When I internally rank my favorite finance terms (accountants are strange), one of the main ranking categories is how close the word is to a fighting description you’d see in a superhero comic book. SPAC is right at the top of that list. Can’t you picture Batman punching someone in the head and a massive SPAC sound appearing in the air above them?
Special purpose acquisition companies (SPACs) are all the rage in the finance universe right now. They allow individual investors to invest in private equity-like deals and give startups a less expensive way to go public while dodging a traditional initial public offering (IPO).
Read on to see if your business could work with a SPAC.
Overview: What is a SPAC?
SPACs are commonly called blank check companies. A seasoned and popular investor raises money which is held in a trust until they can use it to purchase a private company and take it public. The SPAC effectively has a blank check to use on an acquisition.
Typically, the main investor receives 20% of the shares in the SPAC as payment for finding and negotiating the deal. Shareholders vote on whether to purchase the company that the lead proposes. Usually the SPAC has two years to find a deal.
The main investor differs from a typical lead investor in venture capital financing, but the same mentoring type relationship may happen with the startup.
How SPAC works to raise capital
Traditionally, when a private company wants to go public to raise cash, it engages an investment bank (which charges a fee based on the IPO price) to underwrite an IPO. The investment bank analyzes the company’s cash flow and proposes an IPO price. From there, the business management team goes on a roadshow to pitch the company to investors and eventually lists on an exchange.
With a SPAC, the money is raised ahead of time and the SPAC is already on an exchange. When the deal is complete, it simply changes the name and ticker symbol of the subject stock.
5 benefits of selling to a SPAC
Here are a few reasons to consider a SPAC IPO.
1. You don’t have to do a roadshow
Roadshows are intense. Mark Zuckerberg made national news when he didn’t want to wear a suit and tie at Facebook roadshow events. I don’t even remember the last time I wore a tie.
In a roadshow, you will visit countless institutional investors who have all read your SEC filings and analyzed your financial projections. Each one has been seasoned through years of bad deals to want to kill your pitch and show why your business won’t succeed.
With a SPAC, you only have to pitch to one institutional investor who analyzed your financials and has been seasoned by years of bad deals to try to kill your pitch and show you why your business won’t succeed.
2. You don’t have to worry about the market
Though it’s rare, IPOs have been killed by market turbulence. Most IPO investors want to get out as soon as possible. They can only do that if the market responds well to the IPO and the stock rises in the first year or two. If the IPO price keeps coming down because of the market’s reaction, institutions may drop out. With SPAC financing, you only have to worry about the shareholder vote.
3. There’s less due diligence
Each benefit so far is a form of one general benefit: you get to work with just the SPAC instead of a team of investment bankers and numerous faceless investors.
In an IPO, you’ll face endless due diligence. Each investor wants to do their own analysis and you have to file forms with tremendous detail about the company with the SEC. To go public, you’ll never escape the SEC, but you’ll have to suffer only one due diligence from the SPAC and have to negotiate only things such as business valuation with them.
4. You’ll work with experienced investors
Investment bankers work long hours, and the directors generally have a ton of experience doing deals, but few of them have much experience on the business side either as an investor or an operator. Investment bankers are generally salesmen.
If you consider working with a SPAC, you may work with someone who was a founder before, someone who knows what it’s like to dig through accounting software to find an arcane report. Or you may work with someone who has worked in venture capital (VC) for years and is better at working with an actual business.
5. You can stop raising venture capital
Speaking of venture capital, the key benefit to both SPACs and IPOs is that you don’t have to do any more rounds of venture capital. Instead of negotiating with VCs for every financing round, you can let your company’s success do the talking and issue shares when the stock is overvalued.
An example of a SPAC deal
Here are the steps to a typical SPAC deal:
- Structure the SPAC: The SPAC is formed legally and the structure is determined.
- Raise funds: The SPAC employees go on a roadshow and raise the “blank check” funds.
- Pick an investment: The SPAC employees research deals and choose a worthy company to invest in. SPACs usually have two years to find a deal.
- Shareholder vote: Shareholders will vote on the deal, and sometimes shareholders will redeem their shares for cash to avoid being involved in the deal.
- Raise more funds: SPACs rarely raise enough money in the initial fundraise to pull off the full purchase, so they’ll go back on the road and raise enough to complete the acquisition.
- Change the name: The last step will be changing the stock name and ticker symbol to convert the SPAC into the new public company.
Frequently Asked Questions for SPAC
How big are SPAC deals?
Bill Ackman recently raised $4 billion to create the biggest SPAC of all time. Most SPACs are in the hundreds of millions of dollars at most.
Why do investors buy into SPACs?
For many investors, SPACs are the only way to invest in private equity or venture capital-like deals. The SEC prohibits investors with a net worth below a certain amount from buying into these deals, but they can buy shares of a SPAC on the open market.
What are the costs?
SPAC financing still includes underwriting fees to go public and to make the investment worth it for investors. Remember, they’re paying the SPAC founder 20% of the shares. The valuation will likely be less than you’d get in an IPO.
Should you use a SPAC?
While SPACs have been around for almost thirty years, they still have not evolved enough to be an attractive exit for most founders. The costs are just too prohibitive. Over time, SPAC founder share amounts will go down, and someone will figure out a way to make it more cost-effective. Until then, stick to a good old IPO.
Original source: The blueprint