A Special Purpose Acquisition Company (SPAC) is formed by raising capital to take a private company public. They've been around for a while but have increased in popularity in recent years. So far in 2020, 91 SPACs have been formed and raised about $36.2 billion.
Some recent, well-known SPACs include Virgin Galactic (Nasdaq: SPCE), Nikola Motors (Nasdaq: NKLA) and DraftKings (Nasdaq: DKNG). Bill Ackman has also jumped on the SPAC-trend by raising $4 billion to take a "unicorn" company public. It launched on July 22 as Pershing Square Tontine Holdings in the OTC markets. There's also an ETF being launched, Defiance NextGen SPAC IPO ETF, in the coming weeks that will allow investors to gain exposure to this asset class.
How It Works
A SPAC starts as an initial public offering with no business operations that are typically formed by a group that has expertise in a certain area. It raises money by issuing shares. Then, it has two years to complete an acquisition, or it must return money to shareholders. They are known as "blank check" companies because investors don't know what the company will be investing in.
Benefits
Acquired companies get to go public with fewer costs and hassles. However, there's less liquidity, and they often have to get backing from a large investor who can use that to acquire shares at a discount.
Going through the typical IPO process is long and arduous. There are layers of compliance that Investment banks have to go through, followed by a roadshow, where the company meets with prospective investors, and have to answer questions about their business model.
Even after this, IPOs can fail due to a lack of demand. In contrast, a SPAC is much more certain. Additionally, SPACs are a better option during the coronavirus when the multiple steps of the IPO process have to be done virtually. In a larger sense, it's a more democratic and decentralized process than IPOs.
Controversy
Until a few years ago, companies that went public through a SPAC were considered less legitimate. It was often a tactic used by foreign companies whose financials and business model wouldn't be able to withstand the scrutiny of regulators and analysts. The number of high-profile individuals launching and backing SPACs has reduced this concern.
It's also an indication of the strong bull market in stocks, where there is insatiable demand. It could also be interpreted that these savvy operators are taking advantage of the "froth" in the market and increased risk appetites. Of the 89 SPACs that have gone public since 2015, they are down by an average of 18%, while the S&P 500 is higher by nearly 40%.
Despite the recent rise of SPACs, it's expected that the largest unicorns like Stripe, Airbnb, or RobinHood will be going public through the traditional, IPO process.