What is a special purpose acquisition company (SPAC)? What is a blank check company? Should you invest in SPACs, and how do they work? Both a SPAC and blank check company are publicly-traded shell companies that raise collective investment funds through an initial public offering (IPO) in the form of a blind pool. The funds are placed into a trust until an acquisition is made or a predetermined period of time elapses and the fund is liquidated. SPACs are increasingly being viewed as an alternative to the IPO process in particular for silicon valley companies since the failed WeWork IPO. Some recent SPAC mergers have been controversial such as Nikola Motors (NKLA) and Luckin Coffee (LKN). Many argue that these companies would not have made it through the traditional IPO process. We will also learn about Direct Listings, like the Spotify listing which is another alternative to the IPO process.
Welcome back to patrick boyle on finance i made a video about a week or so ago about nikola the electric truck company that doesn’t necessarily appear to make electric trucks but they definitely can draw pictures of them and sometimes they even roll them down hills my favorite comment on that video was that the company should have called themselves newton rather
Than rather than nicola because they’d built a gravity-powered truck anyhow i mentioned in in that video that nikola had gone public through a spac and an awful lot of people then asked me to explain how spacks work so let’s discuss today the difference between spikes ipos and direct listings the idea of a spac or a special purpose acquisition company has been
Around for quite a long time but they’ve grown increasingly popular in the last year or so a spac which is also sometimes referred to as a blank check company in the press is a corporate shell usually sponsored by a well-known investor that goes public by issuing shares and raising money from investors with a plan to find a private company or companies to buy or
To merge with the merger when it does happen takes the target company public without an initial public offering the spac is a publicly listed shell entity with cash pre-merger and post-merger the shareholders of the original spac are now holding shares in the target operating company which is now publicly listed because of the merger process there’s less scrutiny
In this process than there would be in a typical ipo for the same company worth to go public directly thus there’s been some controversy with companies like nicola and luck and coffee and many have argued that these companies would not have made it through the due diligence involved in a typical ipo investors who buy this back in its initial public offering don’t
Know what stock they’re ultimately going to get the shares that investors originally purchase in a spac ipo will eventually transform into shares in a real operating company the target company but these investors don’t initially know what company that it’s going to be they are effectively buying the target company’s ipo in advance without knowing what the target
Company is or the price that will be paid now it’s worth noting that these deals are usually structured such that if the investors in the spac don’t like the target company they can get their money back by just backing out of the deal before the merger closes the appeal of this approach is not at all obvious if you’re an investor you’ll presumably pay more for
A company that you like and understand than for a company to be named at some point in the future if you’re a company looking to go public the spike approach has a number of obvious disadvantages the fees work out usually to be way higher than with a regular ipo where a bank takes a fee of between one and seven percent usually closer to the seven percent of the
Ipo funds raised spikes typically pay investment banks a fee of around five and a half percent of the money raised which is a lot like a regular ipo the remainder of the proceeds raised in the ipo are then the funds that are used to buy the target company that it then plans to take public so the spac will usually also then pay another layer of investment banking
Fees around the merger process with the target company in addition to that spax typically give their sponsor the famous investor who runs the spac and finds the targets to take public 20 of the shares for free which once again the cost of this is passed on to the target company so spec fees can come to around a quarter of the money raised which is three or four
Times as much as an investor would normally pay in terms of fees to participate in a regular ipo the fees in this back are just sort of better concealed than they are in an ipo now alongside the money in the spac there’s usually a thing called a pipe which stands for a private investment in public equity pipes are another type of investment vehicle typically
Held by the spa sponsorship management team or other investors associated with the deal and the pipe vehicle invests usually alongside in the proposed merger takeover transaction of the operating company being taken public these pipe investors usually will pay lower fees overall for the opportunity to participate in the transaction than the spac investors pipe
Investors are able to buy into the newly public operating company at a lower fee than those being absorbed by the spac shareholders so a lot of people invest in both the spac and the pipe and so thus their average fees work out to be a little bit less so it’s not as terrible for those investors but obviously if you don’t get the opportunity to invest in both
It’s not a it’s not an amazing deal so the merger transaction is therefore funded by a combination of spac cash previously raised in its ipo as well as pipe funds which are raised by the spike management and associates the overall funds used then to execute the purchase of the operating company can be significantly larger than the spax ipo funds raised because
Of these additional pipe funds so the ratio of pipe to spec money is often two and a half to one and that means that a spec that did an ipo and raised will say 500 million dollars in cash to do an acquisition could now in conjunction with a pipe purchase a company worth as much as 1.75 billion or at least by that much equity similar to people who invest in ipos
Spac investors hope to acquire their target company at as low a price as possible the spac is in the business of getting a good deal for its shareholders so it wants to buy the target at a price that’s below fair value and then the example of nikola corp for example they paid around 10 a share and the stock closed on the day of the merger at 33.97 so that’s
Kind of the type of pop in an ipo that venture capitalists love to complain about because of course no one loves selling something at 10 bucks a share that instantly is trading at 34 a share obviously on day one this is great if you are the spac shareholder in this example but it’s not so great if you are the private company founder who sold your position too
Cheaply to the spac management team spikes also usually give their investors warrants which means that if the stock does go up a lot the company then has to give away even more of it to the initial spec investors which dilutes the target companies management or the original shareholders down if the share prices go up an awful lot so spikes don’t really avoid the
Under pricing effect of ipos which is generally considered to be negative from the perspective of a company that’s going public in fact they probably exacerbate this problem if you are a company that wants to go public and you’re looking for a calmer more rationally priced lower key alternative to the ipo process a direct listing might be a better idea than a
Spark merger and i’ll explain how that works in just a moment so why have these deals suddenly become so popular well the spike merger has one feature that might appeal to private companies that wish to go public in this economic environment and that feature is that when you sign the merger agreement you’re definitely going public and you know the price you
Don’t necessarily know how much money you’re raising or how many shares you’re selling because the investors in the spac have the right to ask for their money back if they don’t like the deal or if the price goes up an awful lot the spike shareholders can exercise their warrants and dilute you down basically buying more shares from you at this lower price but
You’ll at least raise some money at a fixed price and that is attractive at the moment to certain types of company with a traditional ipo how it works is the deal is first announced and then negotiated so the company files to go public and then the bankers contact investors and market the stock to those investors we work file to go public last year i think was
Last august hoping to be valued at around 96 billion dollars but investors backed away after seeing the prospectus the wework ipo failed at a time when wework badly needed cash in order to run the business the failure to raise this capital caused a company crisis that left it on the brink of bankruptcy and caused the co-founder adam newman to resign in addition
Some other big unicorn ipos had been a bit soft around then and achieved lower prices than they wanted and so for big tech unicorns the ipo was suddenly seen as an uncertain and a risky process one that might end up raising money at a lower valuation than they wanted or not raising money at all suddenly spac mergers seemed appealing in silicon valley as such a
Deal means that a company will at least raise some money at a fixed price so should investors invest in spax and hope to see a pop like they might see with a traditional ipo well just because a spark wants to invest in a company at less than its fair market value doesn’t actually mean that this is going to work out for them in fact historically it didn’t spike
Sponsorship used to be viewed as a fee generating strategy for third tier private equity funds while the spax sponsors made money through guaranteed fees the investments themselves often lost money in order to overprice an ipo you basically have to convince dozens of large sophisticated investors to overpay for a company but if you can just find one spax sponsor
To overpay then you can overprice your company an ipo is effectively a dutch auction where you get bids from dozens of investors and then you price the ipo at the price that clears the market meaning that the whole deal is priced off of the lowest buyer’s price that sells all of the shares a spac merger is a regular auction where you sell your company to whoever
Will pay the highest price of course the universe of merger spac bidders is smaller than the universe of ipo investors so the actual clearing price for a spec could well be lower but if you can find one generous outlier it could be higher it’s not obvious to me that investing in spax is a good way of deploying capital as an investor the premise of the spac relies
Heavily on the reputation or brand of the spac sponsor their ability to raise funds from a broad group of shareholders and a blank check company ipo is much more of a testament to the faith investors having that person’s ability to find and execute on a good deal now i mentioned direct listings a moment ago in an ipo new shares are created underwritten and sold
To the public with a direct listing no new shares are created and only existing outstanding shares are sold with no underwriters involved the idea behind direct listings was why should we give big investors a discount on our shares just to become listed on an exchange let’s just simply list our shares on the stock exchange at whatever price the market will bear
Spotify quite famously went public in 2018 using a direct listing they raised no new capital through that process instead just allowed their shares to be listed on an exchange allowing the public to buy and sell at the price that the market would bear for their stock generally ipos are for the purpose of raising new capital to fund growth in a business or to
Provide an exit for existing shareholders or founders the direct listing approach that spotify took brought in no new capital senior management of spotify claimed that they had no intention of selling down their stakes either through the direct listing the whole purpose was allegedly to provide liquidity for employees who had shares as well as access to spotify
Shares for investors who were interested in being involved in the company’s growth the new york stock exchange has been working to allow companies to use direct listings to raise capital rather than to just facilitate an exit for current investors under the new york stock exchange proposal a direct listing would let both the company and company insiders sell
Stock at the listing there would be no lock up under this proposal insiders could sell shares of the company as soon as it lists rather than having to wait up to we’ll say 180 days to do so so far the securities and exchange commission has rejected this proposal but nicey say they’re still working on it if you found this video interesting do check out my book
On corporate finance which covers this sort of topic i’ve linked to it in the description below this video and the next one which is on the topic of risk parity funds came about due to viewer questions in the comments section of my videos so if there is a topic that you feel i should cover do let me know don’t forget to like and subscribe see you later bye you
Transcribed from video
What Is a Special Purpose Acquisition Company or SPAC | Blank Check Companies, Should You Invest? By Patrick Boyle
