What is a Special Purpose Acquisition Company (SPAC)?
SPAC = Blank Cheque Company
A SPAC is a shell company, also known as blank cheque company, formed specifically for acquiring other assets or businesses.
The SEC filing process for SPACs is typically the same as that of an IPO. However, IPOs have a different funding process which makes SPACs a more accessible alternative.
The SPAC starts looking for funds after they release their IPO date for the first time. Investors place capital on the SPAC IPO, and they are provided with a warrant.
With these warrants, shareholders get the right to purchase shares at a low rate before the shares start trading on the respective exchanges.
What are Initial Public Offerings (IPO)?
IPO is the first opportunity that public investors can use to purchase a previously privately owned company. The company has to go through an extensive registration process at the Securities and Exchange Commission.
Hence, a private company would have to plan for at least six to twelve months for drafting an IPO with their underwriters.
Besides that, they also need to go through three rounds of responses and file at the SEC before actively looking for fundings and investors for their public proposal.
When the SEC approves the IPO and the funding is secured, it puts up its stocks on the respective exchanges to allow public investors to trade.
SPAC vs IPO – pros and cons
The requirements of investors and the market have always influenced the world of investments, and this is specifically true when we talk about the different ways companies go public.
The decision ultimately comes down to whether a company is going public through an IPO or SPAC.
While IPOs are still popular among most companies, SPACs are the best bargain for small companies as they provide an alternative fundraising opportunity that has already started changing how the entire market revolves around companies going public.
Why do companies go public?
The reason behind companies going public can be explained easily in the following pointers.
To Raise Funds
- Going public helps in raising funds and opening potential channels for future revenue growth.
- The early company employees can sell the equity shares they have in their bucket and access liquid cash from the share sale.
Prestige & PR
- Going public also brings the company a lot of prestige and publicity that helps them convey to everyone that they are here for serious business. Besides that, public companies tend to be luckier in recruiting top executives, engaging in acquisitions and mergers.
IPOs vs SPACs
The process of a company going public through an IPO is quite the reverse of what they have to do with a SPAC.
The most striking difference between a SPAC and an IPO is that, in an IPO, the company is operational and organized.
Whereas, when it comes to SPACs, they do not have an organization, and they are established to acquire another company and begin operations.
|Even before the merger starts, the company is established.||An existing company is planning to go public.|
|The company has to get itself registered at the SEC.||The company has to get itself registered at the SEC.|
|Funds are collected by creating an IPO at the beginning.||The company has to look for investors.|
|It opts for target acquisition.||An IPO is formed at the last step.|
|Shareholders’ voting decides the final merger.||Investors fund an operating, organized company.|
|A non-organized company is funded by investors who hope that the acquisition turns successful||Existing financial records back the public investors.|
|The merger turns into a publicly listed company.||An existing stable private history backs the company in going public for more exposure.|
What Does It Mean For The Investors?
Investors and shareholders create SPACs solely on their reputation. There is no real company for the investors to invest in or even record the losses and returns they have experienced.
During a SPAC merger, the investors have to leave their money essentially in a company account that they can use however they like.
In this case, the risks of investments are high, but once the merger gets completed, the returns are higher.
Advantages of a SPAC
Compared to an IPO, SPACs offer a much faster and simpler private-to-public turnaround for the companies. Investors are more inclined towards SPACs as they have witnessed companies’ stock prices shooting up once the merger is completed.
However, this can even lead to unforeseen consequences that involve market overvaluation and a large number of outstanding shares.
SPACs also show significant outcomes once the merger is done. For instance, Quantumscape, a solid-state lithium battery manufacturer merger with the Kensington Capital Acquisition, witnessed tremendous revenue growth.
The stocks were sold at $10 a share during the merger, but the same stock closed at $131.67 a month later. And it does not even end there, as, after 30 days, the shares ended up losing almost 63% of the value.
Advantages of an IPO
One can witness overvaluation even during Initial Public Offerings. Various new IPOs have had investors flock in, but that only resulted in a certain increase in the stock price with very little returns. Nevertheless, the cash that is generated through an IPO can help a successful company expand.
For instance, Airbnb in December 2020 set its IPO share price at $68. However, day one of trading only increased the price of each share up to $146.
But, IPOs can have different experiences too. Vonga was able to raise $531 million before their funding platform experienced a technical glitch.
They promised their customers that they could purchase shares nonetheless, which helped in raising $72 million. Ultimately, the glitch prevented the customer transactions from proceeding, making the shares lose 30% of the value.
Eventually, most large companies opt for traditional IPO processes because they have adequate capital that makes it easier for them to sell certain shares and make a profit.
But, SPACs are comparatively popular among start-ups, young and small companies as it helps them save on fees, complete mergers faster, and acquire a higher valuation.