2020 represented a lot of things. It was the year of the coronavirus pandemic, of zoom meetings, and of bitcoin. But another thing that 2020 brought to the spotlight was SPACs.
And SPACs show no signs of slowing down. In fact, SPACs in the United States raised nearly ninety billion dollars in the first three months of 2021. That’s more than what was raised in the entire year of 2020.
If you’re interested in the stock market, you need to know how SPACs work and how they differ from traditional IPOs. Luckily for you, we are here to help you with just that. So keep on reading and we will take you through everything that you will want to know!
Table of Contents
Why Would a Company Want to Go Public in the First Place?
There are several reasons why a private company might want to go public. First, they may be looking to raise funds and open up more ways to raise money in the future.
Liquidity is another reason. All of the company’s early employees who have equity in the company will be able to sell their shares and come out with a nice profit, hopefully.
Going public also allows you to make your mark in the marketplace. You’ll get a lot more publicity and prestige when you trade on the stock market.
Plus, public companies tend to have better luck when comes to acquisitions, mergers, and recruiting top executives.
Traditional IPO vs SPAC IPO
Believe it or not, IPOs have actually been around for hundreds of years. And since their early days, companies have been coming up with new and innovative ways to make the process easier and faster.
The Tried-and-True Path
If a business decides to go with the traditional IPO process, then it will start a six-month to a one-year journey of working with underwriters and investment banks (the risk assessors) to pitch future investors.
There will be many meetings, S-1 Registration Statement drafting sessions, and even something known as an “IPO Roadshow.” This is when the management team travels around the country to meet with potential investors and market the company.
The Independent Route
A SPAC, also known as a special purpose acquisition company, is basically a shell company that pools money until it decides what it is going to spend the money on.
A SPAC doesn’t have any commercial operations. That means that it doesn’t sell anything and it doesn’t make any products. In fact, the only asset that a SPAC has is the money that it raises in its own IPO.
A SPAC is usually formed, or sponsored, by a group of investors.
By forming a SPAC, a company can become public in just a matter of weeks. Because it takes less time, that also means that there are fewer fees involved.
There is usually a time limit of around two years for a SPAC to acquire a target company. If it doesn’t follow through, it needs to dissolve and give the investors all of their money back.
Understanding how SPACs work is very important for anyone interested in the stock market.
While a SPAC might seem like the hot new thing, it’s really not that new of a concept. A SPAC is always a reverse merger but that doesn’t mean that a reverse merger is always going to be a SPAC.
What Is a Reverse Merger?
A reverse merger is when a private company merges with a public company. It doesn’t need to be a shell company. And the private company goes public during the process.
In the 1980s, reverse mergers were very popular. However, they fizzled out due to claims of fraud.
Is One IPO Better than the Other?
A traditional IPO is not necessarily better than a SPAC. However, you can generally have more confidence that a company with a traditional IPO is going to be legitimate while it’s not as easy to make that assumption with a SPAC.
For a company like WeWork, merging with a SPAC makes a lot of sense. In order for a company to go public with a SPAC, a SPAC needs to want to take that company public.
For companies that aren’t that well-known, it can be difficult to get picked up by a SPAC. But a hot new company usually has an easier time because there’s a lot of buzz around it.
If WeWork went the traditional route, the buzz might fade before they even hit the New York Stock Exchange.
Some might argue that there is an oversaturation of SPACs currently in the market. Many of these companies are growth companies that haven’t even turned profits yet. Unfortunately, if the trend continues, we might see a bubble on our hands.
The SEC Gets Involved
At the end of March in 2021, the SEC (Securities and Exchange Commission) sent letters to banks on Wall Street asking about some SPAC dealings. They also made new guidance when it comes to accounting rules for these kinds of companies.
If the SEC gets more involved, we might see an end to the SPAC craze.
The Importance of Knowing the Difference Between SPACs and Traditional IPOs
Hopefully, after reading the above article, you now have a better idea of how SPACs and traditional IPOs differ. Knowing these differences can make you a better investor.
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