Special Acquisition Companies (Spacs) have been becoming more and more popular in the market recently ( DraftKings, SHLL, NKLA) so I wanted to write a little something explaining the differences and risks between a traditional IPO and going public through a SPAC to newer investors.
What is a Spac?
A Spac is a company that is created with the sole purpose of acquiring a company from the private sector. The Spac will IPO to raise funds and then immediately take the funds and put them into a trust account until an acquisition target is found. Once a target is found then those funds will be used to buy the target company and the spac investors will now own shares of the acquired company. If an acquisition target is not found within a predetermined time frame (usually 2 years) then the money will be taken out of the trust account and redistributed to the investors + any interest accrued while it sat in the trust account.
Let's run through a simple example to really drive the point home. Spac A IPOs for 10$ a share. You buy 100 shares for 1000$. Spac A decides to acquire private company B. After the acquisition occurs you now own shares of private company B (that is now public company B)
The Advantages of a Spac
Spacs are a relatively safe way to invest in private companies that you normally wouldn't be able to because of redemption. You can redeem your shares for their IPO value at two different points in a Spac's life. The first time is if the company cannot find an acquisition target. if this happens you redeem your shares for their IPO price plus any interest collected on the money while it was sitting in the trust. The second time is if you don't like the target acquisition. Before acquiring a company the shareholders are required to vote on whether they want the acquisition to go through or not. Any shareholder that votes against the acquisition will be given the option to redeem their shares for the IPO price regardless if the vote passes or not.
Capital Structure
Spac companies have a comparatively more complex structure than traditional IPOs. In addition to public warrants and public shares, a Spac will also have founder shares and founder warrants. These are given to the management team of the Spac and sometimes to the CEO/employees of the company that is being acquired. Additionally, if the acquisition of a company is approved by shareholders but the spac doesn't have enough funds to complete the acquisition then more shares are sold directly to institutions. (Commonly known as PIPE investment.) Between PIPE investment and founder warrants/shares there can be significant dilution in the market that most people aren't aware of simply because there is a time limit on when warrants or PIPE shares or founder shares etc can enter the market. (This is why NKLA is heavily shorted right now)
The Risks
Investing in a Spac can be a safe way to invest in private companies if done correctly, however, there are a few pitfalls to look out for. Most spacs will IPO for 10$ a share, this means that even if you buy a share for 15$ you can only redeem it for 10$. The price of most Spacs will stay relatively stable at 10$ a share until an acquisition is announced, then demand will increase driving the price up. If you buy into a Spac during this period at higher than the IPO price then you are risking the difference between your purchase price and the IPO price if the acquisition were to fall through and the spac were liquidated. (The price will never fall below 10$ a share because no one will sell something they can redeem for 10$ for less than 10$.)
There is also the risk that the company acquires a flop. If you hold through acquisition and the company stock tanks after the acquisition then you just have to eat the loss. (you cannot redeem your shares for 10$ after the acquisition happens.)
The Take Aways
SPACs can be a safe way to invest in the private sector
Due to their complex capital structure, there can be a lot of shares ready to flood the market that you may be unaware of (see nkla)
As always I'm willing to answer any questions or discussions in the comments.
Submitted July 04, 2020 at 06:56PM by vandytaw https://ift.tt/3f0UKYl
