What Happens After a SPAC Merger? A Look at the SPAC Life Cycle

Special-purpose acquisition companies, or SPACs, were created decades ago to meet a certain demand on Wall Street for a faster, simplified path to an initial public offering (IPO). The SPAC market roared in 2020 and early 2021, but then sputtered to a snail’s pace amid concerns about higher interest rates chilling deals in general, tax changes, and concerns about regulatory scrutiny.  

However, SPACs were still making news as late as mid-2023, when a $23 billion deal by Black Spade Acquisition for Vietnamese electric vehicle manufacturer VinFast Auto (VFS) closed with a big debut on the Nasdaq® by August. However, it was one of only 22 SPAC deals closed by September (see figure 1).

What is a SPAC?

SPACs are often described as “blank check” or “shell” companies because they’re intended to allow early stage firms without established business plans or actual commercial operations to raise money in the public markets. A SPAC will find investors to fund an IPO, and then will use the proceeds to acquire a company that can trade in the public market.

Such deals are required to close within two years, though parties aren’t required to follow the more extensive rules and disclosure processes common to conventional IPOs.

What fueled the recent SPAC boom—and bust?

SPACs were created more than 30 years ago. So, why the boom in 2020?

That year, the COVID-19 pandemic began and spurred the Federal Reserve and other global central banks to cut rates to near-zero to stave off an economic crisis. Many companies found this historically low-rate environment friendly for a range of M&A activity, and SPACs joined the boom.

However, by mid-2022, inflation’s return brought rising rates and an end to the historically easy deal-making environment that got so many businesses and investors to consider investing in younger, riskier companies, including those that went to market via a SPAC.

Recent data from SPACInsider.com shows how precipitous the pandemic-era SPAC rise and fall really was (see figure 1).

By early 2023, news sources had begun to report that many SPACs were moving into bankruptcy court.

So, despite the recent VinFast deal, SPACs can offer a valuable lesson for investors wanting to know more about M&A in general and fast-track deal structures in particular, according to Alex Coffey, senior trading strategist at TD Ameritrade.

Why it’s important to understand a deal’s structure

“SPACs are complex and differ from traditional stocks in several ways, so investors would be wise to educate themselves and understand how these instruments work,” Coffey noted. “The primary thing investors should know is that due diligence responsibility is far greater when investing in SPACs compared to traditional companies and IPOs.”

However, SPACs remain an option for companies to raise capital, and market considerations can always change. As Coffey pointed out, investors should be aware how these particular deals work.

“Recent regulatory warnings have raised questions around the accounting and revenue projections for many SPACs,” Coffey said.

In early 2022, the Securities and Exchange Commission (SEC) proposed new rules to expand information disclosure related to SPAC deals. At the time, SEC Chair Gary Gensler said, “Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO. Thus, investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.”

Until changes potentially happen, here are a few details on how SPACs work.

What’s a typical SPAC life cycle, and what are the possible outcomes?

Again, a SPAC’s life cycle usually takes about two years, and risks to investors can change over that period.

Here’s a simplified summary of the life cycle:

Step 1: SPAC leadership forms a SPAC and describes its plan for the capital it raises.

Step 2: SPAC holds an IPO to raise capital.

Step 3: SPAC either acquires or merges with an operating company or fails to find one and dissolves, returning funds to investors.

According to the Financial Industry Regulatory Authority (FINRA), a SPAC typically has between 18 and 24 months to close an acquisition. If it doesn’t, the SPAC is dissolved and funds are returned to investors on a pro rata basis (net of costs and fees which, depending on the SPAC structure, can be substantial).

However, investors who buy into a SPAC before it purchases anything face the risk of not knowing exactly what their money will be invested in.

SPAC life cycle walk-through

Although SPACs usually have a relatively short life, that doesn’t mean things can’t get interesting or complicated. Here’s a brief summary of a SPAC life cycle from the accounting and consulting firm CohnReznick.

Formation and IPO

In the formation phase, a financial sponsor(s) assembles a management team and funds an equity stake or founders’ stock in the SPAC. The equity investment funds initial business operations to launch an IPO and identify an acquisition target. The founders’ stock often represents approximately 20% of the post-offering stock (though that ratio can vary). After selecting underwriters, the SPAC files a registration statement with the SEC to initiate the IPO allowing shares to be sold to investors.

Target search

Next, assuming the IPO went successfully, the SPAC now has funds to begin its search for an acquisition target, which proceeds in similar ways to a traditional merger and acquisition process as the SPAC identifies and conducts due diligence on potential targets. However, because shareholders can redeem shares, the sponsors must closely monitor cash to ensure sufficient funding to acquire the target and manage post-close operations.

At this point, a so-called PIPE (“private investment in public equity” financing) may issue convertible debt, which converts to stock at a fixed rate at the request of the private investor, thereby diluting the equity of existing shareholders. The goal is to have the selection process end with a definitive agreement between the SPAC and an acquisition target. If the SPAC is unable to find a suitable acquisition target, then it dissolves and returns money to investors on a pro-rata basis.

“De-SPACing”

De-SPACing occurs after the SPAC finds a favorable operating company and transfers capital to the target, which then trades in the public market. Once the merger is complete, the operating company is the sole surviving entity and the SPAC dissolves. De-SPACing —essentially transitioning to life as a normal public company—requires the buyer to obtain shareholder approval in accordance with SEC regulations. Typically, the process includes the commitment of the founders’ shares to the acquisition, a redemption offer whereby SPAC shareholders can redeem their shares, and the filing of an 8-K form with the SEC (effectively, a registration statement for the transaction).

Managing public company operations

At this point, the acquisition is complete, and the company must comply with all public company reporting obligations under the Securities Exchange Act of 1934 and subsequent legislation. The transition “is a significant one for any private company, requiring enhanced governance, controls, technology, and operating procedures,” according to CohnReznick.

What are some unique risks SPACs pose for investors?

Now that you’ve gotten a look at the SPAC life cycle, you’ve likely figured out there are quite a few risks and uncertainties inherent in SPAC investments.

Publicly traded companies are required to regularly disclose detailed financial results in SEC filings, such as quarterly 10-K and 10-Q reports (available on the SEC’s online portal, EDGAR). They also must follow a raft of other SEC and industry rules aimed at providing investors with transparency and a comprehensive view of their financial health.

For SPACs, transparency is a must-have, and investors should conduct more “due diligence” than they would with a traditional public company before putting money into a SPAC, Coffey explained.

 “SPACs can be invested in at multiple stages, and depending on the stage, there are different risks that could be unique,” Coffey commented. “For example, if you invest in the SPAC at the initial stage, you’re really investing in the know-how of the SPAC’s leadership, trusting it will act with the best interests of shareholders in mind.”

And as mentioned above, SPACs may involve speculative investments or companies in development stages that don’t have a specific business plan or purpose. Some of these companies may have developed a plan to engage in a merger or acquisition with an unidentified company or other entities, while others have an open field to select an operating company as the SPAC formation process continues.

Finally, remember that some SPACs may fall within the SEC’s definition of penny stocks or micro-cap stocks, which tend to be thinly traded and more volatile generally than companies with larger market capitalization overall.

Bottom line

Do the risks inherent in the SPAC life cycle mean investors should steer clear? They’re not for everyone, that’s for sure. But as venture capitalists, “angels,” and entrepreneurs know, early stage investing is typically the one with the most risk but with the best opportunity to get in on the ground floor.

It’s not easy, especially when starting out. Successful early stage investing requires intensive due diligence and research, and even then, there are no guarantees. If you decide SPAC investing is for you, it might be a good idea to start small and spread your SPAC investment bucket across several potential candidates.