What Is a SPAC And How Does It Work?

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 Have you ever heard about SPAC? 

At this point probably yes. SPACs have spiked in 2020 and it is a new trend in financial markets.

But, What is a SPAC and Why do investors like them so much?

SPACs s this year have raised triple the amount that they did in al of 2019, with companies slashing dividends and interest rates at rock bottom levels, investors are flocking to SPACs.

So, what exactly are SPACs, and Why are they so popular?

SPACs are also known as blank check companies and have become a popular way in recent years to list companies on a stock exchange.

SPACs are shell companies with no commercial operations but are created solely for raising money for raising capital through an IPO to acquire a private company.

That happens usually by selling common stock, with shares commonly sold at $10 apiece and with a warrant that gives the investor a preference to buy more stock later at a fixed price.

Once the funds are raised, they will be kept in a trust until one of two things happen.

1. The SPAC management team will identify a company of interest, which will be taken public through acquisition using the raised capital in the IPO.

2. IF the SPAC fails to merge or acquire a company within a deadline, typically 2 years, the SPAC will be liquidated and investors get their money back.

SPACs in the 1990s were typically used as a last resort for smaller companies to go public, but they are now gaining popularity among notable personalities in the financial markets led by hedge fund manager Bill Ackman and Palihaoitya. 

The structure of SPAC allows investors to contribute money towards a fund without any knowledge of how their capital will be used, thus the term blank check.

When compared to a traditional IPO, SPACs are not subjected to the immense regulatory and investor scrutiny like a traditional IPO. Moreover, in a traditional IPO, an investment bank is usually hired by the company to underwrite the IPO, which usually tasks 4 to 6 months to complete. SPACs on the other hand typically list in a much shorter time. 

The flip side is that has led investors to become wary of buying shares in companies listed through SPACs due to the lack o scrutiny compared to traditional IPOs.

But, How have SPACs companies performed in equity markets?

A study from Goldman Sachs that analyzed the performance of 56 SPACs that completed acquisition since 2018 found that they tend to underperform the S&P500. Another study from financial times has shown that black check companies in the US organized between 2015 and 2019 found that the majority are trading below the standard price of $10 per share.

But despite all that, 'black check companies' are booming. In fact, funds raised through SPACs outpaced traditional IPOs this year, never-before-seen in Wall Street.

Of the $56 billion invested in SPAC listing in 2020, 99% was raised in the US, and that figure is 12 times the amount raised globally in 2015 over the same period.

As SPAC activity reaches all-time highs, regulators are putting these 'blank check companies' under the microscope. 

Regulators and financial experts are concerned that this new trend will overheat markets and affect the fragile economic recovery.

It is hard to say when the SPAC boom will end, there are a lot of things that could end this trend. But, looking at the past I expect some regulatory actions that could shut this trend down to normal levels.

What about you? What're your thoughts on SPACs? Drop your comments!




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