Background On SPACs

Posted by on July 04, 2020

A special purpose acquisition company (SPAC) is a blank check company formed for the purpose of effecting a merger, share exchange, asset acquisition, or other business combination transaction with an unidentified target. Generally, SPACs are formed by sponsors who believe that their experience and reputation will facilitate a successful business combination and public company. SPACs are often sponsored by investment banks together with a leader in a particular industry (manufacturing, healthcare, consumer goods, etc.) with the specific intended purpose of effecting a transaction in that particular industry. However, a SPAC can be sponsored by an investment bank alone, or individuals without an intended industry focus.

The sponsor of a SPAC contributes 10% of the total post initial public offering (IPO) capital of the company. The sponsor’s 10% capital is used to cover the IPO and ongoing SEC reporting and administration expenses. Although a sponsor will invest 10% of the capital, they typically receive founder’s shares in the SPAC that results in approximately 20% ownership in the post IPO company. Sponsors do not make money unless a successful business combination is completed and the value of their ownership increases enough to justify the time and capital commitment of acting as a sponsor.

When a SPAC completes its IPO, usually 100%, but in no event less than 90%, of the funds raised are held in escrow to be released either upon completion of a business combination transaction, or back to shareholders in the event a transaction is not completed within a set period of time.  Upon closing of a business combination, the SPAC investors can elect to continue as shareholders of the combined business or redeem their shares for cash.  A SPAC business combination must have a market value of at least 80% of the value of the amount held in escrow at the time of the agreement to enter into the transaction.

A SPAC generally has 24 months to complete a business combination; however, it can get up to one extra year with shareholder approval. If a business combination is not completed within the set period of time, all money held in escrow goes back to the shareholders and the sponsors will lose their investment.

SPAC IPOs are usually structured as unit offerings with both stock and warrants to entice investors to bet on the unknown future opportunity. The number of warrants and exercise price can vary.  Although sponsors with a prominent track record can generally attract better valuations and investor deals, with the continuing popularity of SPACs over the years, that has become less important. As an alternative to warrants, some SPAC sponsors agree to over-fund the IPO trust account by some multiple to the investment amount, which over-funded amount would be distributed to the SPAC investors if a business combination is not completed.