SPACs are rising in popularity as a way for companies to go public. But what is a SPAC and
how does it work? SPAC stands for Special Purpose Acquisition Company. These are also sometimes
referred to as blank check companies or shell companies. They are called blank check companies
or shell companies because they do not actually have any existing operations. These are companies
that are formed with the sole purpose of acquiring or buying another company. The whole goal of
this SPAC or shell company is to actually raise money in order to be able to buy another company
and to be able to merge with it. So why would people be willing to give a SPAC their money?
It seems a little bit strange to want to invest in a company that really has no existing operations,
and it seems a little bit strange to invest in something when you don't know
what company they are wanting to acquiring. Well there several reasons that SPACs are
able to raise money. Typically they have reputable sponsors and investors behind the SPAC that are
kind of running the whole operation and looking for those companies to acquire. And a lot of times
these sponsors or investors are well known names, people behind existing successful companies,
or even celebrities. When you invest in a SPAC you don't know which company they are actually trying
to target and trying to acquire. So when you do invest in a SPAC you are very much investing in
the reputation of their team, their management, their sponsors. So that is where those well known
names come into play. So essentially the pitch for a lot of these SPACs goes something like "Hi,
I'm Bill Ackman. Give me money and I'll find a unicorn." So then people who look up to Bill
Ackman and potentially his investor friends or people who have worked with him in the past may
feel more inclined to actually invest in this SPAC that he is behind because he has a certain
reputation and certain knowledge within specific industries. The money that was raised goes into
this interest bearing account which is essentially almost like an escrow account. They go out and
they try to find a company that meets their set of criteria. And until that company is found,
that money does not leave that interest bearing account. SPACs have to find and acquire a company
within a certain timeframe - usually around 24 months. And if they are not able to find
a company to acquire within that time, the money in the SPAC is returned to its investors. There
are definitely benefits for the sponsors as well. They'll typically purchase founder shares which
are essentially shares that are sold at a very good price very early on, and this is essentially
incentive for them to grow the company and for them to continue to increase revenue because
the larger stake that they have in this company - the more shares that they have - the more that
they're going to want it to grow because that just means that they'll be able to make more money. So
that can be a good or a bad thing, it really just depends on how you view it and how much
those sponsors are actually being incentivized. To understand what you're actually getting when
you buy a SPAC and why these are becoming so popular, we need to first understand 3 of the
main ways that a company can go public. These would be an IPO or an initial public offering,
a direct offering, or a SPAC. With an IPO, which I will explain fully in a separate video,
the process to actually go through this initial public offering, get this company approved and
through all of this process is very long, very tedious, and very intense for the companies.
With an existing company IPO's require a long underwriting process. If you've ever tried to buy
a house this is essentially the same thing as the underwriting process that you go through to buy it
where there are people who are checking all of your financial statements, all of your past
revenue, and pretty much anything that has to do with the company, they're going to check. It's
going to take a very long time. But in addition to that, the underwriting process is also going to
involve raising money from additional sponsors. It usually requires a road show which is essentially
going around and having to pitch this company and promote it to potential investors. Once that is
done, and once they have gone through that whole long underwriting process of checking financials
and assets, then the company can finally go public. Most of the traditional IPO process
is done through investment banks and there are a lot of middle men and people in between
as this process goes on. A direct public offering is slightly less complicated than the traditional
IPO process. Usually this is going to cut out the middlemen from the picture so some of those
investment banks and other people involved in between. In a direct public offering it's the
company directly selling securities to the public. This is sometimes done if a company can't afford
the underwriting process or if they just don't want to deal with all of those middlemen.
Slack is an example of a company that did a direct public offering. Then we have SPACs. If a company
is acquired by a SPAC, this is usually the fastest route to going public. When a SPAC is formed,
sometimes the sponsors behind the SPAC already have a target company that they want to acquire,
and other times they aren't clear on the exact company that they want to acquire,
but they have a certain list of criteria and in a particular industry, and they just go for the best
company that they can find. Now how it actually works - that SPAC or that shell company that we
talked about earlier is going to go public through an IPO. Remember how we talked about IPO's having
that long underwriting process? Well for a SPAC that process is much quicker because they don't
have a really long history or intense financial statements because remember they're a shell
company - they don't really have operations. Okay so what do you get when you actually buy
into a SPAC? With a SPAC you are typically going to be buying in units. A unit is usually $10
a piece and it will later split into common stock and warrants. Common stock is just a regular share
of a company, but a warrant actually allows you to buy a share at a fixed price later on. When
you buy a unit it isn't always going to be a one-to-one ratio of common stock and warrants.
So instead of getting one share of common stock and one warrant, you may only get one warrant
for every 5 shares that you have. There are different ways that it's split up depending
on the SPACs and depending on the companies, but that is just something to be aware of. So assuming
that the SPAC actually find a company - they are then going to merge with the company and typically
what will happen is the ticker symbol will change - which is that series of letters that represents
a stock on the stock market. Once regulations are met and all of the paperwork is done,
that merged company is now going to be public. All that means is that it is then available to people
like you and me to buy on the stock exchanges. There are definitely still approval processes that
they have to go through, but in general a SPAC is going to go through much less scrutiny than a
traditional IPO. That may be good for the company, but unfortunately if not enough due diligence
was done, some information can be overlooked or ignored like we saw with the case of Nikola.
SPACs can be beneficial for investors because it can give you a chance to potentially get in
early on a company before that company merges and goes public. The warrants that you get with your
units are kind of an incentive and almost like a reward for investors getting in early on these
SPACs. Because an investor has those warrants, they have the option to purchase more shares
below market value later on. If you choose not to use the warrants and you just want to cash out
instead you can do that as well. And that is one of the ways that an early investor in a SPAC can
kind of have an advantage over the general public. If you want to learn more, be sure to subscribe
to the channel for the next video on IPO's, or if you're watching this a week after I post it,
I will insert the video right here. You can click on that and I will see you over there.