Role of an Exchange: The Facts on SPACs

Everyone is talking about SPACs -- Special Purpose Acquisition Companies. Shaq, Serena Williams, A-Rod, Steph Curry are just a few of the big names you’ve likely heard associated with SPACs. But what exactly are SPACs, and why have they suddenly become so popular?

Everyone is talking about SPACs -- Special Purpose Acquisition Companies. Shaq, Serena Williams, A-Rod, Steph Curry are just a few of the big names you’ve likely heard associated with SPACs. But what exactly are SPACs, and why have they suddenly become so popular?

What is a SPAC?

SPAC is a shell company that has no assets or operations. It exists to raise a pool of capital through an IPO for the sole purpose of acquiring an existing company in the future.  SPACs are formed by sponsors (also referred to as founders), who are usually either high-profile venture capitalists or seasoned corporate executives with strong reputations.

SPACs are commonly referred to as “blank check companies” because investors won’t know the identity of the target company until after the funds are raised. In fact, while some SPACs will disclose that they intend to focus on a specific industry or geographic region, the sponsors are not allowed to identify a target when the funds are raised and can only begin the search for a target after the SPAC’s IPO. Essentially, investors are relying on the sponsor to identify and acquire a successful company that will make their investment profitable.

How Does a SPAC Work?

After the IPO, the SPAC is publicly traded on a major U.S. exchange such as Nasdaq and identified by a ticker symbol that may have a “U” at the end. This is because unlike a traditional IPO, which sells common stock, a SPAC typically sells units. A SPAC unit bundles a share of common stock with whole or partial warrants. A warrant gives the holder the right to buy additional common shares at a certain price (known as the “strike price”) at a future date after the SPAC completes an acquisition. SPAC units are typically priced at $10.

For SPACs listed on Nasdaq, the ticker symbol of the unit will usually have a fifth character of “u,” and the ticker symbol of the warrant will typically have a fifth character of “w.” Thus, ABCD Acquisition Company would have three symbols: ABCD for the common stock, ABCDW for the warrant, and ABCDU for the unit.

Wondering about Warrants?

By including warrants, SPACs are able to compensate investors for holding their capital until management identifies a target business and closes the merger. There are various warrant formulas among SPAC offerings, but a typical $10 unit is comprised of one common share and one-third of a warrant to purchase another full share at a strike price of $11.50. Warrants in a typical SPAC can first be exercised 30 days after the business combination and up to five years thereafter.

For example, if an investor purchases 300 units of the SPAC, when the units separate, the investor would have 300 common shares and 100 warrants. If after the SPAC acquires an operating company, the shares trade at $16 per share, each warrant is worth the difference between the $16 share price and the $11.50 strike price, or $4.5. The better the merger is considered by the marketplace, the higher the company’s stock price will climb and the more valuable the warrants become. However, if a merger fails to materialize and the SPAC is liquidated, the warrants become worthless. Or, if the merger is poor or even average, there is potential for the warrants to expire essentially worthless, if the company’s stock price doesn’t meet (let alone exceed) the strike price before the expiration date.

While only units are issued by the SPAC in its IPO, the components of the units (the warrants and the common shares) can usually be separated to trade independently within a couple of months after the SPAC IPO closes. It is important for investors to understand whether they are buying the whole unit, just common shares or only warrants.

How are investors protected during the acquisition of a target company?

Once the SPAC completes its IPO fundraising, sponsors have a limited time to acquire an operating business, typically two years. Investors are protected during this period because the capital raised in the SPAC IPO is held in a trust account. After a target business is identified, shareholders of the SPAC are informed about the proposed target in a proxy or information statement filed with the Securities Exchange Commission (SEC). In many cases, shareholders will be asked to vote to approve the transaction.

Any shareholders who don’t want to participate in the merger are given the opportunity to “redeem” or convert their common shares for a pro-rata share of the funds in the trust account. Typically, the redemption amount is equal to the initial public offering price (usually $10.00 per public share), which protects any IPO investors who don’t want to invest in the merger from losing their initial investment However, any shareholders who purchased shares in the SPAC at a premium after the IPO will lose that premium because the redemption amount is limited to the initial offering price. The timing and process for exercising redemption rights vary among SPACs, and sometimes require the assistance of a broker.

When the business combination is announced, investors can obtain information about the target company and the terms of the proposed transaction in Forms 8-K and the proxy statement or information statement filed with the SEC and available through EDGAR. The proposed SPAC combo is subject to a second round of reviews from the listing exchange, where the combined company must meet all initial listing requirements; it’s also subject to review of its disclosure by the SEC.

To merge or not to merge?

Once the merger process is complete, the target company is combined with the SPAC in a reverse merger process called a de-SPAC transition. The SPAC takes the identity of the company it acquired and usually lists under a new ticker symbol.

If the sponsors fail to make an acquisition by the deadline, the SPAC is liquidated and funds are returned to investors, although shareholders may be able to approve a short extension in some cases. Capital generally cannot be disbursed from the SPAC trust account except to make an acquisition, to redeem the shares of investors who do not wish to participate in the acquisition or to return the money to investors if the SPAC is liquidated.

Why are SPACs surging in popularity?

Economic uncertainty due to COVID-19, the 2020 presidential election and subsequent change in the administration appear to have fueled a boom in SPACs and business combinations. Companies may be looking to hedge economic volatility by going public and potentially raising capital quickly, and notably, the SPAC process is often faster than a traditional IPO.

Sponsors are also looking for new companies to invest in, and ostensibly they like SPACs for the opportunity to create value through synergies and potentially become part of a public company management team or board. Sponsors can be richly compensated for consummating a deal.

Interested in learning more about a SPAC?

Investors can obtain information about a SPAC throughout its lifecycle from filings made with the U.S. Securities and Exchange Commission (SEC), which is available on its EDGAR database. The SPAC’s prospectus or registration statement, typically a Form S-1, will provide information about the SPAC’s area of focus, how long the SPAC has to complete a transaction, the background of the SPAC sponsors and other key personnel and information about how they are compensated, the terms of the SPAC’s warrants, and information about when the units will separate. Like a traditional operating company, the SPAC’s Form S-1 is reviewed and declared effective by the SEC and the listing exchange reviews the SPAC to make sure it satisfies the initial listing requirements. These reviews are an integral part of the work done by stock exchanges to protect investors.

Information is provided for educational purposes only. The content does not attempt to examine all the facts and circumstances which may be relevant to any particular company, industry, strategy or security mentioned herein and nothing contained herein should be construed as legal or investment advice. Nasdaq does not recommend or endorse any securities offering; you are urged to read the company’s SEC filings, undertake your own due diligence and carefully evaluate any companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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