Simplifying SPAC Mergers – Part 1 – Fundamentals Explained

SPACs can offer quick and lucrative results for companies, and that’s exactly why the trend is picking steam across the globe, when done right.

Simplifying SPAC Mergers – Part 1 – Fundamentals Explained

When companies first come into existence, they do not really know when they will require additional capital, or how they will accumulate it, to successfully run (and grow) their business. Opting for an IPO is one of the most popular ways to raise capital and boost public profile. By selling company shares to the public, organizations can expand their business, fund upcoming research and development, and even pay off debt.

But given the time and effort that goes into the IPO process, many companies are now opting for a Special Purpose Acquisition Company or SPAC that allows them to quickly pool funds in order to finance a merger or acquisition opportunity – within a defined timeframe.

In this first part of our two-part series on “Simplifying SPAC Mergers”, we will deep dive into the fundamentals of SPACs: right from what they mean, their typical equity structure, trend analysis, and the benefits and risks of SPACs vis-à-vis IPOs.

Economics explained for the Founder, Investor, and Target

According to a recent report by Wall Street Journal, SPACs raised a record $82 billion in 2020 along, setting a new all-time record.

Companies that are looking to go public are increasingly evaluating if the benefits of merging with a SPAC would be preferable to an IPO. Although this depends on many factors, here’s the economics explained for the founder, investor, and target:

  • What SPAC means for the founder: Founders who prioritize growth can opt for SPACs to easily raise capital and expand their operations – without having to worry about IPO-related challenges like meeting regulatory requirements, driving efforts to attract institutional investors, or paying underwriting fees to investment banks who can facilitate the process.
  • What SPAC means for the investor: Most SPAC investments are sponsored by industry executives with substantial M&A experience and a proven ability to source transactions. For investors, SPACs are particularly compelling, as they receive about 20% of the common equity in the SPAC as compared to 3% to 4% of the IPO proceeds.
  • What SPAC means for the target: A target company that gets acquired through SPAC can enjoy benefits such as improved speed of going public (3-6 months as compared to 12-18 months via an IPO) at a guaranteed price (in comparison to an IPO where the price largely depends on market conditions at the time of listing).

Trend analysis

SPAC mergers, although extremely beneficial, aren’t simple, and require careful understanding of all the intricacies. When done right, SPACs can offer quick and lucrative results for companies, and that’s exactly why the trend is picking steam across the globe. Here’s looking at some impressive numbers as stated by KPMG:

  • SPAC stocks have delivered average annualized returns of about 17.5% since 2015, showcasing the efficiency with which private companies can tap public equity markets.
  • Between 2018 and 2020, the largest SPAC deals in terms of size and volume were in industrial manufacturing, followed by technology, media, and telecom, and consumer, retail, and travel.
  • By revenue, most target companies fell under the $500 million range regardless of the industry.
  • About 50% of SPACs have anywhere between $200 million to $400 million at their disposal.

Typical equity structure and PIPE financing

Although SPAC sponsors are constantly on the lookout for investors who can pool in money, in some cases, they need to arrange for the second category of investors to supplement the original IPO proceeds with additional funding. Via a private investment in public equity or PIPE commitment, they can buy shares of publicly traded stock at a price below the current market value, and raise capital as required.

Although a publicly-traded company may utilize a PIPE to fund day-to-day operations, upcoming expansion, or future acquisition, the equities never go on sale on a stock exchange. Instead, investors can purchase the company’s stock in a private placement, and not worry about registering PIPE shares in advance with the SEC or comply with federal registration requirements for public stock offerings – thus enjoying the faster speed and fewer administrative requirements.

SPAC versus traditional IPOs – the benefits and risks

When discussing SPAC, it’s impossible to not compare it with its distant cousin – the traditional IPO. So, here’s how SPAC is different from an IPO:

  • An IPO enables a company – especially private ones – to access significant funds to expand its business by selling its shares to the public. This is possible once a thorough audit of the financials is conducted by the SEC, after which the stock exchange examines the application. Once approved, the business defines the number of shares it will sell, an investment bank determines the IPO price based on evaluation, and the stock is released for public trading at a predetermined price.
    • Benefits of IPO include successful fundraising, more price transparency, better exit opportunities, and better credibility
    • Risks of IPO include the need to comply with a laundry list of regulatory requirements, price volatility, loss of control, and high cost of transactions
  • SPAC is fundamentally a shell company – with no offices and no employees – that acquires an existing business and makes it public. In contrast to an IPO, a SPAC sells shares to investors to go public on the stock market and then drives efforts towards acquiring a company – before a pre-defined deadline. SPACs are usually created by a team of high-profile investors such as hedge funds or private equity heads and industry leaders, who raise capital, research the market for companies seeking to go public, and then acquire those that meet the criteria.
    • Benefits of SPAC include faster execution, reliable prices, lower costs, and better access to operational expertise
    • Risks of SPAC include the possibility of shareholder dilution, poor financial diligence, and the repercussions of poor underwriting

For any private company, raising capital is a fundamentally complex part of the growth journey. However, this complexity can greatly be minimized by taking the SPAC route that allows companies to go public – quickly and efficiently. With SPACs raising approximately $26 billion in proceeds in a single month – setting a new record – it makes sense to take the SPAC route to enjoy higher valuations, ensure greater speed to capital, and not get bogged down by a slew of regulatory demands.

Stay tuned for our second part of the SPAC Merger series to learn about the financial, accounting, and reporting considerations to keep in mind while taking the SPAC merger route for sure-shot success.


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