Special Purpose Acquisition Companies (SPACs)

In News

• The government is considering a regulatory framework for special purpose acquisition companies (SPACs) to lay the ground for the possible listing of Indian companies through this route in the future.

About SPACs

• Meaning:
  • A special purpose acquisition company (SPAC) is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) or the purpose of acquiring or merging with an existing company.
  • They are also known as “blank check companies”.
• Aim:
  • To raise money in an initial public offering (IPO), and at this point in time, it does not have any operations or revenues.
• Participants:
  • Investors in SPACs can range from well-known private equity funds and celebrities to the general public.
• Escrow account:
  • Once the money is raised from the public, it is kept in an escrow account, which can be accessed while making the acquisition.
  • If the acquisition is not made within two years of the IPO, the SPAC is delisted and the money is returned to the investors.

Working of a SPAC

• SPACs are generally formed by investors or sponsors with expertise in a particular industry or business sector, to pursue deals in that area.
• In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don’t identify that target so as to avoid extensive disclosures during the IPO process.
• IPO investors typically have no idea about the company in which they will ultimately be investing.
• SPACs seek underwriters and institutional investors before offering shares to the public.
  • An underwriter is any party that evaluates and assumes another party’s risk for a fee, which often takes the form of a commission, premium, spread, or interest.
  • An institutional investor is a company or organization that invests money on behalf of other people.
• The funds SPACs raise in an IPO are placed in an interest-bearing trust account. These funds cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated.

Challenges/ Risks associated with SPAC

• Leap of faith: An investor in a SPAC IPO is making a leap of faith that its promoters will be successful in acquiring or merging with a suitable target company in the future.
• The reduced degree of oversight from regulators: coupled with a lack of disclosure from the typical SPAC means that retail investors run the risk of being saddled with an investment that could be massively overhyped or occasionally even fraudulent.
• Low returns: Returns from SPACs may be well below expectations when the initial hype has worn off.
• SPAC bubble: dismal performance could mean that the SPAC bubble that some market experts had warned about may be in the process of bursting.
• Increased regulatory oversight: SPACs have lost some of their luster due to increased regulatory oversight and less than stellar performance.

Significance/ Importance of SPAC

• Conversion to a publicly-traded company: Through an SPAC transaction, a private company can become a publicly-traded company with more certainty as to pricing and control over deal terms as compared to traditional IPOs.
• Celebrities make them famous: While SPACs are essentially shell companies, a key factor that makes them attractive to investors is the people who sponsor them.
• Faster process: A company can go public through the SPAC route in a matter of months, while the conventional IPO process is an arduous process that can take anywhere from six months to more than a year.
• Premium price: The owners of the target company may be able to negotiate a premium price when selling to a SPAC because the latter has a limited time window for making a deal.
• Experienced management and vast market: Being acquired by or merging with a SPAC that is sponsored by prominent financiers and business executives can give the target company experienced management and enhanced market visibility.

Way Forward

• Celebrity involvement in a SPAC does not mean that the investment in a particular SPAC or SPACs generally is appropriate for all investors.
• It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.

Source: IE