What are SPACs, and why have they become so popular?

Finance Tips

In the world of startups and venture capital, the ultimate goal for many founders is to eventually grow so large to be listed on a public stock exchange via an initial public offering (IPO). While that goal is still present, there is another onramp to the public markets that were previously less used but are currently gaining steam in the financial sector.

A new path to the stock market has emerged for growing companies.
A new path to the stock market has emerged for growing companies.

What is a SPAC?

A special-purpose acquisition company — or SPAC for short — is a corporation listed on a public stock exchange for the sole purpose of buying another company to absorb. Generally, the vast majority, if not all SPACs’ initial funds, are held in a trust to be used for funding future acquisitions.

In practice, a SPAC doesn’t do much on its own except raising capital and making acquisitions with that capital. This might seem unimportant, but SPACs are facilitating the flow of billions of dollars in mergers and acquisitions yearly.

Below you will see a diagram from PwC of how a typical SPAC works. As you can see, the process is quite simple; once the SPAC is formed, it goes through a process of searching and negotiating on acquisition deals. Within the company’s bylaws, it has a specific window of time to make an acquisition, or else it will go through dissolution and return any remaining capital to investors.

The lifecycle of a SPAC.
The lifecycle of a SPAC.

SPACs have become all the rage over the past few years. In 2020 alone, $64 billion was raised via 200 SPACs, closing in on the amount raised through traditional initial public offerings (IPOs) over that same time. With 2021 less than halfway through, that number has already more than doubled to $105 billion. So, why are SPACs taking over?

This mostly has to do with the convoluted and lengthy process of taking a private company public. To list on a major stock exchange, a private company must adhere to a strict series of regulations and transparency that can be difficult. Instead, SPACs provide marked improvements to the IPO process for many companies, including:

  • Liquidity – Investors can quickly sell shares of the SPAC on the open, public market.
  • Access to investment – Retail investors can invest in an already publicly traded SPAC before it makes an acquisition, granting them ground floor access to new investment.
  • Cost reduction – Companies looking to go public can do so at a much lower cost through a SPAC.
  • Speed – It’s faster to complete a SPAC deal than to go public via an IPO.
  • Catches in-betweeners – Companies that are too big to get more venture capital funding, but too small or uncertain to go public themselves, have more of an opportunity in the SPAC market.

Recent notable SPACs

DraftKings

At a $3 billion valuation, DraftKings was an important SPAC in 2020. Diamond Eagle Acquisition raised $350 million the previous year in its SPAC funding. The gambling company has benefited immensely from going public; they were recently valued at almost $20 billion via its listing on the Nasdaq. 

Virgin Galactic

Investors went into outer space with this SPAC.
Investors went into outer space with this SPAC.

Social Capital Hedosophia decided to go galactic when it merged with Virgin Galactic, allowing the space exploration company to list on the New York Stock Exchange. The deal valued the new company at $2.2 billion and left it with close to $450 million in cash. Virgin founder Richard Branson made it clear that this was his best move at taking the company public quickly. “I’m impatient. The SPAC gets through all the nonsense of public companies. Yes, I thought, that’s great, let’s do it,” Branson said.

Nikola Corporation

In June 2020, the electric carmaker Nikola got in on the SPAC action after merging with VectoIQ Acquisition Corp, a SPAC led by former General Motors executives. In May 2018, VectoIQ raised $200 million in an IPO itself. Then, in March of that same year, the merger was approved, putting the company’s valuation at $3.3 billion. The deal put Nikola on the Nasdaq stock exchange under the symbol NKLA. It was a massive win for a company that has yet to generate revenue on its upcoming line of hydrogen-powered electric trucks.

Skillz

A mobile gaming SPAC
A mobile gaming SPAC.

The team that took DraftKings public via a SPAC did the same for mobile esports company Skillz at the end of 2020. Through a new company, Flying Eagle Acquisition, the SPAC was completed at a valuation of $3.5 billion. Skillz was already on its way to growing adoption thanks to higher usage during the coronavirus pandemic. The company is hoping that this latest move will help it grow even further.

Skillz founder and CEO Andrew Paradise noted that taking the SPAC route cost the company a bit more money. However, in the end, it was worth it.

“The SPAC gave us more opportunity, and we met with more than 100 investor groups in the process… The competition between SPACs was hotly contested and only slightly more expensive than a traditional IPO,” said Paradise.

Is hype leading to overvaluation?

One concern about the growing popularity of SPACs is the large valuations many companies are receiving. The SEC has already raised concerns that SPACs have “potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs, each of which is designed to hunt for a private target to take public.”

This hype has allowed companies to shop around for the best deal, waiting for a SPAC to overvalue them so much that the offer is too good to pass up. While this is excellent news for the acquired companies themselves, it could come back to harm investors later if these large valuations don’t hold up over time.

Additionally, some companies like WeWork that couldn’t fund an IPO on their own are going the SPAC route. This may be a warning sign that the path to a publicly-traded company via a SPAC is too easy, and regulations might need to tighten as a result.

A next-generation financial tool?

With the tech industry booming like never before, many wonder if SPACs represent a better way for startup growth than the traditional route of IPOs. If so, it could lead to an influx of publicly traded companies for years to come. Still, this hype has led to extreme valuations for many acquired companies and could result in financial losses down the road for investors. Still, this doesn’t diminish the benefits and upside that SPACs bring to the table.