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How SPAC Merger Works: A Step-by-Step Guide

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How SPAC Merger works

People see SPACs as an alternative method to acquiring a business, but investing is similar to purchasing stock. One has to go to their broker and make an order. Those who prefer the online method may visit their brokerage platform and create a limited order. In a way, SPACs operate completely blind. Before sending out letters detailing their proposed target company, investors will have no idea what the company might turn into.

For this reason, investing in a SPAC is seen as a high-risk, high reward move. It is crucial to account for interested parties to conduct their research about the SPAC. This process involves knowing the people behind the operation. It is essential to trust the board, especially members who know what they are doing. 

There must also be a synergy with the industry they are targeting. It might not be the best idea to invest in a company that one will have no interest in, as this might cause dissociation. Currently, lucrative fields include finance, technology, sustainable energy, and others. It is also vital to know the number of people in the SPAC. When there are too many resources, it can backfire because more significant funds mean targeting more prominent companies. 

Components of SPAC

A SPAC consists of various components that ensure the successful acquisition of a company. These components include:

1. Founders

A SPAC consists of founders and business executives who are experienced in this field to know which company to acquire for profitable business. The founders are also the primary resource to collect funds from the investors as SPACs are just shell companies and the experience of founders can skyrocket the company’s success. Founders provide the starting capital and they hold the major stake in the company.

2. IPO

The next component of SPAC is IPO. The management team of a SPAC company first contracts an investment bank while issuing the IPO. The investment bank upon agreement handles all the IPO with a fee, normally 10%. The units sold in the IPO represent one or more shares of a stock.

3. Target Company

A target company is a company to be acquired. After capital is raised through an IPO, the management team has to identify the target company and complete the acquisition within 18 to 24 months. Once the target company is acquired, the founders will profit from their stake in the company. They usually get 20% of the stock whereas investors receive equity based on their contribution to the company.

Capital Structure of SPAC

SPACs consist of two major components in their Capital structure. They include:

1. Public Units

SPACs depend on IPO to raise the capital required to complete the acquisition. The investors are the primary source of capital including retail. All of the money raised in the IPO is held in a trust account. Investors receive share units in return of their investment and a warrant to purchase more stock. The purchase price per unit can depend upon the company and issued IPO, usually $10.00. The units can be divided into shares of common stock and warrants that investors can use to trade in the public market.

2. Founder Shares

The founders are the selling point when collecting funds from the investors. In return, the founders purchase founder shares when registering the SPAC. Founders hold the 20% ownership stake in the company’s outstanding shares after the IPO is completed. These shares are provided as a compensation to the management team who don’t get any commission or salary until the acquisition is complete.

How SPAC Merger Works: The Working Mechanism of SPAC Companies 

Phase 1: Fund Raising

The way SPACs raise funds still hinges on an initial public offering. How SPAC deals with IPOs consists of  a common stock share infused with a warrant to buy additional stock at a set price and date. The investors  who sell with the SPAC IPO pay an amount that is called the Net Asset Value or NAV of the company,  which is $10 for every share plus interest. Investors also pay a premium when investing in SPAC, such that  to get the premium, one has to deduct the NAV from the payment investors made in SPAC. So, for example,  when an investor pays $15 and the SPAC’s NAV is $12.5 ($10 plus interest), the premium he paid is $2.5. 

Phase 2: The Net Asset Value (NAV)

When the price of SPAC dips below NAV, it means that the value of such an investment is undervalued.  And, when it reaches above its NAV, it doesn’t mean that the price is overvalued. Some catalysts such as new mergers can increase market optimism. Using NAV can also mean that investors are protecting their  money and minimizing investment risks since when SPAC doesn’t complete a business combination, investors can pull out their investments at any time. When the market is in favor of them, investors can  maximize their gains and hold their investments as long as possible. 

Phase 3: Analysis

Investors may use several tools to monitor the growth of the company’s NAV to minimize risks of losses.  After some time and the IPO finishes, the warrant ends, and trading occurs independently of the SPAC. A  majority (about 85% or more) of the proceeds in the IPO should be stored in an escrow account. These will  be held for future transactions. Typically, almost all the capital raised remains in the report, while the  remainder is allocated for fees and expenses. 

Phase 4: Finding Target Company

The funds stored in the escrow are also used in government bonds. Once the IPO completes, the SPAC must find a target company. While this is happening, the stock of the SPAC nears the initial IPO price because of  government bonds. SPACs have a time limit of about two years to find a target. Otherwise, all the money  collected must go back to the shareholders. 

Once a target is identified, the SPAC sponsors must release a statement. In this announcement, people are  alerted about the target company. They must negotiate with authorities and other institutions for the deal to go smoothly. For instance, the Securities and Exchange Commission or SEC must review the terms of the  agreement before approving it. 

Phase 5: Proxy Vote

If the SEC decides that there is no problem with the acquisition, the SPAC shareholders must vote on the  company of choice. If the majority decides that the target choice is satisfactory, the next step is to determine  if they want to liquidate their shares. This entire process is known as a proxy vote. The maximum percentage  of people who wish to liquidate must not be higher than 50%. 

The usual companies targeted by SPACs have values double the money raised during the IPO, although sometimes it can go as high as four times the amount. For the SPAC to make the deal a reality, they must secure money from other sources. These will serve as additional capital to compensate for the investors that chose to liquidate their shares. 

Phase 6: Private Investment in Public Equity

The final step is for the SPAC to equalize the debt to balance things out. This process happens with the help  of buyout firms. It is also known as a PIPE or a “Private Investment in Public Equity.” Once everything is  approved, the acquisition becomes a reality, and the resulting company becomes a new listing in the stock  exchange market. 

Final Words

Whether or not a SPAC is worth investing in relies on a person’s goals and interests. For those into the art of  high-risk, high rewards, then putting resources into a SPAC is a choice to stand behind. The benefits might  offset the risks, and one never knows if a previously no-name venture will become the next big thing in a  few years. Find more about SPACs at SPACrun. SPACrun provides fresh updates on breaking mergers and definitive agreements with premium SMS/Email alerts. Sign Up to SPACrun today!

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