Shell company or shell company. Why this way of entering the stock exchange has become so popular and what an investor who wants to make money on SPAC needs to know.

Thousands of instruments are traded on the US stock exchanges NYSE and NASDAQ. Among them, under a typical ticker, there are not only ordinary shares that reflect the share of ownership in the company's business, but also securities of companies that do not conduct any business at all. These are SPAC shares. Due to the sharp increase in their popularity in 2020, it is worth familiarizing yourself with this concept and what lies behind it.

What is SPAC

Special purpose acquisition company, or SPAC for short, is a specialized company for targeted mergers and acquisitions. It does not conduct operational activities, and its main goal and characteristic is the listing of a selected private company through a merger, rather than a traditional IPO.

The history of such companies began in the 90s, but in the last 4 years there has been a clear growing trend. Over the past year, the number of SPACs has more than doubled from 2019, and placement revenue has tripled.

With the help of a merger with SPAC in the recent past, such sensational companies as Nikola Motor, Virgin Galactic, DraftKings, Opendoor have become public.

Examples of currently traded SPACs that have not begun to merge: Pershing Square Tontine Holdings (PSTH), Churchill Capital Corp IV (CCIV).

How it works

The principle of operation of this mechanism is as follows: a well-known investor, financier, media personality announces the creation of a SPAC and conducts an IPO, indicating rough guidelines - in which company of which industry, sector, activity, the proceeds will be invested in the future. Typically, the price of one SPAC share at the IPO is set at $10.

Proceeds from an IPO are sent to a special trust account, similar to the escrow account used when buying real estate. The final consent to the purchase of a particular private company must be obtained from the shareholders of the SPAC. At the same time, the duration of the SPAC is limited, usually a period of 24 months. If during this period an object for absorption is not found, the shareholders of SPAC receive their investments back at the IPO price, and all costs of the company's activities are borne by the creator.

In addition to shares, SPACs almost always issue warrants. A warrant is a security that gives the right to purchase a company's shares in the future at a fixed price, which additionally stimulates investment in SPAC at the stage of its IPO.

Also, when implementing the merger mechanism, additional capital can be attracted from the market through a relatively wide distribution. This element of a public offering is called PIPE Raise (private investment in a public company).

Consider a conditionally simplified example. Businessman Bill has a promising startup "A" that needs funding. Bill would like to take company "A" public, but it is very difficult: just preparing all the necessary documents and passing the checks will take years. And it’s not certain that A shares in an IPO will be in demand among investors, especially if the startup is not yet showing impressive profits, and Bill rarely tweets and has not yet become a world-famous entrepreneur.

Venture capitalist Joe, known to everyone on Wall Street as a seasoned and successful business tycoon, took SPAC "B" public to make money. You could say that the main capital of "B" in an IPO is the reputation of its creator, but Joe's reputation is just such that many investors gladly invested in "B" securities. Joe has capitalized on his SPAC and has about a couple of years to find his target.

If Bill and Joe meet and come to an understanding, then, with the consent of the investors, "B" can absorb "A". Thus, "A" will be on the exchange very quickly and with an already established investor base. The combined company will be named "A" and the ticker will change accordingly.

What is the benefit

The creator (sponsor) of SPAC gets the opportunity to significantly increase his investments, often many times, due to the authority of his person, professional skills, attracting investments and agreeing on a merger in the future. Typically, the sponsor receives a 20% stake in SPAC at face value, which is then sold at market prices.

Investors who buy SPAC shares at an IPO get the opportunity to earn much more than conservative instruments - deposits, bonds, or even shares of stable companies. They have a potentially growing story at an early stage and yet have stipulated conditions for the return of funds in the absence of an object for investment. In addition, they get a more predictable allocation (that is, the investor has a higher chance of getting as many shares as they would like) than with a regular IPO.

A private company goes public without the cost of an IPO, avoiding a number of disclosure requirements, which in particular forbid it from making optimistic forecasts for the future, and, most importantly, in a short time frame, which allows it to take advantage of the positive market conditions.

What to pay attention to

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In 2020, against the backdrop of the pandemic, on the one hand, the public company market was flooded with liquidity, and on the other hand, it faced venture capital problems. This contributed to the growth of SPAC's popularity. The regulator, represented by the SEC, does not disregard these trends by issuing a special bulletin for investors in such companies.

It emphasizes that no matter at what stage you invest in SPAC, you should carefully read the SPAC IPO prospectus, which can be found on the regulator's website, as well as its reports filed with the SEC.

By buying SPAC shares on the secondary market, investors can pay much more than the IPO price. And in the absence of an acquisition and liquidation target, SPACs will only be reimbursed in the amount of the IPO price, or, more precisely, a proportional share of the amount held in the trust account.

How to recognize SPAC

You can use one of the screeners to select stocks. For example, finviz.com allows you to filter stocks by Shell companies.

Briefly: what an investor needs to know about SPAC

• SPAC is a "shell company" created to list another company on the stock exchange. When a SPAC IPO takes place, it is usually unknown which company will be the target of a takeover in the future.

• Investing in SPAC allows you to enter a growing project at an early stage with a more predictable level of allocation and on attractive terms.

• But, as always, the possibility of higher profits comes with increased risks

• The investor should definitely read the SPAC IPO prospectus and its reports, as well as evaluate the experience of the SPAC founders.

• SPAC investors will receive their funds back at approximately the price of its IPO if no target is found, but in each case the terms of the return should be reviewed by the investor in advance.