ECONOMIC COMMENTARY

The attack of the SPAC

Key takeaways

  • A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing non-public operating company.
  • The SPAC strategy offers several distinct advantages over a traditional IPO, such as providing companies access to capital, even when market volatility and other conditions limit liquidity.
  • As SPACs continues to grow in popularity, investors should continue to use the same due diligence (if not more) when investing in a SPAC as they would in more traditional investments. Be sure to tap experts who can help you identify your goals and gauge your tolerance for risk, cost and complexity.

In 2020, special-purpose acquisition companies (SPACs) grew in popularity, quickly becoming the avenue of choice for companies aiming to go public. Today, SPACs continue to gain in popularity as a potential liquidity option for many businesses aiming to enter the public markets. If you are an investor, you have probably wondered whether investing in the SPAC phenomenon is right for you. But, are you aware of how they work and the personal finance considerations when de-SPACing? When faced with a liquidity event such as this – where the process is often condensed in comparison to a traditional IPO – awareness and adequate time for financial planning are essential.

What are SPACs?

Special-purpose acquisition companies (SPACs) have become a preferred way for experienced management teams and sponsors to take companies public and raise additional capital. SPACs have been on a meteoric rise, increasing in both number and dollars invested. The number of SPACs have increased from 20 in 2015 to 247 in 2020 and increased in valued from $3.61bn in 2015 to $75.39bn in 2020 [source: Deal Point Data] and represented over 30% of IPO activity in 2019. Why SPACs now? Read this article to uncover the reasons.



A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing non-public operating company. The operating company (target) merges with the publicly traded SPAC and become a listed company in lieu of executing its own IPO.

SPACs are an alternative source of financing for the operating company where the Sponsor raises money through an IPO process prior to identifying the Target that will subsequently be merged into the SPAC. The Sponsor will typically identify a certain market vertical, geography or niche that they expect to focus on, usually aligned with their prior investment or operating expertise.

SPACs are often called “blank check companies” because they are comprised of funding from institutional investors but have no product or business operations, rather cash in a trust account which is intended to purchase a target company.

Following the SPAC IPO, proceeds are placed into a trust account and the SPAC typically has 18-24 months to identify and complete a merger with a target company, sometimes referred to as de-SPACing. If the SPAC does not complete a merger within that time frame, the SPAC will liquidate, and the IPO proceeds will be returned to the public shareholders. The Sponsor, however, does not receive a return on their “at risk” investment. This “at risk capital” is usually in the range of 2% of the total capital raised.



Once a target company is identified and a merger is announced, the SPAC’s public shareholders may vote against the transaction and elect to redeem their shares. If the SPAC requires additional funds to complete a merger, the SPAC may issue debt or issue additional shares, such as a private investment in public equity (PIPE) deal. After the SPAC and Target negotiate a Definitive Agreement, and required filings are complete, the merge or “de-SPAC” occurs, and the newco begins to trade as a public entity under a new ticker on the NYSE or NASDAQ.

What are the advantages and disadvantages of a SPAC?

The SPAC strategy offers several distinct advantages over a traditional IPO, such as providing companies access to capital, even when market volatility and other conditions limit liquidity. SPACs could also potentially lower transaction fees as well as expedite the timeline to become a public company. SPACs are an alternative source of financing for a company “Target”.

Advantages:

  • Faster execution than a traditional IPO – as fast as two months.

  • Upfront valuation – Target company maintains control of the process and company valuation by negotiating directly with the Sponsor.

  • Additional Sources of Capital – Access to primary capital.

  • Lower cost to going public compared to traditional IPO route.

  • Access to operational expertise.

However, the merger of a SPAC with a target company presents several challenges, including having to meet an accelerated public company readiness timeline as well as complex accounting and financial reporting/registration requirements that may differ based upon the lifecycle of the SPAC involved. The target company’s management team will need to focus on being ready to operate as a public company within three to five months of signing a letter of intent.

Disadvantages:

  • Shareholder dilution (Sponsors own 20%).

  • Capital shortfall from potential redemptions upon “de-spac”.

  • Compressed timeline for company readiness.

  • Narrower scope of due diligence of merger/acquisition.

Financial planning for SPACs

As the conversation and interest around SPACs continues to evolve, investors should continue to use the same due diligence (if not more) when investing in a SPAC as they would in more traditional investments. It is important to properly assess risk and reward for your own personal finances. People often focus solely on tax minimization and don’t understand that they may be taking on excess risk in the meantime. Be sure to tap experts who can help you identify your goals and gauge your tolerance for risk, cost and complexity.

Your Private Bank relationship manager is available to discuss your personal situation. SVB Private Bank and Wealth Advisory has many services and solutions to help fit your needs.

Read our recent article, Tips for Personal Financial Planning before an IPO to learn more about how to make the right decisions based on your wealth goals.

Key terms

  • Sponsor: Individual or group that creates a SPAC. After merge with Target, there is typically representation of the SPAC Leadership in the “newco” Board of Directors.

  • Target [Company]: Company which SPAC entity intends to purchase via merger.

  • De-SPAC: Process in which SPAC and Target formally merge and begin to trade under a new ticker.

  • At-risk Capital: The SPAC owners are required to pay in 1-2% of SPAC investment to cover SPAC expenses, investment banking fees to take the SPAC public, perform the company search and pay the operators. If the SPAC never buys a target, this money is lost.

  • Sponsor Promote: SPAC Sponsors typically receive 20% of the equity of the SPAC. For example, if a Sponsor raises a $500M SPAC, they may receive $100M of the value when the SPAC buys its target. In some cases, hurdles are inserted - for example, a Sponsor may only receive 20% of the value over an 8% a year internal rate of return (IRR). Sponsors’ equity is diluted when additional investors join the syndicate and/or when the de-SPAC process closes.

  • Lock-up: Period after de-SPAC where newco shares are restricted from sale by SPAC sponsor or Target shareholders. There is a typical 6-month Lock-up, and occasionally additional Lock-up tranches. Sponsors are often subject to additional restrictions.

  • Warrants: SPAC Sponsors negotiate warrants with the Target company in addition to their Promote. Early SPACs had 1:1 warrant coverage (i.e. they could buy one share at a steep discount for every share the SPAC bought in the private company). More recent SPACs have reduced this ratio to 1:5, but this varies as part of the merger negotiations.

  • PIPE: Private Investment in Public Equity, a SPAC typically raises additional capital from a PIPE to allow for acquisitions of bigger private companies or better capitalization of a business if needed.

Attribution:

  1. “Why so many companies are choosing SPACs over IPO” - John Lambert, KPMG.
  2. “Why companies are joining the SPAC boom” - Mike Bellin, PWC.
  3. “How special purpose acquisition companies (SPACs) work” – PWC.
  4. Joe Koontz, Managing Director, SVB Private Bank.

SVB Private advisor

  1. Health Insurance Portability and Accountability Act (1996).
  2. Family Educational Rights and Privacy Act(1974).

Larry Crickenberger is a VP, Financial Planning Specialist with SVB Private, where he provides guidance on estate tax, insurance and financial planning issues and helps identify strategies that apply to the unique needs of Founders, VC/PE Investors and Executives. Larry also works to identify a network of financial planning professionals to assist our clients in implementing these strategies, including attorneys, CPAs and insurance professionals.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein