What Is a SPAC Vs IPO?

Anyone following the stock market news lately will have noticed the proliferation of something called a “SPAC”. While not a new thing, SPAC mergers became especially popular in 2020, and have grown even more so since. But what are they, and why is everyone so keen on them all of a sudden?

What Is A SPAC Investment?

A SPAC – or special purpose acquisition company – is a company set up with the sole intention of raising funds through an IPO to later buy another, private business, making that second company public through its acquisition.

SPACs are sometimes referred to as “blank check companies”, as at the beginning of an IPO process the sponsors of the SPAC rarely disclose which, or what kind, or company they intend to acquire.

Who Can Start A SPAC?

Anyone can start a SPAC in theory, although in practice it’s usually undertaken by an experienced management team, with prior knowledge of the ins-and-outs of the entire process.

The undertaking isn’t without costs, however; a SPAC still has to undergo many of the same regulatory and legal checks that a regular IPO does, and so sponsors of a SPAC will at least have a few hundred thousand dollars to spare to cover the initial setup costs.

Sponsors also have to fund a fraction of the expected IPO proceeds – normally 3-4% – in return gaining 20% of the common equity of the company.

What Is The Purpose of a SPAC Vs An IPO?

Traditional IPOs can take a long time to finalize, and are subject to stringent SEC oversight and scrutiny. Time is money, and legal fees aren’t cheap.

Alternatively, SPAC IPOs are much quicker with less friction, and are significantly less expensive to complete. SPACs are not operational companies, and their running costs are next to nothing – certainly compared to a real-world business, at least. This makes them highly attractive for potential investors.

Furthermore, because of the nature of a SPAC, once the funds are raised and a target acquisition is sought, the capital investment can be placed in an interest-bearing trust account until the merger is complete.

SPACs generally have two years to make a deal, after which the proceeds from the IPO are liquidated and returned to shareholders.

Is a SPAC A Good Investment?

When an investor contributes to the liquidity of a SPAC deal, they don’t just receive shares in the IPO – they also receive warrants in addition to regular stock. These warrants are either private placement warrants, which go to the SPAC sponsor, or public warrants, which are given to third-party investors.

The warrants essentially act as a kind of options contract, giving the holder a right to buy future stock at a pre-specified price, and are an important part of what makes SPAC investing so appealing.

While the terms of each warrant will differ between each SPAC, warrants are still considered a valuable security that offer investors much needed optionality.

Source: Unsplash

Can A SPAC Buy Real Estate?

A SPAC can buy any kind of company, and this includes real estate-focused businesses too. In fact, the well-known REIT giant Simon Property Group raised $300 million earlier this year through its own SPAC, Simon Property Acquisition.

And while the REIT SPAC could use its funds to purchase more brick-and-mortar building stock, the company is still free, if its chooses, to acquire a REIT-adjacent business instead.

Why Are SPACs So Popular?

Much of the hype surrounding SPAC mergers lately has come from the high-profile success of some big-name deals. For instance, the sports betting operator, DraftKings (DKNG), went public through a reverse merger with the Jeff Sagansky-associated SPAC Diamond Eagle last year, and its shares are up ~400% on its $10 offer price as of today’s prices.

That said, not all SPACs are a roaring success. Many potential mergers fall through and never see the light of day. And even if a SPAC does go through, there’s no guarantee it will deliver the kind of capital returns that investors expect.

Pre-merger SPACs can also trade at premiums so high that investors should be wary of choosing the right entry price for each SPAC.

QuantumScape Corporation (QS), an electric vehicle battery developer, was changing hands in December 2020 for over $130 per share. It now sells for less than $23.

SPAC Versus IPO: Conclusion

SPACs aren’t a modern, novel invention. They first had their heyday in the 1980s; but because of their speed, ease, and rapid access to capital, a fresh breed of investors are seeing them through new eyes again.

They are not risk free, however, despite the many upside potentials they promise. Yet SPACs have never been more popular – the 456 SPAC IPOs in 2021 alone was more than the 451 in the previous nine years combined. In fact, SPACs now account for 64% of all IPOs in the US this year.

So. yes – it looks like SPACs are here to stay.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.