What Is a Special Purpose Acquisition Company?
A special purpose acquisition company (SPAC) is a publicly traded shell corporation formed solely for the purpose of raising capital through an initial public offering (IPO) to acquire or merge with an existing private company. Often referred to as "blank-check companies," SPACs do not have any active business operations at the time of their IPO; their only assets are the cash raised from investors. The primary goal of a SPAC is to identify and complete a merger or acquisition with a private operating business, thereby taking that private company publicly traded without the traditional IPO process. This unique structure positions SPACs as a distinct financial instrument within the broader realm of capital markets.
History and Origin
Special purpose acquisition companies first emerged in the 1990s as a niche financial vehicle, but they gained significant prominence and popularity in the 2020-2021 period, attracting substantial investor interest. Initially, these entities were viewed as a quicker, and at times, less complex alternative for private companies to access public market capital compared to a traditional initial public offering (IPO). The surge in SPAC activity during this era was record-breaking, with hundreds of SPAC IPOs raising billions of dollars, a stark increase compared to previous years.21 This period saw companies across various sectors, from technology to electric vehicles, leverage SPACs to go public.20 The Securities and Exchange Commission (SEC) also began to issue investor bulletins and statements during this time, indicating increased regulatory attention on SPACs.19
Key Takeaways
- A special purpose acquisition company (SPAC) is a shell company that raises capital through an IPO with the sole intention of acquiring or merging with a private operating business.18
- SPACs typically have a specified timeframe, often 18-24 months, to identify a target company and complete a business combination. If no acquisition occurs within this period, the funds are generally returned to investors.17
- The proceeds from a SPAC's IPO are held in a trust or escrow account until an acquisition is completed.15, 16
- Investing in a SPAC allows public investors to participate in potentially high-growth companies that might not otherwise pursue a traditional IPO.14
- Sponsors, often experienced management teams, form SPACs and generally receive a significant equity stake in the SPAC, known as "founder shares."13
Interpreting the Special Purpose Acquisition Company
Understanding a special purpose acquisition company involves recognizing its two distinct phases: the initial shell company phase and the post-acquisition operating company phase. In its initial stage, a SPAC is essentially a pool of cash with a management team, seeking a suitable private company to acquire. Investors in this phase are essentially betting on the expertise and due diligence capabilities of the SPAC's sponsors to find a promising target.
Once a target company is identified and a definitive agreement is reached, shareholders typically vote on the proposed business combination. If approved, the private company merges with or is acquired by the SPAC, becoming a publicly traded entity. At this point, the SPAC essentially transforms from a cash-holding shell into an operating business. The investment performance then hinges on the success and integration of the newly public company. Investors must evaluate the target company's business fundamentals, growth prospects, and the terms of the merger to interpret the potential success of their SPAC investment.
Hypothetical Example
Consider "Horizon Acquisition Corp.," a hypothetical special purpose acquisition company formed by a group of experienced tech executives. Horizon raises $200 million in an IPO, with each unit priced at $10, consisting of one share of common stock and one-half of a warrant. This $200 million is placed into a trust account.
Horizon Acquisition Corp.'s management team then begins searching for a private, high-growth technology company. After several months of due diligence and negotiations, they identify "InnovateAI," a promising artificial intelligence startup, as a suitable target. Horizon proposes to acquire InnovateAI for an enterprise value of $1.5 billion. The terms of the acquisition involve a combination of the SPAC's cash, new debt, and additional equity issued to InnovateAI's existing shareholders.
Before the deal closes, Horizon's shareholders vote on the proposed acquisition. Shareholders have the option to redeem their shares for their pro-rata portion of the trust account if they do not approve of the deal. If the deal is approved and closes, InnovateAI becomes a publicly traded company under a new ticker symbol, effectively completing the "de-SPAC" transaction. Investors who chose not to redeem their shares now hold stock in the combined entity, InnovateAI.
Practical Applications
Special purpose acquisition companies offer an alternative route for private companies to become publicly traded, bypassing some aspects of the traditional initial public offering (IPO) process. This can be particularly appealing for companies seeking greater price certainty, speed, or a perception of more control over deal terms.12
For sponsors, often prominent private equity managers or industry veterans, SPACs provide a mechanism to leverage their expertise and network to identify and acquire promising businesses. An investment bank typically plays a key role in the underwriting of the SPAC's initial public offering, facilitating the capital raise from public investors. SPACs have been used by a wide array of companies for public listings, reflecting their flexible application in capital markets. The Securities and Exchange Commission has provided guidance to investors on understanding SPACs, including information on the initial stages of a SPAC and the subsequent "de-SPAC" transaction where the operating company is acquired.11 Recent reports suggest a resurgence in the SPAC market, signaling their continued relevance as a pathway to public markets, especially for companies that may not be ideal traditional IPO candidates.10
Limitations and Criticisms
Despite their appeal, special purpose acquisition companies are not without limitations and criticisms. One significant concern revolves around potential dilution for public shareholders. This can arise from the "founder shares" awarded to sponsors, which typically represent a substantial percentage of the SPAC's equity for a nominal cost, and from warrants issued to investors, which can lead to more shares being issued later.9
The performance of companies that have gone public via SPACs has also been a subject of scrutiny, with many de-SPACed companies experiencing significant declines in share value post-merger.8 Critics have pointed to factors such as inflated valuations, lack of thorough due diligence on target companies due to compressed timelines, and potential conflicts of interest for sponsors.7 Regulatory bodies, including the SEC, have expressed concerns regarding investor protection, particularly around disclosures and the aggressive revenue projections sometimes made by target companies.6 Some companies that went public through SPACs during the boom period have even faced significant financial challenges, with a number filing for bankruptcy.5 This highlights the inherent risks for shareholders, especially if the acquired business does not perform as anticipated.
Special Purpose Acquisition Company vs. Initial Public Offering
The primary distinction between a special purpose acquisition company (SPAC) and a traditional initial public offering (IPO) lies in the sequence and nature of the public listing process.
In a traditional IPO, an existing, operating private company goes directly to the public markets to raise capital by selling its shares. The company's financials, business operations, and management team are all well-established and subject to extensive scrutiny and regulatory filings before the shares are offered to the public.
Conversely, a SPAC conducts its IPO before it has identified an operating business to acquire. It raises money as a "blank-check" company, and only after its own public listing does it seek out a private company to merge with, effectively taking that private company public through a "de-SPAC" transaction. This method can offer the acquired private company a faster path to public markets and greater certainty regarding valuation, as the SPAC's initial capital is already raised. However, for investors, a SPAC IPO involves investing in the management team's ability to find and execute a successful acquisition, whereas a traditional IPO involves investing directly in an existing business.
FAQs
How long does a SPAC have to find a company?
A special purpose acquisition company typically has between 18 to 24 months to identify and complete a merger or acquisition with a private company. If the SPAC fails to do so within the specified timeframe, it generally must liquidate and return the funds held in trust to its public shareholders.4
What happens if a SPAC doesn't find a target?
If a special purpose acquisition company fails to complete an acquisition within its mandated timeframe, the funds held in the trust account, along with any interest earned, are returned to the public shareholders. The SPAC is then liquidated.
Are SPACs risky investments?
SPACs carry inherent risks. While they offer the potential for investors to get in on high-growth companies earlier, risks include the possibility that the SPAC may not find a suitable target, the acquired company may underperform post-merger, or investors may experience dilution from founder shares or warrants. It is essential for investors to understand the risks involved with these complex financial instruments.2, 3
Who creates a SPAC?
Special purpose acquisition companies are typically created by experienced sponsors, who are often professionals from the world of finance, such as private equity fund managers, hedge fund managers, or seasoned industry executives. These sponsors form the SPAC, raise capital through an initial public offering, and then seek a target company.1