- By Vaishnavi Ajit Burangey
WHAT IS SPAC?
A Special purpose Acquisition company (SPAC) is a specialized financial vehicle that operates as a "blank cheque" company, raising funds by issuing an initial public offering (IPO) solely with the objective of acquiring a pre-existing private com
pany. This offers a streamlined option to the conventional IPO process, enabling private companies to become public sooner. Fundamentally, investors invest capital in a management team, who go out to look for an appropriate target company to acquire, under the premise that if they are unable to find one within a specified timeframe, their investment will be repaid. SPACs, while they hold promise, come with inherent risks, including lack of knowledge regarding the ultimate target company and its performance, which must be scrutinized prior to investment.
MAIN PURPOSE OF AN SPAC
The basic objective of a Special Purpose Acquisition Company (SPAC) is to create a quicker and less conventional route for private businesses to enter the public market. A SPAC acquires money in an initial public offering, establishing a fund pool held in trust, which its management uses to pursue and target an appropriate private operating company. This merger, or acquisition, essentially makes the private company public, bypassing the standard, frequently lengthy and costly IPO process. Essentially, the SPAC is a financial intermediary, allowing private companies access to public capital and conversion into public companies.
RISE IN SPAC
The growth of SPACs in 2020-2021 represented a dramatic shift in public market financing, with record-breaking activity—248 SPACs raising $83.4 billion in 2020 and 613 SPACs raising $162.4 billion in 2021. Favourable market circumstances, private equity involvement, and the appeal of a speedier, more flexible alternative to traditional IPOs all contributed to this spike. High-profile transactions, such as Virgin Galactic's merger with a SPAC, demonstrated their potential. Increased competition for objectives, as well as questions over long-term performance, prompted regulatory scrutiny, casting doubt on the SPAC boom's durability.
KEY RISKS AND CHALLENGES
SPACs are a serious threat and challenge to the IPO market, mainly due to valuation risk resulting from negotiated price over market-driven demand, potentially causing overvaluation. Sponsor conflicts of interest, as a result of the "promote" equity holding, could give precedence to deal completion at the expense of shareholder value. Redemption risk, where investors redeem assets prior to an acquisition, can leave merged companies undercapitalized. Higher regulatory oversight creates costs and complexity, and market volatility significantly affects the performance of SPAC. Pressures to pick a target quickly may cause it to purchase low-quality companies, leading to inferior post-merger performance. In addition, substantial shareholder dilution and the likely inability of private companies to meet public market standards contribute to the intrinsic risk involved in SPACs, impacting the general stability and trustworthiness of the IPO market.
BOOM TO THE IPO MARKET
SPACs energize the IPO market by substantially streamlining the process of going public and hence appealing to companies hungry for quick infusion of capital. The shortcut makes available the public markets to a broad spectrum of enterprises, even those that could be discouraged by the complexity and expense of conventional IPOs. The sheer number of SPACs actively hunting for acquisitions creates a huge boost in deal flow, spurring activity for investment banks and supporting financial services. Additionally, SPACs introduce a dynamic component to the market, providing negotiated valuations and operating expertise that can entice innovative, high-growth businesses. This increased activity and the commotion around SPACs mutually intensify investor appetite, attracting greater capital into the IPO market and creating a more active and accessible platform for public listings.
SPAC FORMULATION PROCESS AND ITS EFFECT ON THE IPO MARKET
Special Purpose Acquisition Companies, or SPACs, are now a legitimate alternative to the traditional IPO process for private firms wishing to go public. SPACs first come public as blank check companies to raise money to purchase a target firm, unlike initial public offerings (IPOs), where companies raise capital by selling shares directly. Though the process of this method gives an accelerated and unregulated way into the stock market, it has faced more criticism as concerns arise regarding performance as well as transparency.
The following explains the SPAC process:
• Initiation – A SPAC sponsor forms a shell company, formulates an investment strategy, and builds a management team. The team can consist of industry specialists or financial experts. They contribute initial capital and make preparations for the IPO of the SPAC.
• SPAC IPO – The SPAC is taken public, raising capital from investors. Because it has no business, the IPO is quicker than a standard IPO. Investor money is kept in trust until a merger is finished. Public investors get shares and warrants, while sponsors receive a 20% interest (referred to as the "promote") in the resulting merged company.
• Search & Negotiation – The SPAC searches for a private firm to merge with, typically within two years. It identifies high-growth firms, negotiates an agreement, and can raise additional funds through PIPE (Private Investment in Public Equity). Investors can redeem their shares prior to the merger's completion.
• Merger or Wind-down – If a merger is agreed upon, the shareholders of the target company are given SPAC shares, and the merger is completed. If no merger occurs within two years, the SPAC is wound up, and investors are refunded their money.
• Post-Merger – The new company has a new name and stock symbol. Shareholders now consist of previous SPAC investors, shareholders of the acquired company, and any PIPE investors. Sponsors have to wait before selling their shares to ensure long term commitment.
FUTURE OF SPAC
These firms are utilized frequently in the United States, United Kingdom and some other developed countries. In the US, SPACs must be approved by the Securities and Exchange Commission (SEC) and are listed on stock exchanges like the NASDAQ or the NYSE. Capital raising is done through an IPO which subsequently is utilized to buy the target that is a particular company already known or one named by the SPAC Board in accordance with its prospectus. Finally, the purchased target is merged with the SPAC via a reverse merger. In India the use of SPACs listed abroad for acquisitions of Indian companies has faced difficulties due to regulatory barriers. India lacks a SPAC regime and on account of certain regulatory constraints, SPACs have not been that successful. But because SPACs have proven effective in catalysing mergers and acquisitions activity, the debate rears its head after every slowdown in finances and is beginning once again in the backdrop of reanimating the economy in a post-Covid scenario. In conclusion, SPACs have proven to be both a boon and a bane in the IPO market. Although they provide companies with a faster and more agile means of going public and offer opportunities for early-stage investors, their risks cannot be ignored. Misaligned sponsor incentives, poor post-merger performance, and increased regulatory attention have raised concerns regarding their survival in the future. Although disrupting traditional IPOs, SPACs' future is dependent on greater transparency, tighter regulations, and better-quality deals to ensure long-term financial market growth.
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