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How do SPACs work?

Special purpose acquisition companies (SPACs) help companies make the leap from privately held to publicly traded entities with less red tape and faster than an initial public offering (IPO). While a traditional IPO process can take several years, a SPAC can usually take a company public much more quickly.

SPACs, also known as “blank check companies,” are publicly traded shell companies. They have no active business operations and are typically formed by a group of investors called sponsors. These individuals usually have a strong interest or background in a particular industry they target.

Along with investments from sponsors, SPACs raise additional capital through an initial public offer which is often priced around $10 per share. Most of the money is placed in escrow while the SPAC looks for potential companies to acquire. Acquisitions usually must be completed within 18 to 24 months after the IPO closes, or the SPAC dissolves and returns remaining funds to investors.

Is the SPAC bubble about to burst?

SPACs have been around for nearly three decades but experienced a boom starting in 2020. In 2021, these companies registered a record $160 billion on U.S. stock market exchanges, double the amount from the year before. However, SPAC performance has steadily declined since March 2021, leading many financial experts to believe that they have run out of steam.

CNBC reports unfavorable market conditions along with the speculative nature and volatility of SPAC shares are the main reasons for significant losses in January’s tech-driven sell-off. CNBC’s proprietary SPAC Post Deal Index fell 23%. The financial network reports that nearly 600 SPACs are still searching for potential acquisitions.

Pros and cons for businesses targeted by SPACs

Deals with SPACs are much different than sales to traditional strategic buyers. Since they are shell companies without operational capabilities, they do not assimilate companies into their structure. Rather, businesses continue to operate as they have, but just as publicly traded businesses. This can be attractive to a target company for many reasons. First, the company goes public more quickly, eliminating the need for marketing to bankers and potential investors.

SPACs historically provide greater certainty over pricing than traditional IPOs, which are also significantly impacted by market volatility and other forces. Another positive is that owners and investors usually have faster access to cash since share lockups required by the IPO process do not apply.

One of the greatest disadvantages is that many companies are not ready for the complex changes that need to be made. When the transaction closes, the company must immediately operate as a public entity. One way to prepare is for the targeted company to approach a SPAC acquisition as if it is doing an IPO of its own. That is why it is advisable to consult with a knowledgeable business acquisition attorney to cover all the bases.