SPAC (Special Purpose Acquisition Company)

SPAC (Special Purpose Acquisition Company), often called a “blank check company,” is a shell corporation with no commercial operations, formed strictly to raise capital through an Initial Public Offering (IPO) for the sole purpose of acquiring an existing private company. Imagine a group of experienced investors, known as “sponsors,” creating a company that does nothing and owns nothing. They then convince the public to give them a giant pot of money—a blank check—on the promise that they will use it to buy a great private business within a set timeframe, typically two years. The money raised from the public is held in a trust account, earning interest. If the sponsors fail to find a suitable acquisition target and complete a merger (a process known as the “de-SPAC”), the company is liquidated, and the IPO investors get their money back with interest. While it sounds like a low-risk proposition initially, the devil, as always, is in the details.

The lifecycle of a SPAC is a race against the clock, blending Wall Street finance with entrepreneurial deal-making.

1. 1. The Setup: A team of “sponsors,” often high-profile financiers or industry veterans, pays a nominal amount for “founder shares,” typically representing 20% of the company's equity post-IPO. This is their main incentive and is often called the “promote.”
2. 2. The IPO: The SPAC goes public. Instead of selling shares in an operating business, it sells “units” to the public, usually at a standard price of $10.00 each. A unit typically consists of one common share and a fraction of a warrant, which gives the holder the right to buy more shares at a fixed price in the future. The IPO proceeds are placed in a trust account.
3. 3. The Hunt: The sponsors now have 18-24 months to find a private company to merge with. They vet potential targets, conduct due diligence, and negotiate a deal.
4. 4. The De-SPAC: Once a target is identified and a merger agreement is signed, it's announced to the public. The SPAC's shareholders must vote to approve the deal. This is the moment the blank check gets filled in, and the private target company effectively becomes a publicly-traded entity, bypassing the traditional IPO route. If shareholders approve, the merger is completed.

A critical feature is the redemption right. Before the merger vote, any SPAC shareholder who doesn't like the proposed deal can redeem their shares and get their original investment (e.g., $10.00) back, plus accrued interest.

SPACs became wildly popular because they seem to offer something for everyone, though the benefits are often not what they seem.

• For the Target Company: It offers a faster and more certain path to the public markets than a traditional IPO. The sale price is negotiated upfront with the SPAC sponsors, avoiding the pricing uncertainty of a typical IPO roadshow.
• For the Sponsors: The “promote” is the jackpot. Their 20% stake, acquired for a pittance, can become immensely valuable if the merged company's stock performs well (or even if it just doesn't collapse immediately). This creates a powerful incentive to get any deal done.
• For IPO Investors: The ability to redeem shares before a merger offers downside protection, making it seem like a “risk-free” bet. If they don't like the deal, they get their money back. If they do, they can hold on and hope for the stock to pop. The warrants are a free sweetener, offering potential future upside.

From a value investing perspective, the SPAC structure is riddled with red flags. While the pre-merger phase might seem safe, the post-merger company is often a terrible investment proposition.

• Heads They Win, Tails You Lose: The sponsors' incentives are horribly misaligned with long-term shareholders. Because their founder shares are so cheap, they can profit even if the merged company's stock price falls dramatically. Their priority is to close a deal, any deal, before the two-year deadline, not necessarily to find a fantastic business at a fair price.
• Massive Dilution: The 20% sponsor promote and the public warrants create a huge overhang of potential new shares. This means a shareholder's ownership stake is heavily diluted from the start. For the stock to be a good investment, the underlying business must perform spectacularly just to overcome this initial dilution. You are essentially starting the race several laps behind.
• Adverse Selection: Why would a truly great company, one with strong financials and a durable competitive moat, choose the SPAC route over the more prestigious and rigorous traditional IPO? Often, the companies that merge with SPACs are speculative, pre-revenue, or simply not strong enough to withstand the scrutiny of institutional investors in a normal IPO process. They are selling a story, not proven earnings or free cash flow.
• Paying for Hype: The final valuation of the merged company is not determined by the market but is negotiated between the target and the motivated SPAC sponsors. This often leads to wildly optimistic valuations based on fantastical future projections rather than current business reality.

A SPAC is a financial instrument, not a business. For a value investor, the only thing that matters is the quality of the underlying business you are buying and the price you are paying for it. The SPAC boom has overwhelmingly involved merging with speculative, unprofitable companies at inflated prices, enriching sponsors at the expense of ordinary investors who hold on post-merger. While the pre-merger arbitrage (buying units and redeeming shares) can be a niche strategy for sophisticated funds, for the average investor, it's a minefield. The real investment decision happens after the merger is announced. At that point, you must ignore the SPAC hype and analyze the new public company on its own merits. More often than not, a value investor will find a heavily diluted, overvalued business with misaligned management incentives—a classic “cigar butt,” but one that's already been smoked. Proceed with extreme caution.