The hot new financial buzzword is SPACs. Media outlets have been writing extensively on this for the past few months now. So it’s time that we break down what exactly Special Purpose Acquisition Company are for our readers as well. In layman’s terms, these companies have an exclusive aim to merge with other entities. But WHY? 

So the investors who are incorporating SPAC promise to take it public I.e to release IPO. People who buy such IPO become part-owners of the SPAC. The SPAC has only one role and that is to find and merge with a target company that has a working business model and is looking for an IPO ( it is important to note that the time frame for this is 2 years).  Now the shareholders of the SPAC will have an option to either accept the merger and receive shares of the new combined entity or redeem their SPAC shares at the original price of the offering. If the SPAC fails to find any potential entity, it will return the money to its shareholder.

 This is only one half of the story which is related to investors participating in the SPAC. What about the company that’s merging with the SPAC? What’s in it for them?

Well the whole process of an IPO is very lengthy; takes a minimum of 12-16 months. Then you have to market it properly and hope that the investors would subscribe to it. There is always a fear of investors underpaying and with lockdowns in place, it becomes more difficult to market the IPO. So what is an alternative? SPAC will go public for them and when it is completed the entity can simply merge with it ( prices can be negotiated mutually).  The whole process will take them less than 3 months. This makes companies less dependent on investment banks for valuations.

So in conclusion, SPACs help other companies IPO in a relatively short amount of time. And they eliminate some of the uncertainties involved in the process. At least that’s what they claim. And for people sponsoring/investing in the SPAC i.e. the people responsible for taking the SPAC public and negotiating with target companies, this can be an avenue to make a lot of money. All they had to do was pay a nominal amount for a sizeable stake in the SPAC before marketing and taking it public.

Does this leave us with one final question? Why have they become so much popular now? A lot of high profile investors like Chamat Palihapitiya are backing this alternate route for companies to go public. SPACs are also attractive to companies that think that they can’t market IPOs efficiently especially during a pandemic.

Stay tuned for more articles!!!

Sanskar Dugar, London School of Economics and Political Science

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