Summary List Placement
SPACs were once a little-known way for private companies to go public without having to IPO.
But in 2020, the number of SPACs on the market quadrupled from the year before, according to SPAC Insider data. And so far this year, the number has almost reached that record high from last year. January was a record-setter, with close to $26 billion raised via SPACs.
Those launching SPACs aren’t just former CEOs or private equity investors anymore. Celebrities, like Colin Kaepernick and Shaquille O’Neal, have gotten in on the action. Plus, everyday investors are buying into the new trend.
The concept of a SPAC and the process to create one aren’t as complicated as they may seem.
A SPAC stands for “special purpose acquisition company.” It’s a fancy term that simply refers to a business that has a war chest of cash and a single objective: to take a private company public.
“The SPAC has become a vehicle for private companies to get into the public market sooner and faster and, in a sense, a little bit easier,” said Yelena Dunaevsky, a transactional insurance broker at Woodruff Sawyer who specializes in SPACs.
To find out how they’re formed from start to finish, Insider spoke to industry experts, including a lawyer, insurance broker, investor, SPAC veteran, and analyst.
The big idea
A SPAC begins just like any startup — with an idea.
A few people get together — perhaps a former CEO with some industry expertise, a SPAC veteran, an asset manager, a known deal maker, or nowadays even a celebrity — with an idea to start a SPAC in the hopes of finding an industry-specific company or just any company to take public. According to Ari Edelman, a partner at Reed Smith who specializes in SPACs, these people are typically confident in their network and their ability to make a deal happen.
These initial SPAC management teams have generally been small, just three or four people. But amid the frenzy, people are starting to gather big teams and set up multiple SPACs simultaneously, said James Graf, an industry veteran who himself recently launched three new SPACs.
Regardless of its size, the new team must first be established. So, they create an LLC, or limited liability corporation, typically in Delaware. In industry speak, this is called the “sponsor.” The team needs the help of lawyers and bankers to get started, and they will rely on those specialists from beginning to end.
Next comes the actual SPAC. The sponsor creates the SPAC before taking it public through an Initial Public Offering, or IPO.
Now just like any startup, the SPAC management team needs to put up some money in order to get that eventual payoff. That money is referred to as the “risk capital.” This capital funds the SPAC from its inception until its eventual merger with a private business.
Sometimes, the team itself will fund the risk capital. But Graf said it’s becoming “increasingly common” to bring in other financial investors to help out.
For a team targeting the creation of a $200 million SPAC, they’ll need about $7.5 million in risk capital. Here’s a breakdown of the math, according to Graf and Harvard Law.
The underwriter takes a 2% fee. So in a $200 million IPO, that means the underwriting cost is $4 million.
The team will need another $2 million to cover expenses that come from lawyers, the Securities and Exchange Commission, FINRA, and others, as well as for daily operating expenses.
Lastly, the team needs about $1.5 million for two years of Directors and Officers, or D&O, insurance, which protects the SPAC management team from lawsuits.
This all adds up to a grand total of $7.5 million needed to fund the risk capital for a $200 million SPAC. But that’s not a hard number. Because of the frenzy of SPACs entering the marketplace, the demand for insurance, lawyers, and underwriters has gone up, and with that, so have the prices.
Dunaevsky said pricing for the D&O insurance has gone up five times since the summer. “If SPACs don’t plan on the big price tag, and don’t plan on insurance far in advance, they can run into problems,” she said.
Insurance can increase in price depending on who’s on the SPAC team. For example, celebrities are more expensive to insure and so are managers with a riskier business history.
Edelman said the price of lawyers has also increased, and it’s become “much harder to find a good lawyer with a lot of experience” as a result of the high demand.
In exchange for putting up millions of dollars in risk capital, the team receives 20% of the shares in the eventual public SPAC for a nominal amount of cash, generally about $25,000. This incentive is called the “promote.”
For example, the team would receive 2.5 million shares on top of the 10 million shares issued in the IPO. But those 2.5 million shares won’t be worth anything until the SPAC merges with a private company.
“This is their startup,” Dunaevsky said. “So they will get paid, if everything goes well.”
Taking the SPAC public
Before the SPAC goes public, the team will go out and talk to institutional investors and put a list together of groups that will subscribe, or buy into, the IPO. This list is called the “order book.”
Then, to actually take the SPAC public, the team and its lawyers prepare and file the S-1 registration statement with the Securities and Exchange Commission — just like anyone else seeking to IPO.
“It’s really boilerplate these days,” said Julian Klymochko, the CEO and chief investment officer of Accelerate Financial Technologies. The filing simply states the management bios, the ticker symbol, the name, and how it’s different from other SPACs.
Klymochko, who runs a SPAC-focused exchange-traded fund, added that most SPACs will also note what industry they’re looking to do a deal in, “whether it’s fintech, technology, sustainability, renewable energy, real estate, electric vehicles or things of that nature.” Some, he said, are diversified and keep it “very general,” but usually that’s private equity firms like Apollo or Fortress.
The SPAC doesn’t have to stick with whatever industry it lists in the filing. “It’s hilarious because there were a bunch of cannabis SPACs, and not one of them did a cannabis deal,” Klymochko said. For example, Tuscan Holdings, which had targeted a cannabis merger, ended up buying battery maker Microvast, and another cannabis SPAC created by former Canopy Growth CEO Bruce Linton bought a company that makes LiDAR sensors and perception software for autonomous-driving vehicles.
Edelman said the process of filing and hearing back from the SEC typically takes about 30 days.
After approval, the SPAC can go public. Once it lists on the Nasdaq or New York Stock Exchange, investors can buy into the new company, just like any other IPO. The one difference is that investors are buying “units” instead of shares. Each unit, which typically sells for about $10, includes one share and a fraction of a warrant.
“Just like the ‘promote’ incentivizes the sponsor to create SPACs and find deals, the warrants are a way to entice public market investors to invest in the SPAC IPOs,” said Cameron Stanfill, a venture analyst at PitchBook Data.
The money raised from the IPO goes directly into an untouchable trust, where it accrues interest until the SPAC finds a private company and uses the funds to merge with that company.
Consumers don’t know at the end of the day what the SPAC is going to do, so in reality, they’re betting on the SPAC sponsors when they invest. There’s not much risk, outside of opportunity cost, to investing in a SPAC. If the SPAC fails to strike a deal, investors get their $10 back plus interest.
SPAC-offs and SPAC-ups
Once the SPAC management team has its treasure trove of cash, it can start hunting for deals, and it has a limited time to do so.
Most SPACs get about two years to find a private company to take public, but with the high demand, SPACs have often been finding deals within just a month or two from the IPO. Before the frenzy, teams would have to chase down private companies and explain to them why it made sense to go public through a SPAC.
“The dynamic has completely changed,” Graf said. “It’s not the SPACs that are chasing targets; it’s the target companies that are chasing SPACs.”
Oftentimes, multiple SPACs will be competing for the same private company in what’s now known as a “SPAC-off.” A private company will then weigh the valuation, cash, investors, and guidance each SPAC can provide.
Once a SPAC finds a company to merge with, the management team will go looking for “pipe financing.”
In the $200 million SPAC example, if a private company wants $600 million at closing, then the SPAC will find big chunks of institutional investors to commit to making up the difference once the deal is completed.
The deal itself is known as a “reverse merger.” This is a term outside of the SPAC world, too. If a public company isn’t doing so well, for example, a private company could take over, using the public entity to enter the market. In a SPAC merger, the private company is using the SPAC to take it public, instead of going through the traditional IPO process itself and risking a failed offering or a bad opening day on the market when it starts trading.
Once the deal terms and pipe financing are in place, the SPAC publicly announces the merger and pulls in public relations representatives to help market the deal through press releases, podcasts, and elsewhere, Klymochko said.
If the public likes the deal, shares will trade higher on the news. This is called a “SPAC-up.” If there’s no SPAC-up, it’s not a good deal.
At this point, stockholders can redeem their shares if they don’t like the deal. That means they’ll get their $10 per share plus interest back from the trust. But they get to keep the warrants or sell them. If a SPAC is overwhelmed by redemptions, it may cancel the deal.
But if the stock is trading higher on the deal news, the original shareholders may cycle out of the stock and take their profit, letting new investors get in on the going-forward company.
A majority of shareholders have to agree it’s a good deal, but Klymochko said he’s never seen a deal get voted down.
“They’re incentivized to vote it through. If you vote down a deal, then [the SPAC] fails, and the warrants go to zero,” Klymochko said. “So if you don’t like the deal, either you sell if it’s trading above the cash value, or you just redeem if it’s trading below the cash value.”
The time from announcing a deal to receiving shareholder approval typically takes about three months. Once shareholders approve, the deal closes in a matter of days with the help of lawyers and bankers advising the SPAC and private company.
This is the “de-SPAC.”
“You’re no longer a SPAC,” Dunaevsky said. “You are now a combined operating company.”
SPAC management may take a seat or two on the board or get involved in management to help guide the going-forward company and look out for the interests of public shareholders.
At last, Klymochko said the SPAC “changes the name and ticker symbol, and then they’re off to the races” as the new public company.
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