A successful private company looking to scale has a few options that immediately come to mind to fund growth:
- Conduct an IPO and raise capital through a public offering.
- Raise capital through one of the SEC’s private offering exemptions.
Each option has its advantages and disadvantages. Because repayment on loans starts almost immediately, this puts pressure on companies to deliver results from expansion immediately, which is not practical in most cases.
IPOs are lengthy and pricey.
Private offerings require time and management to take their eyes off the proverbial wheel of their business to devote the time required to raise capital.
For private companies looking to raise capital, there is another option – one that’s been around for decades, but that has been gaining significant momentum lately. That option involves Special Purpose Acquisition Companies (SPACs).
How popular are SPACs? In 2020, SPACs raised over $82 billion in the capital – SIX TIMES, the record $13.6 billion raised in 2019.
What are SPACs?
SPACs, also known as “blank check” companies, are companies formed to raise capital through an IPO. At the time of going public, SPACs typically don’t have any operations, assets, or deals in place. SPACs are explicitly formed to pursue deals through a merger with a private operational company – essentially taking the private company public.
SPACs are generally formed by sponsors with expertise in a particular industry who are pursuing acquisition targets with experience and expertise in that particular industry.
SPACs generally have two years to find an acquisition target and to complete a deal or face liquidation. In the meantime, the money SPACs raised in the IPO is placed in an interest-bearing trust account. These funds can only be disbursed in the event of an acquisition or returned to investors in the case of a liquidation.
A sponsor with expertise in last-mile shipping and delivery also has experience with raising capital. She decides to form a SPAC to expand operations beyond her Northeast U.S. base. She raises $5 million and finds an ideal private company in the West looking to expand operations.
The SPAC acquires the private company, and the private company merges into the SPAC, becoming a public company. The private company now has access to $5 million in capital, and the sponsor now has an equity interest in a company with operations in the West.
What’s In It For The Sponsor?
Experienced operators or businesses in certain industries can scale their operations through SPACs and diversify in markets and geographic locations where they may not already have a foothold. By leveraging the expertise of already established private companies in these markets or geographic locations, through their equity ownership in the SPACs, they can diversify their portfolio without tying up the time and labor required to do it themselves.
What’s In It For The Private Company?
The benefit to the private company is quick access to capital and the opportunity to team up with an experienced sponsor to accelerate the company’s growth and scaling. Without expending the headache and out-of-pocket expenses of going public or even raising capital through a private offering, these companies can stay focused on their business.
What’s In It For Investors?
Limited Downside Risk – Because investors’ capital is placed in escrow in an interest-bearing account; there is limited downside risk in investing in a SPAC. In the worst-case scenario, a target is never identified, and a deal never goes through, and the investor earns a little interest. The upside potential from acquiring a good merger target outweighs this limited downside risk.
Liquidity – Investors typically receive both stock and warrants in connection with their SPAC investments. Because investors can freely trade their stock and warrants during the interim stage before an acquisition – the investor enjoys liquidity not enjoyed with private investments. An investor could sell his/her shares of stock if they needed to liquidate for whatever reason but hold onto the warrants to benefit from any upside from a completed acquisition and merger.
Input – The greatest advantage from an investor’s standpoint in a SPAC investment vs. a private investment is the input afforded to them with a potential deal. Although investors are not involved in the target search, they can vote on any opportunity presented to them and, in essence, nix a potential reverse merger transaction if they choose. Having a say in the investment decision is what sets SPACs apart from other investing decisions.
Finality – SPACs aren’t open-ended where investors sit around wondering when something will happen with their investment capital, if anything. There is a time limit (not more than two years) in which the SPAC is required to complete an acquisition and reverse merger. Investors have the comfort of knowing that if a deal is not struck – one that the investors are comfortable with – before the expiration date, that their investment funds will be returned.
The win-win-win to the sponsors, private target companies, and investors is why SPACs are such a popular vehicle for raising capital right now.