In this article I’ll try and explain in a brief manner as to what SPACs are in the financial world and why they have gained a lot of popularity recently!
So let’s get right to it, what are SPACs? The term SPACs stands for Special Purpose Acquisition Companies. SPACs are basically shell companies that are created by a set of investors/sponsors and have no business functionality. So you might be thinking ‘what’s the point of creating a SPAC, when it literally does nothing’. SPACs are actually created for a very specific objective. The objective is to be able to raise money through an IPO as a shell company. After raising the money, they then use this money to acquire/merge with other companies(usually private companies). So if a hypothetical private company, Kota Technology, is trying to go public, they can get acquired by a SPAC and get listed as a public company on the stock exchange. Usually a SPAC has a time period of 18–24 months to acquire or merge with a private company. If they fail to do so, the money that is invested and raised through the SPAC will be returned to the investors.
So why would Kota Technology choose the SPAC route to become a public company rather than going the traditional way of becoming public. The main reason is that SPACs allow private companies to avoid the regulatory procedures and some of the pitfalls of a regular IPO, while it allows the private company to still get access to the large inflow of public money as the company gets listed on the stock exchange. Furthermore, the private company would also be able to get the expertise of the sponsors (hedge fund managers, top investors/executives). These are some of the main reasons why private companies might choose to go through the SPAC route.
How do investors or sponsors make money through a SPAC? The sponsors and investors in a SPAC are able to buy and sell shares of the SPAC just like any other publicaly listed company. The price of the SPAC shares go up and down depending on how successful the SPAC is on acquiring private companies and how successful these private companies are once they are public. The price fluctuation of the shares of the SPAC determine whether the investors make money or lose money.
Although the shares of investors and sponsors have the potential of getting them huge returns once the private company goes public, there are chances that the public market might not be as receptive or intrigued by the company that the SPAC acquired and therefore could lead to a lack of demand of shares, which could cause losses for the investors/sponsors. Another thing that investors are vary about is the lack of liquidity of their capital that they invested in the SPAC. Usually SPACs wait around for sometime (ranges between 18–24 months) before finding their target company for acquisition. During this period, the investor’s money is just sitting with the SPAC and they have no way of accessing it for long periods of time, which can create a large opportunity cost. If the SPAC doesn’t find a company to invest in within 18–24 months and chooses to liquidate, then the investor gets back their money but in reality actually makes a loss as the investors could have easily invested this money in bonds/securities which would have guaranteed them a return on investment.
Some popular SPACs:
- Social Capital Hedosophia Holding (run by Chamath Palihapitiya)
- Pershing Square Tontine Holdings (run by Bill Ackman)