Special purpose acquisition companies (SPACs) are gaining momentum as an alternative method to the traditional initial public offering (IPO) process.
SPACs saw a boom in 2020 that is expected to continue into the new year. In fact, more companies became publicly traded via a merger with a SPAC in 2020 than in all of the last decade.
As the SPAC hype continues, we’re taking a look at the key differences between the traditional IPO process and that of a SPAC.
What is an IPO?
In a traditional IPO, a company raises capital by selling ownership in the company (stock) to the public for the first time. The IPO must be underwritten, generally by an investment bank that facilitates the registration and listing of the company’s stock on a stock exchange.
The first step in the IPO process for a company seeking to go public is to hire an underwriter(s) to manage the IPO. Once the underwriting deal is finalized, the lead investment bank drafts and files a registration statement with the Securities and Exchange Commission (SEC).
The registration statement is intended to provide a reasonable basis upon which an investor can make an informed investment decision and includes detailed information about the company and its products, business plan, management team, financials, current ownership structure, use of proceeds, and any other pertinent information. The SEC then reviews the draft registration statement to verify compliance with applicable disclosure and accounting requirements. Once satisfied, the SEC works with the company and its underwriter to set a date for the IPO.
It’s important to note that the SEC does not evaluate or offer an opinion regarding the merits (or lack thereof) of a security offering, and they do not guarantee the accuracy or completeness of disclosure information. That responsibility ultimately lies with the issuer.
After the registration statement has been finalized and, underwriters are also responsible for organizing the IPO roadshow. This may consist of global events and include video, online, and in-person presentations. The aim of the IPO roadshow is to provide the issuer’s management team and underwriting team a chance to pitch the IPO to, and take indications of interest from, retail investors and institutional investors (like hedge funds) before the stock begins trading. The underwriter’s profit is the difference between what they paid the company for its stock and the price at which it sells that stock. Because the underwriter is committed to purchasing the stock directly from the company, they have a compelling incentive to help ensure that the company’s market debut is successful.
What is a SPAC?
A SPAC is a company formed to raise funds via an IPO with the intent to identify and merge with an undetermined private company in the future. SPACs are formed by sponsors who typically have expertise in a certain industry and may already even have a potential target company in mind. Often referred to as a “blank check company,” SPAC investors don’t know what company the SPAC will ultimately target for acquisition. Once the acquisition or merger happens, the SPAC shares convert to shares in the newly merged entity.
The SPAC process isn’t completely dissimilar to the traditional IPO process. To raise the funds that will later be used for the acquisition, the SPAC must follow the usual IPO process, including filing a registration statement with the SEC, clearing SEC comments, and undertaking an IPO roadshow. After the IPO, in which securities in the SPAC are sold, proceeds are held in a trust until the acquisition target is selected and the merger completed. The SPAC has a set period of time (usually 18 to 24 months) to identify an acquisition target and close the transaction. If an acquisition isn’t completed in time, the SPAC is dissolved, and the funds are returned to the investors.
Once a target company has been identified, negotiations have been finalized, and the acquisition agreement has been signed, shareholders in both the target company and the SPAC generally must vote to approve the proposed transaction. If the merger is approved by shareholders and the terms of the agreement are met, the SPAC and target will combine to form a publicly-traded company. At this point, SPAC investors may choose to sell out of their position or remain invested.
Is an IPO or SPAC better?
As SPACs are seeing a spike in utilization, it begs the question – is going public via a SPAC preferable to doing so through a traditional IPO? It really comes down to the preferences of the company seeking to go public. Two of the major draws for a company to consider going public by merging with a SPAC are 1) the abbreviated timeline versus a traditional IPO, and 2) a negotiated acquisition price versus IPO pricing which is dependent upon multiple factors and entities, including the lead underwriter, the issuer, the markets, and institutional investor feedback from the roadshow. However, going public via SPAC is not necessarily more cost-effective than going public via IPO, as the sponsors of the SPAC typically invest a minimal amount of capital but own approximately 20% of the SPAC.
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