SPACs: An Overview

A special purpose acquisition company (SPAC) is a public traded blank check company formed for the sole purpose of completing a merger, share exchange, asset acquisition, share purchase, reorganization, or similar business combination with one or more operating businesses. This transaction is commonly referred to as the initial business combination or the de-SPAC.

Although SPACs have existed for decades, they became a major capital-markets phenomenon during 2020-2021. While issuance has slowed following market corrections and increased regulatory scrutiny, SPACs continue to be used as an alternative route to the public markets.

What is a SPAC and how does it operate?

A SPAC is created by sponsors, typically experienced investors, sector specialists, or former executives. Because a SPAC has no operating business, its value proposition lies entirely in the experience, reputation, and deal-execution capability of the sponsor group. Many SPACs pursue targets in a particular industry (technology, fintech, energy transition, healthcare), and sponsors often have deep experience in that sector. Others are generalists.

The SPAC seeks to raise capital through an initial public offering (IPO). The funds raised are placed in a trust account and cannot be accessed until the SPAC completes a business combination or liquidates.

The SPAC structure

Common stocks and units

Most SPACs offer units in their IPO, each consisting of one share of common stock, and a warrant, or fraction of a warrant, to purchase additional common stock.

The warrant compensates investors for allowing their capital to remain locked in trust during the search period. Warrants typically have an exercise price above the $10 IPO price (commonly $11.50 per share).

Each SPAC varies. Larger, high-profile sponsors may offer 1/3 warrants per unit. Mid-tier SPACs may include 1/2 or full warrants. Some SPACs avoid warrants altogether by using a overfunded trust, where more than $10 per share is deposited into the trust account. The overfunding is financed by the sponsor’s concurrent private placement.

After the IPO, units typically separate, and the common stock and warrants begin trading independently.

The sponsor promote

To form the SPAC, sponsors acquire founder shares for nominal value. After the IPO, these founder shares convert into approximately 20% of the outstanding common stock – referred to as the “promote”.

Founder shares align sponsor incentives toward completing a successful transaction, and are generally locked up for one year after the business combination, subject to early release if the stock trades above specified price thresholds or if a change of control occurs.

To fund IPO expenses, sponsors typically purchase private placement warrants (or, in warrant-lesss structures, shares) at the time of the IPO. These proceeds are held outside the trust account and are used to pay underwriting commissions and other expenses.

The trust account

 At least 100% of IPO proceeds must be deposited into a trust account managed by an independent trustee. The trust is inviolable – funds cannot be released until the SPAC completes the de-SPAC, or if no business combination is completed by the deadline, the funds are returned to public shareholders.

Interest generated in the trust may be used for taxes and limited working capital expenses. Upon completion of the business combination, public shareholders can choose to redeem their shares for their pro rata portion of the trust regardless of how they voted.

If the SPAC fails to complete a business combination within its allotted timeframe, commonly 18-24 months but extendable by shareholder vote, the SPAC must liquidate, and founder shares become worthless.

Size and dilution

In a typical structure, the amount raised in the IPO is approximately 25%-33% of the anticipated enterprise value of the target company. This ratio minimizes dilution from the founder shares, public warrants, private placement warrants, and potential PIPE (private placement in public equity) financing.

If more capital is needed at the business combination stage, the SPAC may raise additional equity or convertible securities. To protect the sponsors’ 20% promote, some SPACs adopt a dual-class structure whereby founder shares convert into exactly 20% of post-combination outstanding shares (excluding target consideration shares).

SPACs may also raise debt financing to support the transaction.

The IPO process

SPAC IPOs are registered on Form S-1 and proceed similarly to an other IPO, except that the SPAC has no operational history. The registration statement focuses on SPAC structure, sponsor background, business strategy, intended industry focus, risk factors, and management disclosure.

The SPAC must certify that it has not identified any specific target before the IPO. If it had, disclosure obligations for the target would fundamentally alter the offering.

As shell companies, SPACs face specific regulatory limitations. They cannot use free writing prospectuses for their IPO or for three years after the business combination. They must mark their SEC filings as shell companies until the de-SPAC closes. They cannot use Form S-8 for employee benefits plans until 60 days post de-SPAC. Rule 144 resale is unavailable for one year after filing Form 10 equivalent information following the business combination.

Most SPACs qualify as emerging growth companies and may confidentially submit draft Form S-1 filings to the SEC.

NASDAQ considerations

Most SPACs list on the NASDAQ Capital Market, subject to SPAC-specific rules in IM-5101-2. Among others, the target must have a fair market value of at least 80% of the amount in the trust. The SPAC must complete the business combination within 36 months (or a shorter period stated in its registration statement). Public shareholders must have the right to vote and redeem (or redeem without a vote if the SPAC uses tender offer procedures). At least 300 round lot holders (at least 100 shares each) are required at listing. After the business combination, the combined company must meet all initial listing standards.

The process leading up to the business combination

Timeframe

A SPAC may not engage in substantive discussions with any target before its IPO. Once public, the SPAC begins its search. If it is unable to finalize a business combination within the permitted timeframe, it must liquidate unless shareholders approve an extension.

Expenses

IPO expenses are funded from sponsor private placement proceeds. Sponsors may also make working capital loans, sometimes convertible into warrants.

Shareholder approval and redemptions

Once a target is identified and a definitive agreement is signed, the SPAC must provide public shareholders with detailed information about the target, audited financial statements, pro forma financials, and risk disclosures. This may take the form of a proxy statement filed under Regulation 14A, or a tender offer under Regulation 14E.

Shareholders may redeem regardless of whether they vote for or against the business combination. Many merger agreements contain minimum cash conditions to ensure the transaction remains viable after redemptions.

Upon closing the business combination, the SPAC becomes an operating public company subject to standard reporting obligations.

Certain benefits of the SPAC structure

Public investor perspective

SPAC investors (a) enjoy downside protection through the redemption right, (b) liquidity, as shares and warrants trade publicly, (c) upside optionality through warrants, and (d) the ability to choose whether to participate in the post-merger company or redeem for cash.

Management team perspective

For sponsors, a SPAC provides (a) access to substantial capital through the public markets, (b) a fast, more flexible route to executing an acquisition, (c) attractive economics through the promote and warrant holdings, and (d) the ability to compete for high quality private companies seeking to go public.

Conclusion

SPACs provide a distinctive alternative to traditional IPOs by offering public investors capital protection and optionality and giving sponsors a powerful acquisition vehicle. Although market conditions have evolved and regulatory requirements tightened, SPACs remain viable tools for taking private companies public, provided that transactions are structured with transparency, realistic valuations, and strong governance.

Torres & Zheng at Law, P.C., regularly advises clients on IPOs, SPACs, and de-SPACs. If you would like us to assist with your transaction, please contact our team.