Special Purpose Acquisition Companies, commonly known as SPACs, became one of the most talked-about topics in finance during the early 2020s. While the SPAC boom has cooled significantly since then, SPACs remain a relevant topic for anyone recruiting for investment banking. They come up in interviews, they are still used as a path to the public markets in certain situations, and understanding them demonstrates that you have a well-rounded knowledge of capital markets and M&A.
In this guide, we will cover what a SPAC is, how the SPAC process works from IPO to de-SPAC, the key players involved, the pros and cons for companies and investors, and what you should know for investment banking interviews.
What Is a SPAC?
A SPAC is a shell company that has no commercial operations. It is formed for the sole purpose of raising capital through an initial public offering (IPO) and then using that capital to acquire or merge with an existing private company. The result is that the private company becomes publicly traded without going through the traditional IPO process.
SPACs are sometimes called “blank check companies” because when investors buy shares in the SPAC’s IPO, they are essentially trusting the SPAC’s management team (known as the “sponsor”) to find and acquire a suitable target. At the time of the IPO, no specific acquisition target has been identified.
How Does a SPAC Work? The Full Lifecycle
The SPAC lifecycle has several distinct phases. Understanding each one is important for grasping how value is created (or destroyed) and who benefits at each stage.
Phase 1: SPAC Formation and IPO
The process begins when a sponsor (typically a team of experienced investors, former executives, or finance professionals) forms the SPAC entity and takes it public. The SPAC IPO is relatively straightforward compared to a traditional IPO. Units are typically priced at $10 each and consist of one share of common stock plus a fraction of a warrant (which gives the holder the right to purchase additional shares at a set price in the future).
The proceeds from the IPO are placed in a trust account and invested in short-term, low-risk securities (typically U.S. Treasuries). This money sits in the trust until the SPAC identifies and completes an acquisition, or until the SPAC is liquidated if no deal is completed within the specified timeframe, usually 18 to 24 months.
Phase 2: Target Search and Negotiation
After the IPO, the SPAC sponsor begins searching for a private company to acquire. This is where the sponsor’s industry expertise and deal-making experience become important. The sponsor is looking for a company that would benefit from being public and that can be acquired at a valuation that creates value for SPAC shareholders.
Once a target is identified, the SPAC and the target company negotiate the terms of the merger. This process is similar to a typical M&A transaction, with due diligence, valuation analysis, and negotiation of the merger agreement. Investment banks often serve as advisors to both the SPAC and the target during this phase.
Phase 3: The De-SPAC Transaction
The “de-SPAC” is the actual business combination: the merger between the SPAC and the target company. This is the most critical phase of the process and involves several important steps.
First, the SPAC must file a proxy statement (or registration statement) with the SEC, disclosing the terms of the proposed transaction. SPAC shareholders then vote on whether to approve the merger. Importantly, shareholders who do not want to participate in the deal can redeem their shares for a pro rata portion of the trust account, typically at or near the original $10 per share IPO price. This redemption feature is a key investor protection mechanism.
If the deal is approved and enough capital remains after redemptions, the merger closes. The target company effectively becomes the publicly traded entity, and the SPAC’s ticker symbol is typically changed to reflect the new company’s brand.
Phase 4: Post-Merger Public Company
After the de-SPAC, the combined entity operates as a regular publicly traded company. It must meet all the same reporting and regulatory requirements as any other public company. The sponsor’s warrants and promote shares vest, and the management team of the target company typically stays on to run the business.
Key Players in a SPAC Transaction
Understanding who is involved in a SPAC transaction (and what their incentives are) is essential for analyzing these deals.
The Sponsor
The sponsor is the entity that creates and manages the SPAC. Sponsors typically receive a “promote” (usually 20% of the SPAC’s post-IPO equity) for a nominal investment (often around $25,000). This promote is the primary economic incentive for the sponsor and can be extremely lucrative if the deal goes well. However, it also creates a potential conflict of interest: the sponsor has a strong incentive to complete a deal (any deal) because the promote is worthless if the SPAC is liquidated.
SPAC Investors
SPAC investors, the people and institutions that buy shares in the IPO, have downside protection through the redemption feature. If they do not like the proposed deal, they can redeem their shares at the trust value. The warrants provide additional upside if the stock performs well after the merger. Hedge funds and institutional investors have historically been the primary buyers in SPAC IPOs, often using an arbitrage strategy of redeeming shares at trust value while retaining the warrants.
The Target Company
For the target company, a SPAC merger offers a path to the public markets that can be faster and more certain than a traditional IPO. The target negotiates a fixed valuation with the SPAC, which reduces the pricing uncertainty that comes with a traditional IPO roadshow. The target company’s shareholders receive shares in the combined entity.
Investment Banks
Investment banks play multiple roles in SPAC transactions. They underwrite the SPAC IPO, advise on the de-SPAC transaction, and often help arrange PIPE (Private Investment in Public Equity) financing to supplement the trust capital. SPAC-related work can sit across the equity capital markets (ECM), M&A, and leveraged finance teams at a bank.
PIPE Financing: Why It Matters
In many SPAC transactions, the trust capital alone is not sufficient to fund the acquisition, especially if a significant portion of SPAC shareholders choose to redeem their shares. To bridge this gap, SPACs often raise additional capital through a PIPE, where institutional investors commit to purchasing shares at a set price, typically at the time the de-SPAC transaction is announced. PIPE commitments provide certainty of funding and signal institutional support for the deal.
Pros and Cons of SPACs
Advantages
- Speed: A SPAC merger can be completed in 3-6 months, compared to the 6-12+ months a traditional IPO might take.
- Valuation certainty: The target company negotiates a fixed valuation with the SPAC, reducing the pricing risk of a traditional IPO.
- Forward projections: Unlike a traditional IPO, where companies are limited in the financial projections they can share publicly, SPAC mergers have historically allowed companies to present forward-looking financial projections to investors.
- Investor downside protection: SPAC investors can redeem their shares at trust value if they do not support the proposed deal.
Disadvantages
- Dilution: The sponsor promote and warrants create significant dilution for the target company’s shareholders and for SPAC investors who do not redeem.
- Sponsor conflict of interest: The sponsor has a strong financial incentive to complete a deal, even if the deal terms are not ideal for other shareholders.
- Redemption risk: High redemption rates can leave the SPAC with insufficient capital to close the deal, requiring additional PIPE financing or renegotiation.
- Post-deal performance: Historically, many companies that went public via SPACs have underperformed relative to companies that went through traditional IPOs.
- Regulatory scrutiny: The SEC has increased oversight of SPACs in recent years, including new rules around financial projections, disclosure requirements, and liability standards.
SPACs in the Current Market
The SPAC market experienced a massive boom in 2020 and 2021, when hundreds of SPACs went public and raised tens of billions of dollars. The combination of low interest rates, abundant liquidity, and retail investor enthusiasm created a perfect environment for SPAC issuance. However, the market corrected sharply starting in late 2021 and into 2022, driven by poor post-merger performance, increased SEC scrutiny, and rising interest rates.
Since then, SPAC activity has declined significantly. Many SPACs that were unable to find suitable targets were forced to liquidate and return funds to investors. The deals that have continued to get done tend to involve higher-quality targets and more investor-friendly terms. While SPACs are unlikely to return to the frenzy of 2020-2021, they remain a viable path to the public markets for certain companies in certain market conditions.
SPACs in Investment Banking Interviews
If you are preparing for investment banking interviews, you should be able to explain the basic mechanics of how a SPAC works, including the IPO, the trust, the de-SPAC process, and the redemption feature. You should also understand the key players and their incentives, the role of PIPE financing, and the pros and cons of SPACs relative to traditional IPOs and direct listings.
Be prepared for questions like: “Walk me through how a SPAC works.” “Why would a company choose to go public via a SPAC rather than a traditional IPO?” “What are the risks for investors in a SPAC?” These questions test your understanding of capital markets, valuation concepts, and transaction structures.
A solid understanding of SPACs also shows interviewers that you follow the markets and understand how different transaction types fit into the broader landscape of investment banking. Pair this with strong knowledge of DCF analysis, comparable company analysis, and financial statement linkages, and you will be well-prepared for the technical portion of your interviews.
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