Special Purpose Acquisition Company (SPAC) Explained:

Examples and Risks

What Is a Special Purpose Acquisition Company (SPAC)?

A special purpose acquisition company (SPAC) is a company without commercial operations and
is formed strictly to raise capital through an initial public offering (IPO) for the purpose of
acquiring or merging with an existing company. IPO is an initial public offering. In an IPO, a
privately owned company lists its shares on a stock exchange, making them available for
purchase by the general public. Many people think of IPOs as big money-making opportunities
—high-profile companies grab headlines with huge share price gains when they go public.

Also known as blank check companies, SPACs have existed for decades, but their popularity has
soared in recent years. In 2020, 247 SPACs were created with $80 billion invested, and in 2021,
there were a record 613 SPAC IPOs. By comparison, only 59 SPACs came to market in 2019.

KEY TAKEAWAYS
 A special purpose acquisition company (SPAC) is formed to raise money through
an initial public offering (IPO) to buy another company.
 At the IPO, SPACs do not have business operations or stated targets for acquisition.
 SPAC shares are structured as trust units with a par value of $10 per share.
 Investors in SPACs range from prominent private equity funds and celebrities to the
public.
 SPACs have two years to complete an acquisition or they must return funding to
investors.

How Does a Special Purpose Acquisition Company (SPAC) Work?

SPACs are commonly formed by investors or sponsors with expertise in a particular industry or
business sector, and they pursue deals in that area. SPAC founders may have an acquisition
target in mind, but they do not identify that target to avoid disclosures during the IPO process.

Called “blank check companies,” SPACs provide IPO investors with little information prior to
investing. SPACs seek underwriters and institutional investors before offering shares to the
public. During a 2020–2021 boom period for SPACs, they attracted prominent names such as
Goldman Sachs, Credit Suisse, and Deutsche Bank, in addition to retired or semiretired senior
executives.

What Is an Underwriter? An underwriter is any party, usually a member of a financial

organization that evaluates and assumes another party's risk in mortgages, insurance, loans, or
investments for a fee, usually in the form of a commission, premium, spread, or interest.
What Is Underwriting? Underwriting is the process through which an individual or institution
takes on financial risk for a fee. This risk most typically involves loans, insurance, or
investments.

Example: IPO underwriting

Suppose ABC Company, a promising technology company based in Cebu, decides to go public
and raise capital by issuing shares through an Initial Public Offering (IPO). In this scenario, the
underwriter plays a crucial role in facilitating the IPO process.

Institutional investors are legal entities that participate in trading in the financial markets.
Institutional investors include the following organizations: credit unions, banks, large funds
such as a mutual or hedge fund, venture capital funds, insurance companies, and pension
funds.

An institutional investor is a company or organization that invests money on behalf of clients or

members. Hedge funds, mutual funds, and endowments are examples of institutional investors.
Institutional investors are considered savvier than the average investor is and are often subject
to less regulatory oversight.

The funds that SPACs raise in an IPO are placed in an interest-bearing trust account that cannot
be disbursed except to complete an acquisition. In the event it is unable to complete an
acquisition, funds will be returned and the SPAC will ultimately be liquidated.

A SPAC has two years to complete a deal or face liquidation. In some cases, some of
the interest earned from the trust can serve as the SPAC’s working capital. After an acquisition,
a SPAC is usually listed on one of the major stock exchanges.

Liquidation is the process of ending a business and distributing its assets to claimants, which
occurs when a company becomes insolvent. Liquidation is the process in accounting by which a
company is brought to an end. The assets and property of the business are redistributed.

The purpose of liquidation is to ensure that all the company's affairs have been dealt with and
all its assets realized. When this has been done, the liquidator will apply to have the company
removed from the register at the Companies House and dissolved, which means it ceases to
exist.

What Are the Advantages of a SPAC?

SPACs offer advantages for companies planning to go public. The route to public offering using
a SPAC may take a few months, while a conventional IPO process can take anywhere from six
months to more than a year.
Additionally, the owners of the target company may be able to negotiate a premium price when
selling to a SPAC due to the limited time window to commence a deal. Being acquired by or
merging with a SPAC that is sponsored by prominent financiers and business executives
provides the target company with experienced management and enhanced market visibility.

The popularity of SPACs in 2020 may have been triggered by the global COVID-19 pandemic, as
many companies chose to forego conventional IPOs because of market volatility and
uncertainty.

Volatility is a measure of the rate of fluctuations in the price of a security over time. It indicates
the level of risk associated with the price changes of a security. Investors and traders calculate
the volatility of a security to assess past variations in the prices to predict their future
movements.

Sample Calculation

You want to find out the volatility of the stock of ABC Corp. for the past four days. The stock
prices are given below:
 Day 1 – P10
 Day 2 – P12
 Day 3 – P9
 Day 4 – P14

To calculate the volatility of the prices, we need to:

Find the average price:

P10 + P12 + P9 + P14 / 4 = P11.25

Calculate the difference between each price and the average price:

Day 1: 10 – 11.25 = -1.25

Day 2: 12 – 11.25 = 0.75
Day 3: 9 – 11.25 = -2.25
Day 4: 14 – 11.25 = 2.75

What Are the Risks of a SPAC?

An investor in a SPAC IPO trusts that promoters are successful in acquiring or merging with a
suitable target company in the future. However, there exists a reduced degree of oversight
from regulators and a lack of disclosure from the SPAC, burdening retail investors with the risk
that the investment may be overhyped or even fraudulent.

How can an individual invest in a special purpose acquisition company (SPAC)?

Most retail investors cannot invest in promising privately held companies. However, SPACs are
a way for public investors to now partner with investment professionals and venture capital
firms. Exchange-traded funds (ETFs) that invest in SPACs have emerged, and these funds
typically include some mix of companies that recently went public by merging with a SPAC and
SPACs that are still searching for a target to take public. As with all investments, depending on
the specific details of a SPAC investment, there will be different levels of risk.

What happens if a SPAC does not merge?

SPACs have a specific period in which they need to merge with another company and close a
deal. This period is usually 18 to 24 months. If a SPAC cannot merge during the allotted time,
then it liquidates and all funds are returned to investors.

What Is an IPO?
An IPO is an initial public offering, in which shares of a private company are made available to
the public for the first time. An IPO allows a company to raise equity capital from public
investors.

The transition from a private to a public company can be an important time for private
investors to fully realize gains from their investment as it typically includes a share premium for
current private investors. Meanwhile, it also allows public investors to participate in the
offering.

KEY TAKEAWAYS
 An initial public offering (IPO) refers to the process of offering shares of a private
corporation to the public in a new stock issuance.
 Companies must meet requirements by exchanges and the Securities and Exchange
Commission (SEC) to hold an IPO.
 IPOs provide companies with an opportunity to obtain capital by offering shares through
the primary market.
 Companies hire investment banks to market, gauge demand, and set the IPO price and
date, and more.
 An IPO can be seen as an exit strategy for the company’s founders and early investors,
realizing the full profit from their private investment.

How an Initial Public Offering (IPO) Works

Before an IPO, a company is considered private. As a pre-IPO private company, the business has
grown with a relatively small number of shareholders including early investors like the
founders, family, and friends along with professional investors such as venture
capitalists or angel investors.

An IPO is a big step for a company as it provides the company with access to raising a lot of
money. This gives the company a greater ability to grow and expand. The increased
transparency and share listing credibility can also be a factor in helping it obtain better terms
when seeking borrowed funds as well.

When a company reaches a stage in its growth process where it believes it is mature enough for
the rigors of SEC regulations along with the benefits and responsibilities to public shareholders,
it will begin to advertise its interest in going public.

IPO shares of a company are priced through underwriting due diligence. When a company goes
public, the previously owned private share ownership converts to public ownership, and the
existing private shareholders’ shares become worth the public trading price. Share underwriting
can also include special provisions for private to public share ownership.

Meanwhile, the public market opens up a huge opportunity for millions of investors to buy
shares in the company and contribute capital to a company’s shareholders' equity. The public
consists of any individual or institutional investor who is interested in investing in the company.

Overall, the number of shares the company sells and the price for which shares sell are the
generating factors for the company’s new shareholders' equity value. Shareholders' equity still
represents shares owned by investors when it is both private and public, but with an IPO, the
shareholders' equity increases significantly with cash from the primary issuance.

History of IPOs
The term initial public offering (IPO) has been a buzzword on Wall Street and among investors
for decades. The Dutch are credited with conducting the first modern IPO by offering shares of
the Dutch East India Company to the public.

Since then, IPOs have been used as a way for companies to raise capital from public investors
through the issuance of public share ownership.

What Is the IPO Process?

The IPO process essentially consists of two parts. The first is the pre-marketing phase of the
offering, while the second is the initial public offering itself. When a company is interested in an
IPO, it will advertise to underwriters by soliciting private bids or it can also make a public
statement to generate interest.
The underwriters lead the IPO process and are chosen by the company. A company may choose
one or several underwriters to manage different parts of the IPO process collaboratively. The
underwriters are involved in every aspect of the IPO due diligence, document preparation,
filing, marketing, and issuance.

Steps to an IPO

1. Proposals. Underwriters present proposals and valuations discussing their services, the
best type of security to issue, offering price, amount of shares, and estimated period for
the market offering.

2. Underwriter. The company chooses its underwriters and formally agrees to underwrite
terms through an underwriting agreement.

3. Team. IPO teams are formed comprising underwriters, lawyers, certified public
accountants (CPAs), and Securities and Exchange Commission (SEC) experts.

4. Documentation. Information regarding the company is compiled for required IPO

documentation. The S-1 Registration Statement is the primary IPO filing document. It
has two parts—the prospectus and the privately held filing information. The S-1 includes
preliminary information about the expected date of the filing. It will be revised often
throughout the pre-IPO process. The included prospectus is also revised continuously.

5. Marketing & Updates. Marketing materials are created for pre-marketing of the new
stock issuance. Underwriters and executives market the share issuance to estimate
demand and establish a final offering price. Underwriters can revise their financial
analysis throughout the marketing process. This can include changing the IPO price or
issuance date as they see fit. Companies take the necessary steps to meet specific public
share offering requirements. Companies must adhere to both exchange listing
requirements and SEC requirements for public companies.

6. Board & Processes. Form a board of directors and ensure processes for reporting
auditable financial and accounting information every quarter.

7. Shares Issued. The company issues its shares on an IPO date. Capital from the primary
issuance to shareholders is received as cash and recorded as stockholders' equity on the
balance sheet. Subsequently, the balance sheet share value becomes dependent on the
company’s stockholders' equity per share valuation comprehensively.

8. Post IPO. Some post-IPO provisions may be instituted. Underwriters may have a
specified period to buy an additional amount of shares after the initial public offering
(IPO) date. Meanwhile, certain investors may be subject to quiet periods.
Advantages and Disadvantages of an IPO
The primary objective of an IPO is to raise capital for a business. It can also come with other
advantages as well as disadvantages.

Advantages
One of the key advantages is that the company gets access to investment from the entire
investing public to raise capital. This facilitates easier acquisition deals (share conversions) and
increases the company’s exposure, prestige, and public image, which can help the company’s
sales and profits.

Increased transparency that comes with required quarterly reporting can usually help a
company receive more favorable credit borrowing terms than a private company.

Disadvantages
Companies may confront several disadvantages to going public and potentially choose
alternative strategies. Some of the major disadvantages include the fact that IPOs are
expensive, and the costs of maintaining a public company are ongoing and usually unrelated to
the other costs of doing business.

Fluctuations in a company's share price can be a distraction for management, which may be
compensated and evaluated based on stock performance rather than real financial results.
Additionally, the company becomes required to disclose financial, accounting, tax, and other
business information. During these disclosures, it may have to publicly reveal secrets and
business methods that could help competitors.

Rigid leadership and governance by the board of directors can make it more difficult to retain
good managers willing to take risks. Remaining private is always an option. Instead of going
public, companies may also solicit bids for a buyout. Additionally, there can be some
alternatives that companies may explore.

What Is the Purpose of an Initial Public Offering?

An IPO is essentially a fundraising method used by large companies, in which the company sells
its shares to the public for the first time. Following an IPO, the company’s shares are traded on
a stock exchange. Some of the main motivations for undertaking an IPO include raising capital
from the sale of the shares, providing liquidity to company founders and early investors, and
taking advantage of a higher valuation.

Can Anybody Invest in an IPO?

Oftentimes, there will be more demand than supply for a new IPO. For this reason, there is no
guarantee that all investors interested in an IPO will be able to purchase shares. Those
interested in participating in an IPO may be able to do so through their brokerage firm,
although access to an IPO can sometimes be limited to a firm’s larger clients. Another option is
to invest through a mutual fund or another investment vehicle that focuses on IPOs.

Is an IPO a Good Investment?

IPOs tend to garner a lot of media attention, some of which is deliberately cultivated by the
company going public. Generally speaking, IPOs are popular among investors because they tend
to produce volatile price movements on the day of the IPO and shortly thereafter. This can
occasionally produce large gains, although it can also produce large losses. Ultimately, investors
should judge each IPO according to the prospectus of the company going public as well as their
financial circumstances and risk tolerance.

How Is an IPO Priced?

When a company goes IPO, it needs to list an initial value for its new shares. This is done by the
underwriting banks that will market the deal. In large part, the value of the company is
established by the company's fundamentals and growth prospects. Because IPOs may be from
relatively newer companies, they may not yet have a proven record of accomplishment of
profitability. Instead, comparable may be used. However, supply and demand for the IPO
shares will also play a role on the days leading up to the IPO.