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What Is a SPAC and Why Is It So Big with the Wall Street Crowd?

Delwin Graham - Feb 18, 2021
A “special-purpose acquisitions company” is essentially a shell company set up by investors, or “sponsors,” with the sole purpose of raising capital through an IPO to eventually acquire another company.

What is a SPAC? A “special-purpose acquisitions company” is essentially a shell company set up by investors, or “sponsors,” with the sole purpose of raising capital through an IPO to eventually acquire another company. Also known as “blank-cheque companies”, SPACs have been around for decades but only recently have become more popular. Virgin Galactic (SPCE:NASDAQ), Draftkings (DKNG:NASDAQ), Opendoor (OPEN:NASDAQ), and Nikola Motor Co. (NKLA:NASDAQ) have all gone public by merging with SPACs. In fact, roughly 200 SPACS went public in 2020, raising about US$64 billion in total funding, nearly as much as all of last year’s IPOs combined. And the trend is continuing: DNA-testing startup 23andMe is reportedly in talks to go public through a US$4 billion deal. (Cf., Tom Huddleston Jr., “What is a SPAC? Explaining one of Wall Street’s hottest trends”, www.cnbc.com, January 30, 2021)

A SPAC has no commercial operations; its only assets are typically the money raised in its own IPO. As a result, a SPAC is typically created by a team of institutional investors or Wall Street professionals from the world of private equity or hedge funds. For example, famed investor Bill Ackman of Pershing Square recently raised US$4 billion in the IPO of Pershing Square Tontine Holdings (PSTH:NASDAQ), which will target “mature unicorns” with clean balance sheets. Because money is raised in a blind pool, institutional investors with successful track records can more easily convince people to invest in the unknown.

Once capital is raised in the IPO, the money goes into an interest-bearing trust account until the SPAC’s founders or management team finds a private company looking to go public through an acquisition. When an acquisition is completed (with SPAC shareholders voting to approve the deal), the SPAC’s investors can either swap their shares for shares of the merged company or redeem their SPAC shares to get back their original investment, plus the accrued interest while that money was in trust. The SPAC typically takes about a 20-percent stake in the final merged company. If the sponsors cannot find a suitable deal within a specified time, usually two years since the IPO, then the SPAC is liquidated, and investors get their money back with interest. (Cf., Huddleston, “What is a SPAC? …”)

While much of the recent hype about SPACs has come from the United States, Canada has a long history of experience with blind-pool companies. Originally called “junior capital pools” and listed – beginning in the 1980s – through the Alberta Stock Exchange, these companies were formed to finance speculative exploration opportunities in the oil and gas industry. Since moving onto the TSX Venture Exchange (TSX-V), they have been used in a variety of other sectors, including mining, technology, and pharmaceuticals. (Cf., James Chen, “Capital Pool Company (CPC)”, www.investopedia.com, August 12, 2019)

Capital pool companies were originally created to provide an alternative growth path for Canadian businesses on the TSX Venture Exchange. Because Canada does not have as robust a venture capital industry as the United States, Canadian companies tend to list on the TSX earlier in their growth cycle to access capital. The downside of this earlier listing is that companies often lack the experience of operating as a public company at this critical juncture, which leaves them abandoned by investors. The Canadian exchanges are awash with these orphaned public companies. Capital pool companies were created and promoted as a way to inject early-stage companies with both the capital and expert director-level guidance that is provided in the U.S. by venture capitalists. (Cf., Chen, “Capital Pool Company …”)

Given the success of the CPC program on the TSX-V and taking direction from the number of SPACs in the U.S. market, the TSX introduced its own SPAC program in December 2008. Although similar in design and intent to the CPC program, the SPAC program lists their blind pools on the TSX, as opposed to the TSX-V, and they are required to raise a minimum of CDN$30 million in the IPO. (Cf., Nadim Wakeam, “Blind Cash Pools: Expanding Role in Business Financing?”, Blaneys on Business, June 2011)

Blind-cash-pool companies have been around for decades and have existed as the last resort for small companies that would have otherwise had trouble raising money in the private markets. But why the sudden, recent interest in SPACs for high-profile companies, like Virgin Galactic and Draftkings? Tom Huddleston argues that SPACs have become more prevalent with the extreme market volatility caused by the global pandemic. Many private companies have chosen to postpone their IPOs for fear that market volatility will undermine their stock’s public debut. A SPAC merger allows a company to go public and get a capital influx more quickly than it would have with a conventional IPO. A SPAC acquisition can be closed in just a few months versus the extensive legal and operational preparations for registering an IPO, which could take up to six months. (Cf., Huddleston, “What is a SPAC? …”)

The disadvantages of a SPAC are linked to the fact that it is a blind pool – you don’t know what you are buying, and you are trusting the sponsors to find the best deal. But critics argue that the SPAC sponsors, who are mostly tasked with finding a workable acquisition within two years and not necessarily the best deal, are not incentivized to avoid having the SPAC overpay for the target company. (Cf., Huddleston, “What is a SPAC? …”)

Of course, all SPACs are not created equal. Please contact me at dgraham@cgf.com or 780‑408-1518 for a few good ones.