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What is a SPAC?
A special purpose acquisition company is a type of “blank check company”. A blank check company is a development stage company (a shell corporation) that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person. In particular, a SPAC is created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe. The opportunity usually has yet to be identified.
What are the Structure & Features of SPACs?
SPAC Structure: Generally, a SPAC is formed by an experienced management team or a sponsor with nominal invested capital (commonly known as founder shares). The remaining interest is held by public shareholders through “units” offered in an IPO of the SPAC’s shares. Each unit consists of a share of common stock and a fraction of a warrant (e.g., ½ or ⅓ of a warrant) to purchase a specified number of common shares in the future, with a specified expiration date. The SPAC unit will trade for some time after the SPAC IPO, and sometimes after the IPO the units become separable, such that the public can trade units, shares, or whole warrants, with each security separately listed on a securities exchange.
These are common features of SPACs, however the exact terms will vary by issuer and by listing exchange.
Usually, the founder shares and public shares are identical except for the founder share anti-dilution adjustment and voting agreement/ redemption wavier. Founder shares usually have the sole right to elect SPAC directors.
Generally the founder warrants and public warrants are identical except for the founder warrant cashless exercise and lack of redemption (forced exercise) provisions.
IPO proceeds are placed into a trust account and usually invest in low risk securities like money markets (“Escrowed Funds”)
The US listed SPAC typically has 18-24 months (can be extended to 36 months if shareholders approve) and Canadian listed SPAC typically has 36 months to identify and complete a merger with a target company
Usually a meeting of shareholders must be held to approve any proposed acquisition
If a non-founder shareholder votes against a proposed acquisition, they have the right to receive a pro rata share of the Escrowed Funds.
If an acquisition is not completed within the defined time frame, shareholders have the right to receive their pro rata share of the Escrowed Funds.
Risks of SPACs
Management/Sponsors Expertise and Capabilities: Since investors in a SPAC are usually not aware of the target company until very late stages (shareholder approval stage), they are placing their faith in the sponsors to pick the right business at a right price to go public (reverse merger), with very limited due diligence of their own regarding the targeted company. The risk is management/sponsors don’t pick a right choice or they cannot negotiate a good price.
Oversight and Disclosure: In a traditional IPO process the company goes under significant level of scrutiny and has to disclose details of its operations and financial condition. These disclosures are supplemented by extensive discussions between institutional investors and managers. A SPAC merger requires fewer disclosures, and often does not go through as extensive an institutional investor diligence process. This means that there may be more issues and risks that investors to not understand with a company listing via SPAC compared with a traditional IPO.
The interests of the sponsors may not be completely aligned with investors: SPAC sponsors generally purchase equity in the SPAC at more favorable terms than investors in the IPO or subsequent investors on the open market. As a result, investors should be aware that although most of the SPAC’s capital has been provided by IPO investors, the sponsors and potentially other initial investors will benefit more than investors from the SPAC’s completion of an initial business combination and may have an incentive to complete a transaction on terms that may be less favorable to investors.
Additional Financing and Dilution: The SPAC may require additional financings to fund the initial business combination, and those financings often involve the sponsors. As a result, the interests of the sponsors may further diverge from investors interests. For example, additional funding from the sponsors may dilute investors’ interest in the combined company or may be provided in the form of a loan or security that has different rights from investors’ investments.
Trading price & Liquidity: In the IPO, SPACs are typically priced at a nominal $10 per unit. Unlike a traditional IPO of an operating company, the SPAC IPO price is not based on a valuation of an existing business. When the units, common stock and warrants begin trading, their market prices may fluctuate, and these fluctuations may bear little relationship to the ultimate economic success of the SPAC.
Post IPO, SPACs are traded in secondary market and like any other stock they may become relatively illiquid and hence the investors face widen bid/ask spreads
Wind-up SPACs/Opportunity Cost: There is a reasonable chance that management/sponsors unable to find a target within 24-36 month period and return the Escrowed Funds back to shareholders. Since the Escrowed Funds are normally invested in low risk investments (e.g. money market instruments), the investor is going to miss out on other potential investment opportunities.
Valuation risk: For individual investors, it may be more challenging to price the option-like features of units and warrants. Additionally, similar to IPOs, SPACs are risky and bear the possibility of significant loss.
What’s the difference between units, common shares, and warrants? How are they priced?
Units: “Unites” are security type that is offered in a SPAC’s IPO. Each “unit” consists of a share of common stock and a fraction of a warrant (e.g., ½ or ⅓ of a warrant) to purchase a specified number common shares in the future, with a specified expiration date. Following the IPO, the units become separable, such that the public can trade units, shares, or whole warrants, with each security separately listed on a securities exchange.
Warrant: A warrant is a contract that gives the holder the right to purchase from the company a certain number of additional shares of common stock in the future at a certain price, often a premium to the current stock price at the time the warrant is issued. The terms of warrants may vary greatly across different SPACs, and it is important to understand the terms when investing since they include valuable information such as (a) how many shares the investor has the right to purchase, (b) the price at which and the period during which shares may be purchased, © the circumstances under which the SPAC may be able to redeem the warrants, and (d) when the warrants will expire. To learn more about the specific terms, investors should review SPAC’s documents specially SPAC’s IPO prospectus.
Common Shares: SPACs common shares are similar to any common shares/stock is a security that represents ownership in a corporation, in this case a SPAC. SPAC’s common shares have a couple of distinct features relative to other common shares:
Voting on business combination (merger): SPAC’s holders of common shares (shareholders) have the right to vote to approve business combination (merger)
Redemption right: SPAC’s holders of common shares also have a right to redeem their shares for a pro rata share of the Escrowed Funds if they vote against a proposed acquisition.
As discussed above SPACs are typically priced at a nominal $10 per unit at the time of IOP. However, unlike a traditional IPO of an operating company, the SPAC IPO price is not based on a valuation of an existing business. When the units, common stock and warrants begin trading in the secondary market, their market prices may fluctuate, and these fluctuations may bear little relationship to the ultimate economic success of the SPAC.
One major factor that affects SPAC’s common share price is the fact that the holder can vote against the merger and redeem the share for a pro rata share of the Escrowed Funds ( proceeds of IPO + interest)
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