Special Purpose Acquisition Companies (#325)
/What is a SPAC?
A SPAC is a special purpose acquisition company. It’s a shell company, which means that it has no revenue or operating history at all. Instead, it’s designed to buy another business, using money that it raised through an initial public offering, or IPO, and which is initially stored in an escrow account. Depending on how a SPAC is designated when it’s formed, at least 80 percent of the money raised through an IPO usually has to be spent on an acquisition within two years. If not, then it has to dissolve and return the cash to investors.
If a SPAC is dissolved, the investors don’t get back any of the money earned while the cash was held in escrow, since those earnings are used to pay for operating expenses.
These arrangements certainly might not work out, since the operators of a SPAC might not even know which businesses they want to acquire when they take the business public. Instead, they’re just sitting on a pile of cash, and looking around for opportunities. And, even if they find a possible acquisition target, the purchase is put to a shareholder vote – which might turn down the proposal. Alternatively, the investors might approve of an acquisition, in which case the cash is released from escrow, and the target company is purchased.
If a shareholder votes against an acquisition, then that person can get his funds back that were held in escrow. On the other hand, if the share price of the SPAC has gone up since the date of the IPO, it can make more sense for a shareholder to vote in favor of the deal, and then sell his shares to someone else on a stock exchange at a higher price.
The Cost of a SPAC
What about the cost of a SPAC? This is its main advantage. It usually incurs a 2% underwriting fee at the time of the IPO, and then another 3.5% underwriting fee when an acquisition is completed. Compare that to the 7% fee usually charged on the funds raised through a traditional IPO. Of course, if an acquisition never occurs, then the 2% underwriting fee is essentially lost.
The SPAC Sponsor
So, who starts a SPAC? The party that starts one is a pre-IPO investor, and is called a sponsor. This might be an investment fund, which links up with someone with lots of experience in the industry where the SPAC is going to look for investments. Investment funds like to engage in SPACs, because they have an easy exit – they can just sell their shares on a stock exchange, which is a lot easier than trying to sell off the shares of a private company.
Sponsors have to provide a small amount of pre-IPO capital, usually a few million dollars. In exchange, they receive founder shares in the SPAC. On the day of the IPO, these founder shares are converted into somewhere in the range of 20% to 25% the common stock of the SPAC. Pretty sweet deal for the sponsors.
On top of that, the sponsors receive a warrant for each share of sponsor capital, which allows them to buy an additional share of the SPAC following a successful acquisition. The usual arrangement is that the share price of an IPO is $10 per share, and the warrants have an exercise price 15% higher than that, which is $11.50. It would only make sense to exercise a warrant if the market price of the stock exceeds the $11.50 exercise price. Or, a warrant holder could just sell the warrant to another investor.
Based on these compensation arrangements, it doesn’t make much sense to invest in the IPO of a SPAC – the sponsors are taking such a large ownership interest in the entity.
Accounting for a SPAC
So, what about the accounting for a SPAC? Initially, there’s not much to do. It reports some minor operating expenses, with most of it related to its required quarterly reports to the SEC. If an acquisition is completed, then the owners of the acquiree may be paid in cash, or in SPAC shares, or a combination of the two.
In an acquisition, the SPAC might be considered the acquiring entity, which means that it records the assets and liabilities of the acquired entity at their market values. If the total payout exceeds the net value of these assets, then the residual is recorded as a goodwill asset. When the SPAC is the acquirer, the financial results of the acquired business are recorded starting on the acquisition date.
Or, depending on the circumstances, the acquired entity might be classified as the acquiring entity. This happens when the shareholders of the acquired entity receive a majority of the voting shares of the SPAC, rather than being paid in cash. When this is the case, it’s called a reverse acquisition – where financial statements are issued under the name of the SPAC, but the financials are essentially a continuation of the financial statements of the acquiree.
Some lesser accounting issues are recording the value of the warrants issued to sponsors, and the cash flowing into and out of the escrow account.