There has been a lot of volatility in the markets during 2020 amid the COVID-19 pandemic. Currently, the market value is really high. Many companies are racing to go public this year. Companies want to take advantage of the market rally. Private companies usually go public through a traditional IPO. Another option is to merge with a special purpose acquisition company (SPAC) or a blank check company.
According to a CNN report, Bob Blee, the head of corporate finance at Silicon Valley Bank, said, "The advantages that SPACs have are even more compelling because of Covid-19." He also said, "There's less uncertainty and a faster time to close deals."
What is a special purpose acquisition company?
According to the Corporate Financial Institute, a SPAC or blank check company is formed to raise investment capital through an IPO. The company is created solely to raise capital and merge with another company. The SPAC has to pitch the undisclosed merger to large investors and get financial backing. After the SPAC gets investors to contribute to the IPO, the funds go into a trust and accrue interest until the SPAC merges with a private business.
Once a SPAC is created, it has 24 months to find a business target and complete the acquisition. In some cases, the SPAC can hold a shareholder vote to extend the period to 36 months. If the SPAC doesn’t complete an acquisition, it has to pay bank and broker fees and return the funds to investors.
In the past, there was a stigma on Wall Street about SPACs. Many investors thought that if a company needed to go public through a merger, it probably wasn’t healthy enough for an IPO. Let’s take a look at the pros and cons associated with a SPAC.
What are the benefits of a SPAC?
There are many benefits associated with SPACs. For businesses looking to go public, some of the pros include:
- Going public through a SPAC is usually quicker and cheaper than a traditional IPO.
- There isn’t an IPO window. There isn’t the risk of not being able to raise capital because it’s already available.
- SPAC management stays active in the combined company and has a stake in the long-term success.
- SPACs offer financial flexibility and capital structure.
- There isn’t an IPO threshold. Some small companies don’t qualify for a traditional IPO due to their size or if they are in a down cycle. SPACs look at a company’s growth potential.
- A SPAC has cash, which leads to immediate capital appreciation.
- Since SPACs don’t have long histories like established companies, they tend to draw less scrutiny.
Special Purpose Acquisition Companies (SPACs) can provide a fast track IPO process to private companies and offer investors private equity-like returns with downside protection. Learn more on SPACs from Anna Castro, Sr. Portfolio Manager, TDAM: https://t.co/Zq3Myk97Hq.— TD Asset Management (@TDAM_Canada) August 26, 2020
Investing in a SPAC attracts investors because:
- There’s less downside risk involved since the funds are in escrow.
- Investors can trade their stocks and warrants.
- There is a specific timeframe with limited lockup and illiquidity.
- Investors can provide more input.
What are the cons of a SPAC?
Although there are many benefits to a SPAC IPO, there are also some disadvantages that should be considered.
- Post-transaction trading can be limited if too many pre-acquisition stockholders decide to redeem their stock at the closing.
- The funds are held in a trust and saved for the combined business after the merger. As a result, there isn’t a guarantee that the business will get a reverse breakup fee from the SPAC.
- The amount of cash the SPAC has isn’t certain. The SPAC’s public stockholders can redeem their shares for cash. So, the amount of cash that’s available for paying target stockholders and post-closing operations can fluctuate.
- The SPAC still has to meet certain SEC filing requirements and be ready for the IPO to avoid delays.
- Although there has been a boom in companies going public through SPAC mergers, they generally don’t have a steady long-term success rate. Usually, they outperform the S&P 500 initially and lag broader markets within a year.
Why are there a lot of SPACs in 2020?
There have been a record number of SPAC IPOs in 2020. Some post-merger returns have been impressive. So far, IPOs through SPACs have been outpacing traditional IPOs this year.
SPAC IPOs usually apply to be listed on Nasdaq or the NYSE. Nasdaq tends to be more popular for SPACs because the listing standards aren’t as strict.
Some of the notable SPAC IPOs in the past year are:
- DraftKings listed on the NYSE under the ticker “DKNG.”
- Virgin Galactic listed on the NYSE under the ticker “SPCE.”
- Nikola listed on Nasdaq under the ticker “NKLA.”
- Repay Holdings listed on Nasdaq under the ticker “RPAY.”
- Vivint Smart Home listed on the NYSE under the ticker “VVNT.”
- Collier Creek Holdings listed on the NYSE under the ticker “CCH.”
- Vertiv Holdings listed on the NYSE under the ticker “VRT.”
- Immunovan listed on Nasdaq under the ticker “IMVT.”
- AdaptHealth listed on Nasdaq under the ticker “AHCO.”
- Allied Esports Entertainment listed on Nasdaq under the ticker “AESE.”