What the Heck is a SPAC?

You may have seen some press on something called a SPAC. SPAC stands for Special Purpose Acquisition Company. The basic idea is that an investment firm (VC, private equity, etc) sets up a new company and issues stock to investors through an IPO with the sole purpose of buying a private company. Selling to a SPAC allows a private company to start trading publicly on the stock exchanges without having to go through the hassle of an IPO since they are merging with an existing public entity.

SPACs are red hot right now. It seems like every day a new SPAC is filing to get started. Why is this happening? I suppose the optimistic answer is that for the last few years a lot of successful private companies have stayed private a lot longer than usual. An abundance of venture capital money for later stage startups has been viewed by founders as cheaper and simpler than an IPO. The pessimistic answer is that the investment firms and brokers setting up the SPACs make a bunch of money with these structures, so they will keep making new ones as long as investors are willing to play ball.

With a SPAC, the new company goes public with no operations or business plan. They raise a bunch of money, usually $250–500MM, and then sit on the cash while they try to find a suitable private company to purchase. High profile companies like DraftKings and Virgin Galactic have gone public via SPACs. Alternative power car and truck maker Nikola also did, but that one has been messier of late.

Investors in the SPAC IPO buy the shares of this shell company based on the strength of the investment firm that is leading the charge, on the hopes that they can find a great private company to buy. If they do, then the SPAC stock sees a nice pop when a deal is announced. Still following me so far? I hope so. When a SPAC is created, the cash goes into a bank escrow account and just sits there. The investment firm generally has up to two-years to find an acquisition target. If not, the entity is dissolved and the shares are paid back, minus some hefty fees.

Here is a quick overview of a few notable SPACs that have been created recently. Pershing Square, run by famed investor Bill Ackman, raised a monster $4 Bn SPAC. Sports investors RedBird Capital created a $500MM SPAC. Shaquille O’Neill has partnered with some former Disney execs on the $250MM Forest Road SPAC. There are several SPACs being created by prominent venture capital firms or well-known former startup founders.

With so much SPAC money available, this will create pressure on founders to go public via this mechanism instead of taking later round private money for the next few years. With billions of SPAC cash on the sidelines with a two-year “use it or lose it” timeline, the investment firms will be fighting each other to buy late stage companies. This will bid up the prices and lead to companies going into the public markets before they are ready. Some of these situations will go great and others will likely lead to overpriced, unsuccessful stocks. Only time will tell here.

Thanks for reading today’s post, I hope this helps you better understand SPACs and their impact on the startup scene.

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