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How Special Purpose Acquisition Companies Work

A special purpose acquisition company (SPAC), also known as a blank check company, is a publicly traded company created for the purpose of buying or merging with another company or companies. For reasons explained below, the Securities and Exchange Commission (SEC) has particular regulations for special purpose acquisition companies, which differ from shell companies and venture capital companies. If you want to invest in a SPAC, a financial advisor can help guide you through the process.

Let’s say you and your friend have decided to open a bar. You don’t know how to run one and don’t know what you’d serve. You don’t know where to open this bar nor do you have any specific ideas for what it should look like. What you do have is money — money and, it is to be hoped, some skill at general business management.

Under these conditions you should almost certainly not open your own bar. What you might do, however, is create what is known as a special purpose acquisition company for the purpose of getting into the bar and restaurant business. In other words, rather than launching your own bar from the ground up, you would raise funds and then go looking for an existing business to buy. This would allow you to get into the industry even though no member of your team actually has experience in liquor service. Ideally you would bring your management experience and expertise on board, acquiring the management and staff of your new bar with the purchase.

What Is a Special Purpose Acquisition Company (SPAC)?

A special purpose acquisition company is an early or development stage entity created specifically for the purpose of acquiring or merging with one or more existing businesses. It doesn’t have a business model of its own beyond these financial transactions. Instead, the founders intend to integrate the business models of their future partners.

Typically, a special purpose acquisition company is founded by investors or management-oriented groups. In some cases their goal is to bring their specialties (financial backing and management experience) to bear on businesses with good products or business plans, but which might lack money or leadership experience.

Investing firms that create special purpose acquisition companies are not dissimilar from venture capital firms in many ways. Their goal is to find a business with potential and invest in it, hoping to capture profits down the road. This is, of course, not an exact comparison. Venture capitalists invest in businesses while special purpose acquisition companies practice wholesale acquisitions and mergers.

Likewise, they are not shell companies, which are ones that hold funds and manage another entity’s financial transactions. Sometimes shell companies are used to hold funds for an upcoming merger or acquisition.

Why Special Purpose Acquisition Companies Form

How Special Purpose Acquisition Companies Work

There are a wide variety of reasons to start a special purpose acquisition company, and they account for a significant percentage of all U.S. initial public offerings (IPO). Some investors will start a special purpose acquisition company as a sort of fishing expedition. Their strategy will be to look for promising businesses, either in a specific sector or even from a general perspective. The search can focus geographically to one country or even one state or to several countries.

Other investors will start a special purpose acquisition company looking to acquire a pre-identified business. In these cases, the company exists to raise and structure capital for a planned, specific acquisition. This is a less speculative form of special purpose acquisition company, as it has been built for a known transaction rather than as an vehicle to search for opportunities.

In some cases, existing companies will do this as a sort of back-door IPO. This creates a publicly traded special purpose acquisition company specifically for the purpose of acquiring their private firm.

In more predatory cases a special purpose acquisition company might exist to strip other businesses for parts. They then acquire otherwise viable enterprises and extract as much immediate value as possible. This is instead of letting the business grow over time.

Finally, some companies will start as special purpose acquisition companies, or SPACs. These are special purpose acquisition companies that exist to finance a merger or acquisition within a set time frame. For example, they may tell investors that the company will acquire a company within six months of formation. These companies can either have a known target or may be searching for an opportunity.

Investing in Special Purpose Acquisition Companies

Special purpose acquisition companies are publicly traded. This is one of the key ways that they raise capital for their mergers and acquisitions. The founders will form their company and list shares for public purchase. Third parties can invest in the company by purchasing shares, which in turn gives the special purpose acquisition company the money it needs.

The SEC considers special purpose acquisition companies speculative investments and typically lists them as “penny” or “microcap” stocks. Often the agency will subject these companies to additional restrictions on how they can use any publicly raised funds. For example, as noted on the SEC website, to protect investors the commission may require a special purpose acquisition company to hold this money in an escrow account pending any merger or acquisition. Or it may require shareholder approval of future acquisitions.

This is to prevent fraud. The speculative nature of a special purpose acquisition company creates a near-ideal structure for committing financial crimes. Without oversight, a company could easily accept public investments. They could then double dip by sinking that money into its founders’ own firms. Or it could simply tell investors that the acquisitions failed while pocketing shareholders’ money. Alternatively and more prosaically, the speculative nature of a special purpose acquisition company could simply lead to reckless investments that end badly.

To prevent this, the SEC monitors special purpose acquisition companies fairly closely, and it advises investors to make sure they fully understand the rules and regulations involved in these kinds of investments. Likewise, state securities laws known as blue sky laws set standards for disclosing information and registering securities with the goal of protecting investors against fraud.

Bottom Line

How Special Purpose Acquisition Companies Work

A special purpose acquisition company is a publicly traded firm with no set business plan. It exists to purchase or merge with other existing businesses, adopting their position in the marketplace as its own.

These types of companies or firms are only for “special purpose acquisition” in their early stages. This is before they begin to make acquisitions and mergers. After the acquisitions or mergers, the company has a business model, those of its new partners.

Tips for Investing

  • Consider talking with a financial advisor if you have an opportunity to invest in a special purpose acquisition company. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Investing in SPACs carries a higher risk than many other types of investments. It’s important to make sure that your portfolio isn’t holding too much of this kind of asset. An asset allocation calculator can help you make sure that you have a balanced portfolio.

Photo credit: ©, © Mitchell, © Planet Studio

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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