What Is a Special Purpose Acquisition Company (SPAC)?

Special purpose acquisition companies (SPACs) offer a unique way for companies to go public. A SPAC is a shell company listed on a stock exchange that aims to acquire a private company, allowing it to go public without the traditional initial public offering (IPO) process. This method provides a quicker path to public markets, making it attractive for companies seeking capital and investors looking for new opportunities. SPACs are appealing because they offer flexibility and fewer regulatory challenges.

If you want to create or build out an investment portfolio, a financial advisor can help you analyze investments and manage risk.

How SPACs Work

SPACs have gained popularity as a way for companies to go public without the traditional initial public offering (IPO) process. According to SPAC Insider , only one SPAC went public in 2009, raising $36 million. By 2021, the number increased to 613, with proceeds reaching $265 million. While activity has slowed since then, 2023 saw 31 SPAC public offerings raise $124 million.

A SPAC is essentially a shell company created by investors with the sole purpose of raising capital through an IPO to eventually acquire an existing company. This process allows private companies to access public markets more quickly and with less regulatory scrutiny than a traditional IPO.

SPACs are sometimes called "blank-check companies" because investors in a SPAC do not know in advance what the money they are providing will be used to purchase. Instead, they are betting on the expertise of the SPAC’s management team to identify and acquire a promising private company.

The process begins with the SPAC conducting its own IPO, where it raises funds from investors. These funds are placed in a trust account until the SPAC identifies a target company to acquire. Typically, a SPAC has a two-year window to complete an acquisition, or it must return the funds to investors.

Once a target is identified, the SPAC and the target company negotiate terms, and the acquisition is put to a shareholder vote. If approved, the target company merges with the SPAC and becomes a publicly traded entity. This method can be advantageous for private companies seeking a faster route to public markets, as it often involves less dilution of ownership and can provide more certainty in terms of valuation.

How SPACs Can Go Public

A SPAC starts with its own IPO, raising funds from investors without a specific target company. This money is kept in a trust account until the SPAC finds a suitable private company to merge with.

The SPAC’s management team, often composed of experienced industry professionals, is charged with identifying and negotiating with potential acquisition targets. Once a target is identified, the SPAC and the target company negotiate the terms of the merger, which must then be approved by the SPAC’s shareholders.

Then, the SPAC merges with the target company, known as the “de-SPAC” process. This involves detailed due diligence and negotiation to ensure that the merger is beneficial for both parties.

Once merged, the target company becomes a publicly traded entity , effectively bypassing the traditional IPO route. This process can be advantageous for private companies seeking public status, as it often involves less scrutiny and can be completed more quickly than a conventional IPO.

Pros and Cons of SPACs

Speed and efficiency are the primary advantages that SPACs offer. Traditional IPOs can take months or even years to complete, while SPACs can finalize the process in a matter of weeks.

This expedited timeline can be particularly beneficial for companies in fast-moving industries or those looking to capitalize on favorable market conditions. SPACs also provide greater certainty in terms of valuation and capital raised, as these elements are typically negotiated upfront with SPAC sponsors.

For investors, SPACs provide a way to invest in companies at an earlier stage. This can lead to significant returns if the acquired company performs well post-merger. Additionally, SPAC investors often get warrants , giving them the right to buy additional shares at a predetermined price, which could add another layer of potential profit.

But SPACs come with notable risks and drawbacks. One major concern is the lack of transparency when compared with traditional IPOs. Since SPACs are formed without a specific target in mind, investors initially have limited information about where their money will ultimately be invested. This can lead to misalignment of interests between SPAC sponsors and investors. Also, the time pressure to find a suitable acquisition target can result in hasty decisions and poor outcomes.

The market for SPACs can also be highly volatile, with SPAC stock valuations often fluctuating significantly based on market sentiment and speculation. This volatility can pose challenges for investors seeking stable, long-term growth. Moreover, the surge in SPAC popularity has attracted scrutiny from regulators, which could result in tighter rules affecting future viability of SPACs as an investment vehicle.

Bottom Line

In recent years SPACs have become a popular alternative to traditional initial public offerings. These investment vehicles are essentially shell companies created with the sole purpose of raising capital through an IPO to acquire an existing private company. This process allows the private company to go public without undergoing the lengthy, complex and costly procedure of a conventional IPO. However, lack of certainty about where SPAC funds will be invested can put off risk-averse investors, and their popularity has waned in the last few years.

Tips for Investments

• If you don't know where to invest your money, a financial advisor can help you review different options. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• No matter what type of asset you invest in, if you sell it for more than what you paid, you may owe capital gains taxes. SmartAsset's capital gains tax calculator can help you estimate how much you could pay in taxes.

Photo credit: ©iStock.com/standret, ©iStock.com/standret, ©iStock.com/sarawut khawngoen

The post What Is a Special Purpose Acquisition Company (SPAC)? appeared first on SmartReads by SmartAsset .