SPAC: Definition, Examples, and How It Works

A special purpose acquisition company (SPAC) is when a shell company goes public through an IPO. The SPAC exists to merge with or acquire a private company in the near future, making that company public. SPACs have increased in popularity in recent years, but this growth has also come with criticism. Some people challenge the ethics of using shell companies to skip the traditional IPO process while others see it as a way for the rich to flex their status.

Learning about SPACs can help you understand the various ways companies go public and what this option means for them. Using a reputable source for your information can also help you make strategic investing decisions. Here’s what you need to know about SPACs.

What Is a SPAC?

SPACs are companies designed to go through the IPO process and raise capital from investors with the goal of merging with an existing private company. SPACs are often called “blank check companies” because they lack any sort of business plan or purpose. They are shell organizations that will acquire private firms in the future.

A SPAC will have an IPO and complete the underwriting and roadshow process. However, because it lacks an actual business plan or operations, there isn’t a lot for the underwriters to review. The SPAC only becomes relevant to the public through an acquisition.

A private company might seek out a SPAC to acquire them as opposed to going through the IPO process or doing a direct listing. This is also less limiting than a private placement, which only offers shares to a limited group of investors.

How Do SPACs Work?

One of the best ways to understand SPACs is to break down the processes they complete from the initial IPO until the merger of their target companies. Here’s how a SPAC works:

• The SPAC works through the IPO process to raise as much capital as possible. When people buy shares, the money goes into a holding fund.
• The SPAC pursues acquisition opportunities. The company might have a target industry it wants to pursue or key metrics to consider for its acquisitions. Strategies vary depending on the SPAC’s goals and business plan.
• Using the capital raised during the IPO, the SPAC acquires a private company.
• Once the two companies are merged, the private company is now public.
• Investors can then buy shares of the once-private company on the stock exchange.

Investors initially buy into SPACs because of their potential for success. If an investor buys SPAC shares at a low price and the company acquires a big-name brand, their shares could significantly increase in value after the merger.

SPAC vs. IPO

The blank check company has to complete the IPO process before it acquires private firms, but private companies can skip the IPO process if they are acquired by a publicly traded entity. This means they don’t need to work through the expensive and time-consuming underwriting work or complete a roadshow to drum up interest from investors.

SPAC acquisitions are often faster than IPOs. The process of completing an IPO can take between 18 to 36 months depending on the underwriters, the eagerness of the company, and the completion of legal hurdles. SPACs, on the other hand, are often designed to move from IPO to merge completion within two years. The acquired companies might be able to complete their part, getting merged with and going public, within a few months.

Advantages

SPACs are growing in popularity as more investors learn about this option and companies seek acquisition. There are several advantages to SPACs over traditional IPOs:

• A SPAC acquisition provides a faster path to going public for companies than an IPO.
• The private company doesn’t have to make as much of its historic performance and financial documentation public.
• There are fewer regulatory demands during a merger than in an IPO, making this process faster and easier.

Another advantage is the growing interest in SPACs with investors. If demand is high to invest in SPACs, then these blank check companies shouldn’t have a hard time raising capital.

Risks

Despite their advantages, there are some drawbacks for private companies, investors, and the SPACs themselves in moving forward with this option. Here are a few risks to consider:

• The SEC regulated SPACs in 2024 and might place further limitations on them in the future.
• There’s always a chance that the SPAC makes a poor acquisition choice and the stock prices fall.
• SPACs can become volatile as merger speculation or issues with acquisitions arise. These are not considered low-risk investments.

The availability of SPACs will also determine their value. Demand for these investments may fall as new regulations take effect. In 2022-2023, for example, SPACs experienced a 93.2% drop in funding because of their uncertain futures.

Real-World Examples

One of the best ways to learn about SPACs is to read about the companies that merge with them. Here are a few examples of companies that went public through this method and the results following their debuts:

• Virgin Galactic, a space tourism company owned by Sir Richard Branson, went public through a SPAC merger in 2019. At one point, stock prices reached $62.80 a share, but then fell below the initial trading price of $11.75. By December 2023, it dropped below $2 per share.
• BurgerFi went public through a SPAC in 2020 and experienced moderate success. However, there is currently a class action lawsuit pending against BurgerFi, accusing it of misleading investors about the success of its operations.
• Cannabis company Leafly went live in February 2022 after it was acquired by Merida Merger Corp. Interest in the group was spurned by optimism about future cannabis legalization.

Blank check companies often seek out acquisitions of growing, high-potential private firms. The examples above showcase companies or industries the public is excited about.

History of SPACs

SPACs have a short-lived history. Even though these types of companies have been around since the 1980s, they recently became a common part of investing discussions and opportunities. SPACs rose in popularity during the COVID-19 pandemic when the stock market was volatile and investors were looking for conservative investments. However, as various mergers and acquisitions paid off, people started to notice SPACs. This led to a SPAC boom in 2021.

SPACs became so popular that celebrities started creating their own blank check companies. Some of the biggest names who created SPACs include Shaquille O’Neal, Jay-Z, Ciara, Peyton Manning, and Paul Ryan.

With every boom comes a bust, and SPAC-mania crashed in 2024 after the SEC released new regulations and clarifications on how these firms can operate. Today, SPACs are still around, but investors are more cautious around them than they were in previous years. A celebrity’s ownership alone isn’t enough to drive buy-in.

Keeping up with investing trends, like the rise of SPACs, can help you better understand the stock market. Staying informed through reputable sources can help you make strategic choices and develop an investment portfolio that matches your risk tolerance.