Earlier in January, there was a report in The Wall Street Journal (WSJ) that WeWork, the office space leasing start-up, may go public by merging with a special-purpose acquisition company (SPAC). This is one of the many headlines of late about SPAC — one of the hottest trends on Wall Street.

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Last year, according to Renaissance Capital, about 200 SPACs went public, raising $64 billion in funding. For this year, the SPACs lined up include Butterfly Network (the Bill Gates-backed portable ultrasound start-up) and 23andMe (a DNA-testing start-up).

According to market buzz, digital media companies such as BuzzFeed, Vice Media and Bustle Media Group could also use the SPAC route to bring in money for their investors.

What is a SPAC?

It's essentially a shell company created by investors, called sponsors, solely to merge or acquire another business and take it public — a cheaper and faster alternative to the traditional initial public offering (IPO). The investors are usually those who have expertise in a specific field.

A SPAC has no commercial operations. It does not make or sell any product. Its only assets are the money raised in its own IPO, and its only business plan is to buy another company. Some of the other companies that have taken the SPAC route to access capital from the public instead of the IPO process are Virgin Galactic, DraftKings, Opendoor and Nikola Motor Co.

When a SPAC raises money, those buying into the IPO do not know what the eventual acquisition target company would be. So, investors basically write blank checks to SPACs, which can take up to two years to buy another company even after going public. If it doesn’t, the SPAC is liquidated, and the funds raised are returned to investors.

These early investors basically rely on the sponsors’ reputation in the hope of making a good deal out of the investment. To raise funds, the SPACs must follow the usual IPO process. These funds will be used for acquisition later.

How does a SPAC work?

Till a couple of years ago, SPACs were a small part of the investing landscape. However, their popularity has soared since then. A SPAC has to register with the SEC, even if it’s small — in the IPO world, small means assets under $1 million. Also, SPACs have to keep the investors’ money in a trust or escrow account till a target company is publicly announced. Once that’s done, if the investors are not happy with the deal, they can recover their funds.

What are the advantages of a SPAC?

SPACs are cheap, many of them priced at $10 a share.

They invest in sectors that are hot in the market.

They are open to individual and small investors.

What are the disadvantages of a SPAC?

Investors do not know where or how their money will be used.

There’s a long gap between the time when investors pump money into a SPAC, and when a company is bought and it starts operations.

Why are SPACS so popular?

Over time, many big names such as Richard Branson, Bill Ackerman and Michael Jordan have become involved in SPACs. This apart, mutual fund companies such as Fidelity and T Rowe Price, and investment banks like Morgan Stanley, Credit Suisse and Goldman Sachs, too, have been involved in SPACs. The SPAC boom has continued into 2021 as well. In January alone, SPACs have attracting nearly $26 billion from investors, according to a Bloomberg report.

Compared to an IPO, SPACs offer certain advantages to sponsors and the companies that want to go public. One of the biggest advantages is streamlined disclosure requirements, which save time and money. Also, in a SPAC, there are very few people involved — often just the sponsor and target company at the table.

(Edited by : Jomy)

First Published:Feb 10, 2021 8:48 PM IST