SPACs: The Shortcut to Going Public and What Lies Behind It

SPAC stands for Special Purpose Acquisition Company. In Chinese, it is called a “special-purpose merger and acquisition company,” or a blank-check company. Such a company has no operating assets but promises to acquire a business with money raised through an initial public offering (IPO). Currently, 20% of newly listed US businesses each year go public through this structure. Compared with an IPO or direct listing, a SPAC can skip many steps. For example, there is no lockup period, and a listing can happen in just weeks. This listing model has recently returned to public attention. In the past seven-plus months, 20 companies have gone public in the United States through SPAC mergers, raising US$12.1 billion. At this pace, this year’s proceeds could exceed last year’s record of US$13.5 billion. --- SPAC means “special purpose acquisition company,” also known as a blank-check company. It follows an IPO process, but the sponsor pays the listing expenses. Sponsors are generally private equity or asset management firms. In recent years, SPACs have typically been around US$200–300 million. Substantial money is needed up front, generally an initial 5% contribution. Yet after listing, the sponsor receives 20% of the equity—a form of arbitrage. The sponsor usually recruits a professional management team and must acquire a privately held target within two years of the IPO. For the acquired company, this is effectively a backdoor listing, but the shell is very clean. A SPAC has no business at all, only cash on its balance sheet. Its managers are generally executives from various industries. They may work part time before an acquisition, then manage full time afterward to improve the company’s efficiency. ---- SPACs have recently offered a new choice because they provide a fast route to listing. A traditional IPO takes considerable preparation. Through a SPAC, a company may successfully list in weeks. ---- A SPAC skips many listing procedures and does not require IPO roadshows with large numbers of institutional investors. Another reason it is fast: on the roadshow, you do not need to explain a business. You explain only a vision, mainly presenting your management team as “fantastic” and asking everyone to watch what happens. Essentially, it is “fundraising by slide deck.” SPACs are also not bound by IPO lockup rules. They may be even simpler than direct listings. ---- A direct listing means entering trading directly. A price range is set, but no one knows the exact final per-share price. Direct listings best suit highly recognizable companies. Spotify and Slack listed this way. People already know your brand, so you do not need to spend much time marketing it. Companies that do not need financing generally take this route. Essentially, existing shares are sold, without needing so many new shares. Overall, though, you need a good operating record, a strong management team, and some financial metrics and forecasts. One benefit is having no “lockup period”: you can sell your shares early. ----- The lowest-cost option is not a SPAC but a direct listing. The underwriting fee is about 5%–6% of the total size, but the aggregate amount is actually no less than IPO expenses. Many investment banks, including Goldman Sachs, are now very willing to participate in these SPAC IPOs. Banks have already earned US$400 million in the first half of this year. For direct listings, investment-bank fees are generally low. Banks do not need to underwrite the shares; they act only as financial advisers. The SPAC mechanism is fairly complex. Each IPO unit currently costs US$10 and buys one share plus a right or warrant—an incentive. If the share price rises after an acquisition, your return includes not just the original US$10 share but also the option. Before the SPAC is established, there are only a management team and capital. Some capital pays investment banks to help it list; some covers custody, taxes, operating costs, and other expenses. After listing, the management team also receives annual salaries. ---- A SPAC is somewhat like a private-market fund, charging an annual management fee of 1%–2%. If it finds no suitable target within two years and returns the money to the sponsor, the amount returned may be less than US$10—US$9 and change after management fees. But if the investment goes well, returns are very high. It is equivalent to obtaining 20% of the equity for a 5% contribution. There are risks, too. If it fails, that money is lost. Investment-bank fees alone require 2% of the IPO amount. ---- Could SPACs be less risky than other IPOs? If no target is found, at least the money is returned? If no acquisition occurs, the risk is indeed low: the cash is returned to you. The real concern is acquiring a terrible company. IPO investors can lose out as the share price falls, while the sponsor is unaffected. That is why traditional investment banks such as Merrill Lynch have entered this business. Raise the initial 5%, list, and raise the other 95% in public markets. That 5% is the pre-listing money. Some people describe sponsors as “making something out of nothing.” The sponsor is not itself the management team; it recruits managers. The sponsor is the capital provider, mainly using private capital to contribute around 5%. ---- From a startup’s perspective, which listing route costs the most? Some companies’ operating performance has not yet reached sufficient scale, so they choose a SPAC listing. Traditional listing requirements are high. For a Chinese company to list, net profit must be more than RMB40 million. A SPAC has no such requirement: if its management team likes your company, it can acquire it. Why do some well-known companies use direct listings? They still need the market to price them, so investors broadly must be familiar with their business. A SPAC, however, has already raised the money, making the company’s risk relatively lower. In negotiations, you need only agree with the SPAC’s management on what the company is worth, rather than communicate with countless investors. ---- Consider electric-truck company Nikola. Its first vehicle prototype may not appear until 2021, so it is very, very early stage. It would have no chance of listing through a traditional IPO or direct listing. Many investment banks are selective, too. They may think a company is too small or its product too early and decline the underwriting risk. I remember SPAC IPOs in the 2000s being around 150–200 million; now some exceed a billion or even reach several billion. If operating results disappoint after listing, the share price falls and investors lose. Yet the sponsor, which pays the investment-bank fees, can still make money. That is why people find the structure unreliable. After a target is acquired, the initial capital providers basically make money. ---- Companies that listed through SPACs: Virgin Galactic: market capitalization of nearly 6 billion. DraftKings, a sports-betting company: market capitalization already above US$12 billion. Electric-truck company Nikola listed in June, but its first vehicle prototype may not appear until 2021. It is very, very early stage and would have no chance of listing through a traditional IPO or direct listing. ---- A SPAC called New Frontier (新風天域) is the only SPAC formally listed on the New York Stock Exchange. It raised around US$200 million. In July 2019, it successfully acquired a Chinese healthcare organization, the United Family Healthcare (和睦家) hospital chain. Shareholders at the time included major private equity funds, TPG, and Fosun Pharma. It was a star deal. Many thought selling their shares to a SPAC was a good exit. The hospital group ultimately became one of China’s largest healthcare-service organizations. Getting a SPAC to work in China was quite an achievement. Original: https://mp.weixin.qq.com/s/LhY_vUNE0wG7TyUrRG-jKA