Welcome to Structure Corner, a series of Spotlights where we use StructureFlow to help explain the complexity behind current and engaging commercial issues, harnessing the power of visualisation to do so. In this Spotlight, we’re taking a look at SPACs (Special Purpose Acquisition Companies) and explaining how they work. We hope you enjoy our content!
What is a SPAC?
A Special Purpose Acquisition Company (SPAC) is a ‘cash-shell’ company established to raise money through a public listing, with the purpose of then acquiring an existing private company with commercial operations. SPACs began in the US in the early 1990s, first launched by an investment bank called GKN Securities. Their popularity has varied, but SPACs have experienced a meteoric resurgence in 2020 and 2021, likely due to market volatility making the traditional route of an Initial Public Offering (IPO) less appealing.
How do SPACs work?
The process begins with the Sponsors, who can be legal entities or high net worth individuals. Social Capital’s sponsor was SCH Sponsor Corp, whose shareholders were Chamath Palihapitiya and Ian Osborne. The Sponsors’ role is to set up the SPAC and cover initial costs. As a result, they acquire a shareholding in the SPAC post-IPO – known as the ‘promote’.
Click to view – Stage 1
The SPAC then undergoes an IPO – this is how it raises funds for its acquisition. SPACs usually float at $10 per share. Investors are issued both shares and warrants, being an entitlement to purchase shares in the future for a fixed price. Following the IPO, the Sponsors are typically left with a promote shareholding of around 20%.
Click to view – Stage 2
The proceeds of the SPAC IPO are held in a trust account, until a target company is identified and acquired. This is by far the longest part of the process – SPAC Sponsors usually have two years in which to make an acquisition. If the SPAC fails in its objective, then it is wound up and the IPO proceeds are returned to investors.
Click to view – Stage 3
Once a target company is identified, the SPAC will make its offer, with consideration in the form of shares, cash or a combination. If the SPAC’s offer is accepted, then a ‘SPAC merger’ occurs.
Click to view – Stage 4
The SPAC and target company merge to form a single combined publicly-listed company. It is usually the target company’s name which is used as the ticker on the relevant stock exchange – as happened with Virgin Galactic, which trades on the New York Stock Exchange as “Virgin Galactic Holdings, Inc. (SPCE)”.
Click to view – Stage 5
Pros and Cons
The major advantage of SPACs is that they typically have much shorter listing timelines than traditional IPOs. In addition, SPAC Sponsors generally have industry-specific or general business expertise which can be a valuable attraction for prospective investors. For example, Chamath Palihapitiya – founder of Social Capital – was a senior Facebook executive before moving into the SPAC arena.
However, SPACs have attracted controversy as well as fanfare. At the time of the IPO, only a SPAC’s target industry or geographical region is known. This relative uncertainty has led SPACs to be seen as a significant risk for investors. The favourable terms of the promote for SPAC Sponsors in comparison to investors is also a major point of contention.
It looks as though SPACs are here to stay, but their historical fragility means the SPACs bubble could burst as quickly as it inflated. The UK is currently investigating regulatory change that will make London a more SPAC-friendly market, a trend which may be followed elsewhere. Whatever happens, this is undoubtedly an exciting time for SPACs, and we will be watching with interest.
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If you’re interested in acquisitions and takeovers, head over to our recent post on Football Takeovers.
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