Why Finance Executives Choose SPACs: A Guide to the IPO Rival

Christel Deskins

Executives increasingly are using an alternative to IPOs to take their companies public, choosing to sell to what is known as a special-purpose acquisition company to attract new investors and potentially cut down on the time it takes to reach public markets. U.S.-listed special-purpose acquisition companies, or SPACs, have raised […]

Executives increasingly are using an alternative to IPOs to take their companies public, choosing to sell to what is known as a special-purpose acquisition company to attract new investors and potentially cut down on the time it takes to reach public markets.

U.S.-listed special-purpose acquisition companies, or SPACs, have raised $40.4 billion so far in 2020, compared with $13.5 billion during the whole of 2019, according to data provider Dealogic. By comparison, companies raised $51.3 billion this year through traditional initial public offerings, roughly on par with all of 2019, Dealogic said.

SPACs this year have completed 47 acquisitions totaling $50.2 billion, compared with 22 deals totaling $15.1 billion in 2019, according to Dealogic.

Among the most prominent companies that have chosen SPACs to go public in recent months is

Nikola Corp.

, the electric truck maker. Nikola in June merged with VectoIQ Acquisition Corp., a SPAC with a focus on transportation deals.

Nikola’s founder and executive chairman, Trevor Milton, stepped down this week amid allegations of misleading investors. The company also is facing probes from the U.S. Department of Justice and the U.S. Securities and Exchange Commission about misrepresenting its technology.

What is a SPAC?

A special-purpose acquisition company is a publicly traded company that raises cash for the purposes of acquiring a closely held firm and, through the deal, taking it public.

SPACs often focus on companies within a particular industry. Deals for technology—particularly biotechnology—and transportation companies have been popular for SPACs recently. A number of well-known investors have formed SPACs of late, including William Ackman.

Are SPACs new?

There have been several waves of SPACs dating back to the 1990s, so this isn’t the first time the financing vehicle has attracted interest, said Alysa Craig, managing director for mergers and acquisitions and head of SPACs at

Stifel Financial Corp.

, an investment bank.

One factor that differentiates today’s SPACs from their predecessors is the protections they afford to investors, Ms. Craig said. Shareholders today can redeem their investment in full, plus interest, before an acquisition if they choose not to take shares in the selling company.

SPAC founders today are expected to cover many of the costs associated with setting up the company, such as legal fees, she said. That is different from the previous generation of SPACs, which often put investors on the hook for paying a portion of the upfront costs of setting up the investment company, including legal and administrative fees, according to Ms. Craig.

What is the advantage of a SPAC from a corporate finance perspective?

One of the key advantages for companies looking to go public is efficiency. A SPAC transaction can be completed in a few months, compared with a traditional IPO that likely takes longer and can expose a company to fluctuations in the market, according to Ms. Craig.

When SPACs list publicly, their disclosures are minimal. Essentially a large pool of cash, they usually don’t have any operations to speak of. SPACs also belong to a class of smaller reporting companies that have scaled-down filing requirements, according to Jonathan Ko, an attorney in the securities and capital markets practice at Paul Hastings LLP, a law firm.

When a SPAC finds a target to acquire and ultimately take public through a merger, the filing requirements for the target company are essentially the same as for a traditional IPO, Mr. Ko said. The SPAC is required to present its public stockholders with standard information on the target’s operations to approve the transaction and create the combined company, he said.

Another SPAC advantage is the ability to disclose financial projections—including revenue and profit growth—that can potentially make the company look better to investors, said Jeffrey Cohen, capital markets partner at Linklaters LLP, a law firm. Companies typically don’t do so in a traditional initial public offering because of the liability risks this could present to underwriting banks, he said.

Banks don’t serve as underwriters for SPAC acquisitions, which gives selling parties leeway to include financial projections in the disclosures they provide to investors, Mr. Cohen said. “Those projections form the basis of the initial valuation of the company in a more direct way than you’re able to through an IPO,” he said.

How are SPACs regulated?

SPACs have to meet some of the same registration criteria as companies that plan to list through a traditional IPO, for example filing a registration statement and conducting a roadshow.

But there are some key differences. The SEC requires SPACs to deposit most of the raised funds in a trust until an acquisition is agreed upon. It also prohibits or limits the use of several exemptions and forms. Former SPACs aren’t allowed to use a particular securities registration form to raise capital, known as S-3, until at least one year after completing a business combination.

SPACs in the 1980s were frequently associated with penny-stock frauds and considered largely unregulated. Regulations implemented in the 1990s helped improve practices in the sector. Some SPACs in recent years have been backed by blue-chip institutions.

Goldman Sachs Group Inc.

underwrote its first SPAC IPO in 2016, and the New York Stock Exchange in 2017 allowed the first SPAC, TPG Pace Energy Holdings, in almost a decade to list.

What are the concerns around SPACs?

Some critics say SPACs receive less regulatory scrutiny than traditional IPOs, which are stringently vetted. For investors, that can pose a heightened risk. Investors buying shares in a SPAC might do so with little information, as the vehicles don’t have an operating history, said Jack Ciesielski, owner of R.G. Associates Inc., an investment research firm and portfolio manager. “You are buying a jockey, not the horse,” he said. “You’ve got to have faith in the guy that’s heading it up.”

SPAC founders often have the right to buy 20% of the resulting public company for a low price, giving them a sizable payday even if shares fall.

Write to Kristin Broughton at [email protected] and Mark Maurer at [email protected]

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