The Special-Purpose Acquisition Company (SPAC) Boom

By Queenie Mok

The interest in special-purpose acquisition companies or SPAC has grown exponentially in the past year. Many companies are choosing to go public through these types of companies instead of a traditional initial public offering. In March 2021, funds raised by special-purpose acquisition companies in the United States broke the 2020 record. What are special-purpose acquisition companies? Why are traditional companies interested in them?

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Source: SPACInsider

What are SPACs?

Special-purpose acquisition companies, or SPACs, are created for the sole purpose of raising funds to acquire another company. The special-purpose acquisition company, which is formed or ‘sponsored’ by well-known investors or celebrities, will seek public investors through an initial public offering of its own. The initial public offering investors typically pay US$10 in return for one share of the special-purpose acquisition companies’ stock and a fraction to a full warrant with an exercise price of US$11.50. 

The special-purpose acquisition company will hold the funds raised from the initial public offering in trust and will find an acquisition target within two years of its listing. Once the company finds a target, it will seek shareholder approval for the merger or acquisition. If the shareholders approves, the special-purpose acquisition company will go through a “de-SPAC” process, where it merges with its target company. As the merger is with an already listed company, the target also becomes publicly traded. 

Going public

Source: PricewaterhouseCoopers

Why Are Companies Choosing SPACs over IPOs?

The main benefit of going public through a special-purpose acquisition company is that it is usually a faster process compared to a traditional initial public offering. While a typical special-purpose acquisition company deal takes about three to six months, a traditional initial public offering can take up to a year to complete. Moreover, the target firm seeking to go public only has to negotiate with one party, the special-purpose acquisition company, for a fixed sum in return. Thus, it creates more certainty for the target firm. 

Source: CB Insights Research

Downsides of SPACs

The biggest disadvantage of going public through a special-purpose acquisition company is stock dilution. The sponsor typically receives 20 percent of the company’s stocks for free or nearly free as their “promotion” incentive. In a working paper published by Stanford University, between the years of 2019 and 2020 over 25 percent of all deals involving special-purpose acquisition companies ended with these particular entities having “more free shares given to the sponsor than shares issued to investors for cash”. In addition, if early investors choose to exercise their warrants after the merger, there is further dilution of equity. 

For those investing in a special-purpose acquisition company IPO, at the time when the company is formed, its target for acquisition is usually unknown. Therefore, most investors are often investing based on the reputation of the sponsors, which can be risky. Because of the sponsor’s large “promotion” incentive, there is also a bonus for them to accomplish a deal even if it may not be in the best interest for the special-purpose acquisition company’s public investors. 

Source: CB Insights Research

Appetite for SPACs in Asia-Pacific

Last year, 97 percent of funds raised from special-purpose acquisition companies were from those listed on the New York Stock Exchange and NASDAQ. This is due to different listing rules in the United States compared to other parts of the world. 

Although rules in Singapore and Hong Kong both disallow special-purpose acquisition company listings, regulators and exchanges in both places have been proactive in considering rule changes. In March, the Hong Kong government released a statement saying that it has instructed the Securities and Futures Commission and the Hong Kong Exchanges to establish a framework that will allow for the listing of special-purpose acquisition companies. The Singapore Exchange has also launched a consultative process seeking to allow for some form of special-purpose acquisition company initial public offerings in its country.

The Australian Securities Exchange currently does not allow for the listing of special-purpose acquisition companies. However, there have been calls by venture capitalists and private equity firms to allow for special-purpose acquisition company listings in Australia. For example, Matt Allen, the chief executive of Tractor Ventures has said that continuing to disallow special-purpose acquisition company initial public offerings will mean that more Australian technology firms will choose to go public in the United States through a special-purpose acquisition company instead of through an initial public offering in Australia. 

The Australian Securities Exchange’s executive general manager of listings and issuer services has said that they are currently “examining the SPAC phenomenon closely”. Whether this means that special-purpose acquisition company listings will become a reality in Australia remains to be seen.

Sources: CNBC, The New York Times, AFR, Harvard Law, PwC, Reuters, Forbes, Sydney Morning Herald, The Wall Street Journal, Bloomberg, Morningstar, SCMP

Disclaimer
The authors of this publication are not qualified to provide financial or investment advice and as such the content provided should not be construed in this manner. All information is intended purely for educational purposes and is provided for the personal interest of UNIT members. The opinions expressed within the article do not reflect those of UNIT as an organisation, its partners or its sponsors.