. A traditional IPO is a time-consuming process, which is fraught with uncertainty despite significant resources. In contrast, a listing via a SPAC usually takes less time, which reduces the risk of waning interest until listing, as is often the case with traditional IPOs. Because a SPAC is a shell company with no operations or assets, there is no need for extensive roadmaps, investor pitches or meetings to generate investor interest. This feature saves time, effort and cost. Investors participate based on the reputation and expertise of the management group because there is no company, product or historical data to evaluate. This also allows for greater price certainty and control over the company being acquired because there is no longer a need to make assumptions about how the share price will be set. The price for the shares in the company is negotiated directly with SPAC, which means that the pricing is not left to the market and the risk of strong price fluctuations can be eliminated thanks to the fixed price for the shares.

Like any asset class, this one has its downside. SPAC sponsors are not compensated in the usual way but are typically given 20% of the founders’ shares at a greatly reduced price, known as “promote.” The high number of management shares and the low price dilute the investment value of the project because the sponsors do not contribute nearly as much capital as the shareholders, but they claim a large share for themselves. This makes the SPACs extremely lucrative for the sponsors. Management is compensated for the most part by investments made by shareholders. The repayment claims after expiry of the transaction period serve to protect investors and provide management with an incentive to complete an acquisition in a timely manner. At the same time, there are also disincentives due to the compensation structure. It is conceivable that wrong decisions could be made in the case of acquisitions due to time pressure if the management team does not want to forfeit its performance-related compensation. Even if the acquired company fails after the IPO, the sponsors have already received their share. For this reason, the relationship of trust between the management and the investors must be emphasized as the cornerstone of successful SPACs.

The possibility to minimize costs, time and effort of an IPO and at the same time to realize more flexibility is one of the big factors which speaks for the increasing popularity of SPACs and their success. However, as with any investment, there are risks that must be considered. Due to the nature of a shell company, investors put all their faith in the capabilities of the management team, so composition, expertise and reputation are critical to establishing trust. The lack of regulatory checks through a traditional IPO requires the SPAC to do more intensive due diligence on the target company and thus more self-reliance to identify risks at an early stage. Lastly, a risk-reward ratio must always be determined. The significant risk of SPACs is that the investor does not know what he finally acquires and blindly trusts the management team. At the same time, there is great potential, as an early entry at attractive prices is possible even before the actual IPO.