In 2020 and 2021, hundreds of companies went public without a traditional IPO. They merged with shell companies that had no business of their own, known as special purpose acquisition companies, or SPACs. The boom made SPACs famous, and the bust that followed made them a cautionary tale.
What a SPAC Is
A SPAC is a company created for one purpose: to raise money from investors and then use it to buy a private business. It is often called a blank check company, because investors hand over money before knowing what it will purchase. The SPAC is set up by a sponsor, usually a well-known investor or executive. It sells shares to the public in its own IPO, typically at $10 each, and the money is placed in a trust account. The sponsor then has a limited time, commonly two years, to find a company to merge with.
How the Merger Works
When the sponsor finds a target, shareholders vote on the deal. Any shareholder who dislikes it can redeem their shares and get their money back from the trust, with interest. If the merger is approved, the private company takes over the SPAC’s stock exchange listing and becomes a public company. If no deal is completed before the deadline, the SPAC is dissolved and the money in the trust is returned to investors. This structure means that buying a SPAC at its IPO price carries limited risk until a merger is completed.
Why Companies Chose SPACs
For a private company, merging with a SPAC can be faster than an IPO, and the price is negotiated directly with the sponsor instead of being left to the market on the first day of trading. Until rules were tightened, SPAC deals also gave companies more freedom to promote optimistic forecasts of future revenue, which appealed to young firms with little current income. Sponsors had strong incentives too. They typically receive about 20% of the SPAC’s shares for a very small payment, a reward known as the promote.
The Boom and the Bust
In 2021 alone, more than 600 SPACs went public in the United States, raising over $160 billion. Celebrities, athletes, and former politicians attached their names to them. The results were poor. The sponsor’s free shares dilute other investors, and sponsors earn their reward only if a deal is done, which encourages weak mergers. Many companies that went public this way missed their forecasts, and their share prices fell far below $10. Regulators responded with stricter disclosure rules, and new SPAC activity dropped sharply.
Conclusion
SPACs offer a legitimate alternative route to the public markets, and some well-run companies have used them successfully. They are not a shortcut around the scrutiny that a public listing demands. The episode is a reminder to look closely at incentives. When the people arranging a deal profit whether or not it works out for shareholders, investors need to be especially careful.