INTRODUCTION
The year 2021 saw 1033 companies going public across the United States. A substantial increase from the previous year, 2020 recorded 471 companies going public. High valuations, an extended period of low borrowing rates, and a strong investor appetite for equities all contributed to the spike in newly publicly traded companies.
An IPO, or initial public offering, is the process by which a privately owned company becomes a publicly traded company by offering its shares to the public for the first time. Some IPOs also include an offer for sale (OFS), which enables current promoters to lower their ownership stake in listed companies. However, private investors who are selling their equity receive the funds raised through the OFS channel.
A business may choose to go public for a multitude of reasons, which include generating money to support future development projects or mergers and acquisitions (M&A). Moreover, it makes it possible for the early-stage investors to withdraw their money from the business. Also, the firm's visibility and reputation both significantly increase after an IPO.
Going public through the conventional IPO route comes with a lot of disadvantages. Usually, the expenses related to initial public offerings are high. IPOs include a tonne of additional costs such as legal fees, auditor fees, registration and publishing costs, and underwriters’ fees. It should be outlined that the entire IPO process can take up to a year because it involves a number of steps, beginning with the hiring of an investment banker for underwriting, pricing or valuation of the IPO and finally, allotment of the shares. In addition to the above pitfalls of the IPO process, a detailed catalog of confidential information disclosures is also necessary.
ABOUT SPACs
Here's when SPAC comes to the rescue. SPACs, or special-purpose acquisition companies, are shell companies with no commercial operational existence. These types of companies are formed strictly to raise capital through an IPO with the target of acquiring a company of their interest in the future.
SPACs are generally formed by investors or sponsors with expertise in a particular business sector or industry with the intention of acquiring a target company in the future.
THE PROCESS DECODED
Raising capital through SPACs involves a series of steps beginning from its formation and eventually launching an IPO on any stock exchange. Since SPACs have no operational existence, the whole process of filing for the IPO is eased out as only disclosures regarding the sponsors or investors are required.
This is then followed by investors putting money into these shell companies through their IPO, which is purely based on the reputation or previous track record of the sponsors, as no other metric is involved to access the company for its performance. The investors who contributed to the IPO have no knowledge of the company that the SPAC will eventually acquire, and thus have no idea in which company they are investing. That is why SPACs are also called "blank cheque companies."
The money raised in the IPO is then kept in an interest-bearing trust account till the time the SPAC company acquires the target company. Also, if SPAC is unable to acquire the target company within a specified time period (conventionally 24 months), the money kept in the trust account is returned to the investors, while the interest earned from the trust account is used as working capital for SPACs.
Once the SPAC is successful in acquiring the target company through the capital raised by the IPO, the target company gets listed on the stock exchange. Once acquired, the founders will profit from their stake in the new company, usually 20% of the common stock, while the investors receive an equity interest according to their capital contribution.
When an investor invests in a SPAC, they typically purchase "units" that consist of shares and warrants. These are contracts that give the holder the right to purchase from the issuer a certain number of additional shares of common stock in the future at a certain price, often a premium to the stock price at the time the warrant is issued. Additionally, in some cases, the investor may receive only a fraction of a warrant. It's significant to mention that the fractional warrants that are normally granted as part of a SPAC unit cannot always be traded or used by investors. Instead, the investor must accumulate a whole number of warrants before they can trade or exercise them. During an IPO, a SPAC would typically issue units to investors at $10 per unit, and a warrant (or a fraction of a warrant) to purchase an additional common share contained in each unit can be exercised at $11.50 for each whole number of warrants.
ADVANTAGES
Going public through SPACs does not only knockdown the previously mentioned pitfalls and ensure a timely execution without keeping a check on the regulatory part of it. While as due to the IPO's need for no marketing to generate interest from the public IPO, it aids in cutting down costs significantly.
SPAC sponsors bring substantial operational expertise and vast industry experience. These influential individuals can tap into their network of contacts to offer management expertise or take on a role themselves on the board.
DISADVANTAGES
Due to SPAC sponsors typically owning a 20% stake in the SPAC via founder shares, or "promote," as well as warrants to purchase additional shares, this results in shareholding dilution for the company planning to go public. SPAC sponsors also benefit from an earnout component, which allows them to receive more shares when the stock price achieves a specified target over a certain time frame, which could lead to further dilution.
The SPAC process does not involve the rigorous due diligence of a traditional IPO, which could lead to potential restatements, incorrectly valued businesses, or even lawsuits.
CONCLUSION
The year 2021 saw more than 600 SPACs raise a significant amount of capital. That has been a substantial jump from the previous years. In 2020, 248 SPACs raised more than $83 billion, and in 2019, 59 SPACS raised more than $13 billion. The numbers have been clearly reflecting the rise in SPACs over the years, which experts interpret as an indication that SPACs will continue to be a popular way for high-growth firms to enter the public markets efficiently. Although there has been great buzz surrounding SPACs, there has also been recent controversy surrounding SPACs. Concerns have been raised over SPAC sponsors rewarding themselves by buying up to a fifth of the SPACs' total shares or capital at a huge discount to the issue price. Critics see SPAC as a vehicle for the rich and famous to sidestep regulatory scrutiny and make unfair gains at the expense of ordinary shareholders who are sold shares at par or full value.