What Is a SPAC — In Plain Words

This page is educational only. It is not financial advice.

Short answer

“SPAC” stands for special purpose acquisition company. As the SEC bulletin states it, a SPAC is typically a shell company when it becomes public. That means it does not have an underlying operating business and does not have assets other than cash, cash equivalents and nominal other investments, including the proceeds from its initial public offering, or IPO.

The risk comes first on this page: the bulletin states that SPAC sponsors generally purchase equity at more favorable terms than investors in the IPO or later investors on the open market, that sponsors and potentially other initial investors will benefit more than other investors from completion of a de-SPAC transaction, and that they may have an incentive to complete a transaction on terms that may be less favorable to other investors.

This page prints only what the SEC bulletin named in the Sources box states, in plain words. It has no buying steps, no picks, and no list for judging a SPAC.

What this page covers

This page explains, from that bulletin only:

• The risks the bulletin puts first: sponsor interests, conflicts of interest, and dilution
• What a SPAC is, and what the de-SPAC transaction is
• The trust or escrow account, and the bulletin’s $10 against $12 worked example
• Share redemption and the vote at the time of the de-SPAC transaction
• Warrants, warrant redemption, and the missed-notice warning for warrants
• The time period for completing a de-SPAC transaction, and liquidation

The risks, first

Sponsor interests. The bulletin states that SPAC sponsors generally purchase equity in the SPAC at more favorable terms than investors in the IPO or subsequent investors on the open market. As a result, although most of the SPAC’s capital has been provided by IPO investors, the sponsors and potentially other initial investors will benefit more than investors from the SPAC’s completion of a de-SPAC transaction and may have an incentive to complete a transaction on terms that may be less favorable to other investors.

Nominal consideration and dilution. The bulletin states that it is important to understand the specific features of an individual SPAC, including the equity interests held by the sponsor, which may have been obtained for nominal consideration. The bulletin also states that a SPAC’s IPO prospectus will highlight, among other things, material dilution to public shareholders related to the compensation and any securities issuance.

Conflicts of interest. The bulletin states that the prospectus will highlight, among other things, any actual or potential material conflicts of interest between the public shareholders, on the one hand, and the SPAC’s officers, directors, promoters, sponsor, or its affiliates, on the other hand, and the compensation paid to the sponsor, its affiliates and any promoters.

Additional financings. The bulletin states that a SPAC may require additional financings to fund the de-SPAC transaction, and those financings often involve the sponsors. As a result, the interests of the sponsors may further diverge from other investors’ interests. For example, additional funding from the sponsors may dilute an investor’s interest in the combined company or may be provided in the form of a loan or security that has different rights from that investor’s investments.

Trading price. The bulletin states that when SPAC units begin trading, their market prices may fluctuate, and these fluctuations may bear little relationship to the ultimate economic success of the SPAC.

Relying on the sponsor. The bulletin states that an investor in a SPAC at the IPO stage is relying on the management team that formed the SPAC, often referred to as the sponsor or sponsors, as the SPAC looks to acquire or combine with an operating company.

What a SPAC is

The bulletin states that SPACs have become a popular vehicle for various transactions, including transitioning a company that enters into a business combination with a SPAC from a private company to a publicly traded company.

These transactions commonly involve a SPAC acquiring or merging with a private operating company. The bulletin states that they often occur many months or more than a year after the SPAC has completed its own IPO.

Unlike an operating company that becomes public through a traditional IPO, a SPAC is typically a shell company when it becomes public, as the Short answer above states.

The acquisition or combination with an operating company is known as the de-SPAC transaction. The bulletin states that, once the SPAC has identified a target operating company, the SPAC’s management negotiates with that company and, if approved by SPAC shareholders (if a shareholder vote is required), executes the de-SPAC transaction. The combined company following the transaction is a publicly traded company and carries on the target operating company’s business.

The trust or escrow account

The bulletin states that, typically, SPAC IPO proceeds, less proceeds used for certain taxes, are held in a trust account or an escrow account. The bulletin compares this to an escrow arrangement when buying a house: the money is held by a third party until the transaction is consummated — in the case of a SPAC, the de-SPAC transaction — or the SPAC is liquidated for not having completed a de-SPAC transaction within a certain period of time.

The bulletin states that, typically, in connection with a de-SPAC transaction, a SPAC provides its investors with the opportunity to redeem their shares rather than become a shareholder of the combined company. If the SPAC does not complete a de-SPAC transaction, shareholders are beneficiaries of the trust or escrow and entitled to their pro rata share of the aggregate amount then on deposit in the trust or escrow account.

The bulletin’s worked example — pro rata share of the trust or escrow account. The bulletin states that an investor who purchased shares on the open market is only entitled to a pro rata share of the trust or escrow account, and not the price paid for the SPAC shares on the market. The bulletin’s example states:

• A SPAC had an IPO at $10 per share.
• An investor bought 100 SPAC shares on the open market at $12 per share.
• The shares purchased are associated with a trust or escrow account balance of about $10 per share.
• That share of the trust or escrow account would be worth about $1,000 — not the $1,200 paid for the shares.

Put in plain words from that example, redemption returns the pro rata share of the trust or escrow account, about $10 per share in the example, even when $12 per share was paid on the open market.

Share redemption and vote at the de-SPAC transaction

The bulletin states that, once the SPAC has identified a de-SPAC transaction opportunity, the shareholders of the SPAC will typically have the opportunity to redeem their shares and, in many cases, vote on the de-SPAC transaction. SPAC shareholders can either remain a shareholder of the combined company after the de-SPAC transaction or redeem and receive their pro rata amount of the funds held in the trust or escrow account.

The bulletin states that the SPAC changes from essentially a trust or escrow account into an operating company. An investor can typically decide whether to redeem shares for a pro rata share of the aggregate amount then on deposit in the trust or escrow account or remain an investor in the combined company going forward.

The bulletin also describes cases in which the SPAC does not solicit the approval of public shareholders, such as when the sponsor and its affiliates hold enough votes to approve the transaction. In those cases, the bulletin states, the SPAC will commonly provide shareholders with a combined information statement/prospectus in advance of the completion of the de-SPAC transaction.

The bulletin states that disclosure documents in connection with a de-SPAC transaction will include, among other things, whether or not shareholders are entitled to any redemption or appraisal rights and, if so, a summary of those rights.

The time period, and liquidation

The bulletin states that a SPAC will typically provide for a two-year period to identify and complete a de-SPAC transaction, but it can be as long as three years. The SPAC’s governing instruments may permit it to extend that time period.

The bulletin states that, if a SPAC lists its securities on an exchange, it is generally required to complete a de-SPAC transaction within three years of its IPO or face delisting.

The bulletin states that IPO proceeds are held in the trust or escrow account until a SPAC consummates a de-SPAC transaction or liquidates. If the SPAC is liquidated, shareholders at the time of the liquidation will be entitled to their pro rata share of the aggregate amount then on deposit in the trust or escrow account.

Warrants

The bulletin states that a SPAC IPO is often structured to offer investors a unit of securities consisting of (1) shares of common stock and (2) warrants. A warrant is a contract that gives the holder the right to purchase from the company a certain number of additional shares of common stock in the future at a certain price, often a premium to the current stock price at the time the warrant is issued.

The bulletin states that, in the IPO, SPACs are typically priced at $10 per unit.

The bulletin states that the terms of warrants may vary greatly across different SPACs. Terms of the warrants can include how many shares the investor has the right to purchase, the price at which and period during which shares may be purchased, the circumstances under which the SPAC may be able to redeem the warrants, and when the warrants will expire.

Warrant redemptions. The bulletin states that a SPAC can redeem warrants pursuant to their terms, and that warrant terms can vary greatly among different SPACs. Knowing when warrants can be redeemed and whether they are being redeemed can be the difference between a worthwhile and a worthless investment.

The bulletin states that, typically, the SPAC stock trading above a certain price point, such as above $18, for a specified period of time triggers the SPAC’s ability to redeem the warrants.

Missed-notice warning, for warrants. The bulletin states: if the notice of warrant redemption is missed and the holder fails to exercise within the given period, the warrants can become essentially worthless. The bulletin also states that an investor may not in all cases directly receive timely notice of warrant redemptions.

This page is educational only. It is not financial advice.