Companies that raise capital in an IPO are called special purchase acquisition vehicles or SPACs. Other terms for it include blank-check companies and cash-shells. In this very different type of IPO, funds are reserved for acquisitions. Unlike others, this does not raise capital to grow a company and create liquidity for the closely held shares.
SPACs are like private equity investments, that is why they are also referred to as “single-shot” private equity fund. While smaller investors can enjoy some features as private equity when they invest in SPACs.
History of Special Purchase Acquisition Vehicles
SPACs have only been around in the 90s, and they were unsuccessful. David Nussbaum is considered to be the creator of SPAC. After founding an investment bank called EarlyBirdCapital, in 2003, he filed an S-1 to take Millstream Acquisition Corporation. And was able to raise $20 million to acquire NationsHealth in 2004. The boutique investment bank boasts its recent transactions with different corporations. Such as Graf Industrial Corp., TKK Symphony Acquisition, etc.
From 2006 to 2007, SPACS became more well-known yet declined for some reason. But 2008 was the year that SPACs rose to popularity. This happened due to the New York Stock Exchange and NASDAQ starting to list SPACs.
SPACs raised more capitals in 2015 up until 2017 but still remained below their peak levels during 2007. This was due to the fallout from the subprime crisis and the Great Recession that followed.
In 2017, however, the business rebounded as the New York Stock Exchange. Updated its rules governing them in order to be more competitive with NASDAQ.
SPACs – How it Works
SPACs undergo the usual IPO procedure in which they submit a declaration of registration and firm commitment. Generally, they start out as corporate shells. As they are registrants with properties consisting only of cash and cash equivalents. The Securities Act of 1933 provides that. The founders purchase the shares of the shell at a nominal price to be used for the IPO. This transaction requires a Form S-1 like any other IPO. Here, the founders may disclose details like the nature of the acquisition targets they will need.
SPACs, especially those regulated by the NYSE or NASDAQ, place 90% of the funds raised in the IPO. An independently seen trust account that earns a rate of return, while the company seeks to invest the monies in the acquisition. The trust account funds are usually invested in, or retained as cash in. Short Term U.S. government securities and are released to fund the company mix. Typically it also requires deductions of interest earned on the assets to fund franchise and income taxes.
The new policy of NYSE done in 2017 included the aforementioned requirement, About the placement of 90% of the funds raised in a trust account. As well as the rules on approval of the acquisition. And also lowering the minimum listing size of a SPAC from $200 million to $80 million. NASDAQ also became more lenient to maintain the competition in NYSE.
Founders of SPACs receive a share, usually 20% of the value of the acquisition. They normally do not receive remuneration other than the ownership positions. Their shares are then locked up for a period, about three years, after the IPO date.
Comparison to Other IPOs
One key difference between SPACs and other IPO offerings is that they sell in units that involve a share and one or two warrants. Which usually detaches from the shares and trade a couple of weeks after the IPO. The selling price is $10 per unit. They are also considerably quicker as financial statements are short. And can be prepared in just a few weeks, although they can be risky investments. Due to the possibility that a company may not complete an acquisition. The return on investment is lower and they do not know what targets will be acquired in advance.
There are factors that lead to a value-destroying M&A strategy. But with SPACs, there are only a few strategies as they seek to convert their liquid cash. Into an equity investment in an unknown company. In a study of 169 SPACS from 2003-2010, the researchers, Jenkinson and Sousa, found that over half of the deals immediately destroyed value. After comparing the per-share value of the SPAC at the time of the deal with the per-share trust value. They thought that the SPAC should be liquidated and the acquisition should not go on. If the market value is equal to or less than the trust value.
Why SPACs are Still Popular
Despite the negative results of studies, SPACs continue to rise to popularity. As investments are liquid and the shares are sold to the market in the initial IPO. This is far better than private equity investments which are not very liquid. As mentioned in the first part, they are also available to small or non-institutional investors.
Jenkinson and Sousa, in spite of the fact that they concluded market prices as of the acquisition approval date. Indicated deals can be value-destroying. They found that investors who went along with the recommendations of the SPAC founders. In spite of a negative signal from the market suffered –39% cumulative returns within six months and –79% after one year. It’s not surprising that SPAC founders recommend deals. Since they derive their compensation by receiving 20% of the capital value of any acquisition. Hence, they try to pursue investors to approve in order to get their money. Despite causing them to lose. This is because it can still make a significant return on the founders. Even if SPACs perform poorly, it’s impressive how the investors still approve almost three-quarters of deals.
Lastly, another research about which types of SPACs fared better found out that success is more favorable to SPACs that are more focused and had a management team from an industry with a track record of success. Those that tend to fail more are foreign SPACs.
© Image credits to Amber Lamoreaux