Let's talk about SPACs!

A special purpose acquisition company (SPAC) is a blank-check company that raises capital from investors through an IPO, places the money in a pot, and then uses the pot to purchase a share in an existing private company to combine with it, and eventually take it public.

Traditionally, the SPAC's IPO is valued at $10 per share; if 100 million shares are sold, the SPAC will have $1 billion in its pot. It will seek out a private company and negotiate with it about the size of the stake that the SPAC will obtain in return for its capital. Then they'll announce the deal, also known as a business combination, and hopefully the stock (the already public SPAC stock) will grow in price.

This works in the same way as a traditional IPO. The people who agree to buy a private company's shares at the moment it becomes public are taking a risk and doing the private company a favour. They expect to be able to buy those shares at a bit of a discount. After the company goes public, the stock should trade up, to reward the initial purchasers. This is known as the "IPO pop" in an IPO, and it is strongly criticised by venture capitalists. Of course, there is no guarantee of anything; some IPOs open below their IPO price and similarly, some SPACs trade down as investors are disappointed by the deals they make.

The reduced timeframe for an IPOs is a major advantage of going public through SPACs. Furthermore, it increases the issuer's confidence in raising funds. The involvement of professionals in identifying the target also ensures that the investment is well-planned and managed.

Despite the fact that SPAC is fairly a new product, it has gained traction, with approximately 248 SPAC companies listed on US exchanges in 2020, with an average fund-raise of $335 million. In 2009, there was only one SPAC with a $36 million fund raise. Surprisingly, the average amount raised by a SPAC has increased from $200 million to $335 million in recent years. Around 100 SPACs have been established so far this year, with an average fund raise of $291 million. Previously, nearly 20% of SPACs had to be liquidated; now, the success rate for finding a target and merging is nearly 90%.

Given India's large and mature IPO market, our regulators should consider allowing SPACs to list in the country – with all necessary checks and balances in place. It's understandable that some people are concerned about the risks associated with a new product but even if we start in a limited way, the framework will evolve over time. Our markets and regulators have recently shown a willingness to embrace new ideas and products, and SPAC could be the next big thing.