What is a SPAC, How It Works and Using One to Go Public

businessmen shaking hands

A hot trend in the US market, “SPAC fever”, seems to have made its way to Asia. Notably, Grab, the internet giant and Southeast Asia’s dominant super-app, announced in April 2021 that it would go public in the United States (US) by merging with the SPAC, Altimeter Growth Corp. This marks the largest SPAC merger to date.

The Singapore Exchange (SGX) has also planned a minimum S$300 market value for SPACs and proposed SPAC listing regulations that could be introduced this year.

SPAC fever has also been accelerated by the Covid-19 pandemic, where companies want to make use of a faster way to access capital that a traditional Initial Public Offering (IPO) might be unable to provide.

If you are an individual or a business owner in Singapore who is not sure what a SPAC is or why it has been such a big deal, this article would explain more about SPACs as an alternative way for firms to go public. It will cover:

What is a SPAC?

Special Purpose Acquisition Companies (SPACs) are publicly traded shell companies with no commercial operations, formed for the sole reason of raising capital through an IPO.

Existing operating private companies seeking to go public would typically be merged with the SPAC, bypassing the traditional IPO route in a cheaper and quicker process. This is because the SPAC is already publicly listed before the private company merges with it.

As these SPACs themselves do not have established business operations, and investors who contribute capital may not know how their funds would be used, SPACs are also commonly known as “blank cheque companies”.

How Does a SPAC Work? 

Generally, SPACs are governed by an experienced management team, which would create a separate entity to act as SPAC sponsors. Such sponsors are usually wealthy high-profile investors in private equity, venture capital, hedge funds or banking. Sponsors may also be celebrities.

Some high-profile SPAC sponsors include Chamath Palihapitiya, an investor who formed a US$600 million SPAC that acquired a stake in Virgin Galactic, as well as Bill Ackman, a hedge fund manager who formed a US$4 billion SPAC.

SPAC sponsors will invest nominal capital into the SPAC, constituting roughly 20% interest (and being commonly understood as founder shares or “Class B Shares”). The potential to get a significant return on their investment is termed as the “promote”, given in exchange for sponsoring the SPAC. Sponsors may also be given warrants to acquire more shares in the future in exchange for funding the commission paid to the underwriters.

The remaining interest in the SPAC would then be offered as common shares (“Class A Shares”) or “units” to public shareholders in an IPO. This is the stage of raising capital in the IPO where the SPAC would sell either shares (generally at US$10 per share) or warrants (investment securities such that investors can buy more shares at a fixed price in the future).

The proceeds from the IPO would then be held in a trust account. From here two things can happen. Normally, after the IPO, the SPAC will identify a target private company and negotiate a merger with or an acquisition of this target company using the funds raised in the IPO. This is also known as a “business combination”. The usual deadline for this is within 18-24 months of the IPO. In Singapore, SGX has proposed a maximum period of 36 months from the listing date.

Before the signing of the deal, the SPAC may require additional funding and may issue debt or additional shares in a Private Investment in Public Equity (PIPE) deal to finance a part of the business combination’s purchase price.  The SPAC’s public shareholders can also choose to vote against the merger or acquisition and elect to redeem their shares. However, Class B shareholders are not entitled to redeem their shares before the business combination goes through, nor vote against the merger or acquisition.

Once the business combination goes through, the SPAC and the target company will be combined, turning the previously private target company into a publicly traded operating company (also referred to as a “De-SPAC transaction”).

Alternatively, if the SPAC neither merges nor acquires a target company within the pre-determined deadline as mentioned previously, the SPAC will be liquidated. The IPO proceeds in the trust account would then be distributed to public shareholders, while the SPAC investors lose any investment that has been put into the SPAC to finance the potential De-SPAC transaction.

How is a SPAC Merger Different From a Reverse Merger? 

Reverse mergers, also known as reverse takeovers or reverse IPOs, are an alternative way for private companies to achieve public company status. In a reverse merger, investors of a private company will buy shares of a public company.

The merger is labelled “reverse” because the smaller private company is acquiring the larger public company to form a surviving public entity, and not the other way round as in normal mergers. The private company can thus make use of this process to go public simply by merging with the public company, rather than undergoing the lengthy traditional IPO process.

SPAC mergers are similar to companies that use reverse mergers in that the result of the process is a publicly traded entity. The difference is that SPACs normally come with management teams responsible for the proposed merger and governance matters, which may include overseeing employee arrangements and board transitions.

Conversely, in reverse mergers, the private companies may be the ones responsible for handling employee arrangements and board transitions during the merger. Owners of the private companies would likely retain leadership of their companies by acting as the board of directors and controlling shareholders of the combined company in reverse mergers, unlike in SPACs where the sponsors may seek minority board representation in the merged company.

Additionally, a reverse merger generally occurs when a private company buys more than 50% of the public company’s shares to acquire control of the public company. There is no option for shareholders to redeem their shares in a reverse merger, causing the merger to fail in that manner. This is unlike in a SPAC merger, where the SPAC’s public shareholders (but not Class B shareholders) can object to the acquisition or merger and redeem their shares, forcing the SPAC deal to fail.

There is also less due diligence involved for SPAC mergers than reverse mergers. This is because the public company being merged with a reverse merger is not considered a shell company, whereas the SPAC company is a “clean shell company” with no previous nor current operating businesses and assets. As a result, the SPAC would likely not carry liabilities associated with past activities of the shell company that require more due diligence to be undertaken.

Should You Invest in a SPAC? 

Compared to the traditional IPO process, it is quicker and easier for SPACs to undergo public listing as the SPAC has no prior business operations at the time of listing. If you own a private company seeking to go public, your company can benefit from raising capital without having to negotiate with underwriters, host roadshows, prepare audited financial statements or draft prospectuses, unlike what has to be done for traditional IPOs.

Using SPACs to list publicly can also mitigate volatile market conditions, which often pose a challenge in the traditional IPO process. This is due to the fact that the SPAC has already raised capital in advance, which can be used to facilitate the business combination. On the other hand, companies relying on the traditional IPO process to raise capital may be hindered by market volatility if potential investors take a more cautious approach to investing, causing the listing to be delayed, for example.

Where traditionally only private equity investors can invest in the company before its IPO, using a SPAC to go public benefits your private company as SPACs allow both retail and institutional investors to invest in it before it becomes publicly listed. Your company can also make use of SPAC mergers to make future business projections, which is not allowed in a traditional IPO. Furthermore, as the owner of your private company, you would not have to give up control of management, while being assisted by the SPAC’s expert management team.

If you are thinking of investing in a SPAC as a potential shareholder, you would benefit significantly if the stock price rose higher than the US$10 share price rate you paid. You may also have the chance to exercise your warrants to obtain more common stock shares after the business combination is completed.

Finally, even if the business combination fails, as a shareholder, you may still be able to recoup roughly the same amount you had invested in the SPAC (taking into account the interest earned, but minus any expenses incurred by the SPAC before the merger).

However, it is also important to realise that investing in SPACs is not without risks.

Since it is common for SPACs to have no established business operations and model, having a good management team is important and the success of a SPAC depends hugely on the reputation and experience of the team. Such teams would usually have the ability to manage the SPAC and identify good target companies, but the experience levels of management teams may differ from team to team. As a result, the management team may not always make good decisions.

The time limit to find a company to merge with the SPAC may cause sponsors to grab low-quality target companies just to make the deadline. Sponsors may also negotiate on unfavourable deal terms, which could cause a loss for both private companies and investors.

In addition, as aforementioned, the SPAC deal may not go through if a suitable target company cannot be found, due to the public shareholders objecting to the merger or acquisition of the target company, or due to other reasons. TGI Fridays is an example of a company that failed to merge with the SPAC Allegro Merger due to market conditions and the failure to meet the required closing conditions. The company ended up having to handle its own US$350 million debt. If you are an owner of a private company seeking to go public via a SPAC deal, keep in mind that the deal may not always go through.

When SPAC deals fail, as a shareholder who bought the pre-listing shares, you may lose only the opportunity cost of not investing in higher-return investments. However, if you are a shareholder buying shares on the open market after the SPAC IPO, it is common for share prices to trade a lot higher than the US$10 share price rate. Hence, if the business combination falls through, you would get back only the US$10 per share and lose out on any difference that you had paid to obtain the shares.

Data has also shown that retail investors, especially those who are unable to redeem their shares in SPACs, end up not receiving positive returns from the majority of SPAC deals. The sponsors, on the other hand, still get their promote amounting to about 20% of investor funds as a reward for sponsoring the SPAC, regardless of the performance of the SPAC and market conditions.

More importantly, SGX has highlighted that there is a risk that the remaining shareholdings in the SPAC may be diluted after the business combination, depending on the structure of the SPAC. Dilution may occur when SPACs issue securities like shares, warrants and rights to shareholders (who do not contribute economically to the SPAC merger) for “free”. The value of the shares would thus be diluted by these “free” securities at the time of the SPAC merger.

To counter this, SGX has sought to safeguard the dilution risk in its proposed listing regulations. The proposed safeguards include:

  • Restrictions on the right of redemption after the business combination has been completed (for example, only shareholders who voted against the business combination can redeem their shares)
  • Nullifying and voiding the warrants of shareholders who voted against the business combination and choose to redeem their shares
  • Putting a maximum percentage cap on dilutive impact to shareholders after the business combination, or having warrants that are non-detachable from the ordinary shares of the SPAC (i.e. both would be traded as a single unit on the Mainboard of SGX-ST, preventing one shareholder from holding shares in the SPAC while selling the warrants to another investor, who then converts the warrants to shares and causes a dilution in shareholdings).

SPACs also do not undergo rigorous due diligence before a deal is being made, and the target company does not usually face scrutiny and review during listing as compared to companies that list publicly through a traditional IPO. This means you may be potentially buying shares of companies that are overvalued, or companies that have bad compliance or regulatory track record, accounting irregularities or even falsified statements.

Nikola is an example of a company that merged with a SPAC, but was accused of falsely overstating the workability of its technology. The false statements led to its founder’s resignation, which caused its stock prices to further plummet.

SPACs have started to gain much traction in Asia, although the market for SPACs in Singapore seems to be targeted towards top-end institutional investors. If you are the owner of a private company seeking to undergo a SPAC merger, this may be a good way for the company to bypass the IPO process, but bear in mind that the business combination is not guaranteed.

SGX’s proposed regulations have not been adopted yet and there are uncertainty and risks involved in the SPAC process. If you are a potential shareholder looking to invest in SPACs, you may want to do a good amount of due diligence and research on the SPAC or target company in mind before investing in it.  After all, investing in SPACs is different from investing in normal stocks, so you should also ensure you understand your rights as a shareholder before investing in SPACs.

You may also wish to consult your financial advisor who would be able to give financial advice on the SPAC you are interested in and give investment recommendations that are in line with your financial goals.