Special Purpose Acquisition Group, commonly known as SPACs have been the biggest trend in the mergers and acquisitions industry in the last year, and they have been in the news constantly during that time. With SPACs playing such an important role in the market it’s worthwhile to spend some more time understanding this unique type of buyer for a company. We will look more closely at what SPACs are, how they operate, and what this could mean for the small to mid-sized business market.
What are SPACs?
According to Investopedia, “A special purpose acquisition group (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.” Simply put, SPACs are companies that exist solely to acquire capital and eventually acquire another business. Typically, SPACs look for private companies that are looking to go public, and use the funding from their founders, and from their initial public offering, to expedite the seller’s process of going public.
In a traditional initial public offering (“IPO”), an operating company goes public when it believes it is of a size, and with enough resources, to comply with SEC reporting requirements. In comparison, a SPAC goes public before it has any commercial operations, and thus, is a shell company when it goes public.
How do they work?
Usually, SPACs are formed by a group of industry experts, professional investors, and even public figures. The individuals that make up this group are often referred to as “sponsors” and are the group that leads the SPAC throughout the entire process. It’s important for these individuals to have proven success in the industry that the SPAC is looking to acquire in, as they will have to convince potential investors to invest their money into the promise of a future acquisition.
While the SPAC’s sponsors may have a potential target at the time of formation, often times they are still in the process of seeking out a company during the capital raising process. Furthermore, they avoid disclosing information about potential acquisition targets during the initial public offering, meaning that investors are blindly investing their money without a lot of information regarding what those funds may be used for. Therefore, credibility is key for the sponsors to they can convince their investors that their investment is wise.
Following the initial company formation, the company files for an IPO. Investors have the opportunity to purchase the shares of the SPAC, giving them a stake in the upcoming acquisition, and giving the SPAC more capital to work with. The share price during the IPO is typically $10 and has no relation to the true value of the company at the time of the IPO. The funding from the IPO is usually placed in an interest-bearing trust account until the transaction is completed. This acts as a guarantee that funding will only be used for either completing the acquisition, or to reimburse the investors should the SPAC fail to find a proper target in a certain amount of time, usually two years.
Once the SPAC finds a promising company to merge with, the leadership will negotiate with the seller. Once an agreement is reached, the seller will typically merge with the SPAC, though there are many ways to structure these kinds of deals. One important thing to note, is that shareholders in the SPAC must approve the merger, which leads to the possibility that a deal could be rejected. If the transaction goes through, the seller will continue to operate, only now as a publicly traded company as opposed to a private one.
For Sellers
There are several advantages to selling a business to a SPAC. One of the biggest benefits to smaller companies, is that it can speed up the process of taking a company public. Unlike a traditional IPO, which can take up to 6 months according to an article on CNBC, a SPAC deal can take a private company public in only a couple of months. Furthermore, since the IPO was done upfront via the SPAC, the seller doesn’t have to worry about the potential risk of a poor stock launch if they try to do public funding themselves.
Another advantage of selling to a SPAC, is that they often lead to higher valuations and sales prices for the selling company. Since SPACs only have a short two year window of time in which to find a suitable target, they are typically more willing to pay a higher price in order to get a deal done. According to Investopedia, selling to a SPAC can potentially result in a 20% increase in the final selling price. Clearly, it is extremely beneficial to sell to a SPAC should the opportunity present itself.
While the upside is there for sellers, SPACs are not without risk. One potential issue, is that the shareholders could reject the deal, leaving the seller back at square one. Furthermore, CNBC mentions that the average post-market returns for IPO investors from 2015-2020 is less than those from more traditional IPOs. Given the already risky nature of a SPAC for IPO investors, there’s the chance that a lower return could lead to investors pulling out, which has the potential to severely damage the value of the seller’s company post-transaction.
Final Thoughts
SPACs have the potential to be very beneficial to companies in the small to mid-sized market. They allow for a company to quickly go public, and can lead to a higher sales price. However, due to the fact that SPACs rely on the trust of public investors, and their boom-bust tendencies, means that SPACs aren’t without their risks. Having a mergers and acquisitions advisor like Seck Advisor Group can help you decide if selling to a SPAC is right for you. If you are thinking of selling your company, and want to know more, email me at sseck@seckadvisor.com to set up a call with me. I hope to hear from you soon.
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