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How Blank Check Companies (SPACs) 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 specific 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.

What Is a Blank Check Company or SPAC?

A blank check company, known as 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 Are Created

How Blank Check Companies (SPACs) 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 a 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 might be searching for an opportunity.

Example of When You Might Use a Blank Check Company

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 and a knowledge of operating a similar type of business.

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.

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 their 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. While blank check companies are legal, state securities laws known as blue sky laws set standards for disclosing information and registering securities with the goal of protecting investors against fraud.

Questions to Ask Before Investing in a SPAC

The SEC urges potential investors in a SPAC to make sure they understand several key aspects of the entity and its plans:

  • Do you clearly understand the financial incentives of SPAC sponsors, directors and officers to complete a business combination transaction?
  • Have you thoroughly checked into any potential conflicts of interest of SPAC sponsors, directors and officers to complete a business combination transaction?
  • Have you determined whether these incentives may differ from the interests of public shareholders?
  • Have you quantified, to the extent practicable, information about the losses the sponsors, directors and officers could incur if the SPAC does not complete a business combination transaction?
  • Do you know the amount of control that SPAC sponsors, directors and officers and their affiliates will have over approval of a business combination transaction?
  • If the underwriter of the IPO will provide additional services, like identifying potential target companies, do you know what those potential services are, what the fees will be and how those fees will be paid.

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. Deciding to invest in a SPAC is similar to making a decision on any other investment. It’s important to know what you’re getting into and how it plays into your overall financial picture.

Tips for Investing

  • If you’re considering a SPAC as an investment you may want to first speak to a financial advisor to make sure you’ve fully assessed the risk to your portfolio.
  • Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve 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: ©iStock.com/Dzmitry Dzemidovich, ©iStock.com/Cecilie_Arcurs, ©iStock.com/Blue 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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