Special purpose acquisition companies (SPACs)

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What’s a blank check company?

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A special purpose acquisition company (SPAC) offers entrepreneurs a way to take their companies public without an initial public offering (IPO). The SPAC itself goes public to raise money that will be used to acquire a private company that’s ready for the public market. The acquisition turns a private company into a public one. But because the money is raised without a target in mind, SPACs are often called “blank check” companies.

Companies that successfully went public via SPACs include sports betting company DraftKings (DKNG), electric vehicle maker Lucid (LCID), and financial company SoFi Technologies (SOFI).

The group of people who organize a SPAC are known as the sponsors. The sponsors may have expertise and connections in a particular industry. They receive shares at a discount (often known as the “promote” or “founders’ shares”) to compensate them for their efforts. The sponsors then work with an investment bank to file a prospectus and, eventually, an IPO.

In most cases, the IPO shares are priced at $10 each. The sponsors agree to take the funds raised and use them to acquire a private, operating business. In most cases, the funds must be spent within 24 months of the IPO. The money is held in a trust account until the acquisition is complete or the deadline is hit.

If the deadline arrives without a business combination, the money is returned to investors.

The SPAC’s IPO prospectus often discusses the types of targets the sponsor is considering. However, they have no obligation to find an acquisition that fits those parameters. The ability to find and close a suitable acquisition is the key asset the sponsor brings to the table; some sponsors have better networks and track records than others.

Because the founders’ shares cost less than those issued in the IPO, it’s possible for an acquisition to be a good deal for the founders and a bad one for everyone else.

How a SPAC can benefit investors: Investors buy shares in a SPAC to eventually get shares in an up-and-coming company at a good price. Buying into a SPAC is usually easier than buying shares in a hot IPO or identifying a promising early-stage company for angel investing.

Because the terms of a SPAC combination are negotiated, the founders and investors in the target company have more control over the terms of the deal. This can help them set up the company for success after the transaction closes.

How a SPAC can benefit entrepreneurs: For the founders and private equity backers of a private company that’s considering going public, merging with a SPAC offers more certainty over pricing and deal terms compared to an IPO. And a SPAC transaction is faster than an IPO, giving target companies rapid access to cash and the benefits of being publicly traded.

The financial markets are littered with companies that went public by SPAC and slipped straight to penny stock territory—or bankruptcy court. Because SPAC sponsors do not identify the specific target company at the time of the IPO, investors may have limited information about where their funds will be invested. Some sponsors looking to get a deal done before the deadline may go after a less-than-ideal investment.

Regulatory bodies have introduced guidelines to enhance transparency and protect investors. For example, the U.S. Securities and Exchange Commission (SEC) requires SPACs to file the same quarterly earnings reports and related filings as traditional public companies. When a transaction is announced, SPAC investors receive a proxy statement that describes the target company’s business and the terms of the deal.

SPAC sponsors are not allowed to trade on or tip material nonpublic information about the identity of the target company. Nevertheless, the SEC has gone after a few SPAC executives for insider trading.

SPACs have emerged as an alternative avenue for private companies to access public markets, offering speed and flexibility in the listing process. However, they also come with challenges related to transparency, potential conflicts of interest, and regulatory oversight.

As the market continues to evolve, if you’re considering a SPAC investment, conduct your own due diligence. Weigh the risks and rewards before participating in this dynamic segment of the financial markets.