Investment Banking and Special Purpose Acquisition Companies (SPACs)

Special Purpose Acquisition Companies (SPAC) have become all the rage in the investment banking industry. They are not a new concept. They have been around for quite some time. However, they have become quite popular in the recent past. For instance, in the first half of 2020, $13.5 billion dollars were raised by Special Purpose Acquisition Companies (SPAC). This is greater than all the money which was raised by these companies in 2019. The trend is hinting towards a 100% increase within a short span of one year! In this article, we will understand what Special Purpose Acquisition Companies (SPAC) are and how they are used by investors and investment bankers.

What are Special Purpose Acquisition Companies (SPAC)?

Special Purpose Acquisition Companies (SPAC) are companies that are publically traded but do not conduct any specific business. In common parlance, they can be referred to as shell companies. This means that there is a management which appoints investment bankers who help the company with an IPO. However, after the proceeds have been received, there is no immediate business that the company starts. Instead, the company just keeps on holding the money and waits for a merger and acquisition opportunity. This is the reason why Special Purpose Acquisition Companies (SPAC) are also called “blank check companies”. This is because, investors are in essence, giving blank checks to the management to invest in an opportunity which hasn’t even been identified yet!

The proceeds received from the sale of shares of the Special Purpose Acquisition Companies (SPAC) are placed in a trust. This trust is closely monitored and the money is invested in highly secure and liquid investment. This is done so that the money can be easily drawn down when an opportunity arises. If an opportunity does not arise within a given time frame, the money is returned back to the investors after deducting fees for legal expenses and brokerage.

If the acquisition is actually made, then the investors receive shares of the acquired company. Since there is no money left in the bank accounts of the Special Purpose Acquisition Companies (SPAC) after the acquisition, its shares essentially become worthless. This is the reason that they are often delisted.

What Are Special Purpose Acquisition Companies (SPAC) Used For?

Special Purpose Acquisition Companies (SPAC) are used for several purposes. Two of the most important ones have already been listed below:

  • Acquisition Fund: There are experienced fund managers who want to have cash on hand when the opportunity to make an investment arises. They do not commit any details about the type of investment opportunity they are looking for. However, they just provide vague details about the sector in which they are looking to make investments. The funds accumulated via Special Purpose Acquisition Companies (SPAC) are often compared to private equity funds. However, they are different as compared to private equity funds because their investment are made in a public setting. Also, their holdings are concentrated in one or two companies as opposed to private equity funds who have diverse holdings.

  • Reverse Merger: Some companies want to take advantage of the timing when they go public. Hence, they form a Special Purpose Acquisition Companies (SPAC) in the interim. When the opportune time arises, the SPAC acquires the main company. Since the SPAC is a public entity, the main stream company also becomes a public entity. When the share prices rise, the promoters, then sell them off in the open market.

Common Issues Faced By Special Purpose Acquisition Companies (SPAC)

Even though, SPACs have become very popular in the past. There are a lot of issues related to SPACs as well. Some of them have been listed below:

  • First and foremost, SPACs have an inherent conflict of interest. This is because the shareholders of the SPAC and the ones of the target company may be different. In these cases, the management is not sure about where its loyalties should lie. Also, investment bankers sometimes have undue influence over the management. Often times, they get a SPAC to merge with a company just so that they can earn their underwriting and advisory fee in the process

  • Mergers and acquisitions have a lot of tax complications as well. Companies have to hire expensive specialists in order to manage these issues

  • Exchanges all over the world have become more vigilant. They are now imposing disclosure requirements on unlisted companies merging with listed companies. Hence, there is no advantage as far as disclosures are concerned.

Why Investment Bankers Like Special Purpose Acquisition Companies (SPAC)?

As far as investment bankers are concerned, Special Purpose Acquisition Companies (SPAC) are good for their business. This is because, they get multiple opportunities to engage with the company.

  • First, they earn money when the shell company goes public. This is the form of floatation costs

  • They, they can engage the company in finding an acquisition target as well as the advisory that needs to be done when a target is finally identified.

  • Investment bankers also need to be engaged when the shares of the shell company are to be delisted after the acquisition has been completed.

To sum it up, Special Purpose Acquisition Companies (SPAC) are a unique and innovative method of fund raising which has been created by investment bankers.

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Investment Banking