So, You Want to Learn More about SPACs? Your Top Questions Answered

So, You Want to Learn More about SPACs? Your Top Questions Answered

Derek Gabrielsen, CRPC®, Wealth Advisor

2020 was a tipping point for special purpose acquisition companies, or SPACs. As they grew in popularity, so did investor interest in them. In fact, one Investopedia article cites SPACs raised a record $81.1 billion in 2020.

If you’re trying to piece together what they are and how they work, you’re not alone. Here are a few of the most popular questions we have received on the recent SPAC attack:

1. 1. What is a SPAC? In short, a SPAC is a company formed by investors, or sponsors, with no purpose other than raising capital through an initial public offering (IPO) in order to acquire an existing company. This business model is why SPACs are often referred to as “blank check companies.” Once the acquisition is complete, the founders receive a stake in their new company and investors get equity interest based on their capital contribution. In 2020, roughly $79.87 billion were raised in gross proceeds compared to only $13.6 billion in 2019. DraftKings and Lucid Motors are a few of the notable names in a large list of companies that are using this route to go public.

1. 1. How do they work? Majority of the time, the sponsors do not have their target acquisition picked out when they begin to form a SPAC. Once a target company is decided and funds are in place, the SPAC merges with the target company to become public.

1. 1. Are there any advantages of a SPAC over a traditional IPO? One of the first differences you’ll notice is the sale price of the SPAC target company, which can be up to 20% more compared to a private equity deal. Another distinction is that the speed of the deal can be much faster. SPAC deals are usually completed in four months while the IPO process can take a year or more. Finally, there is traditionally less money left on the table with SPACs, which is common for traditional IPOs when the price is too low.

1. What are the disadvantages of a SPAC? First off, the founders of the SPAC get to keep 20% of the equity as long as a deal is done within two years. Additionally, with SPACs becoming much more popular, there can be multiple ones going after the same target – which has been dubbed “SPAC-offs.” Lastly, because they operate on a tight timeline and must find a target within two years, critics say that the sponsors may not be properly incentivized to find the best possible deal for their investors.

Think you’re ready to get in on the SPAC frenzy? There’s a lot more to it that should be reviewed with a professional. Please contact your advisor at 216.800.9000 to learn more about your options.