I have been seeing this term "SPAC" for quite a while now on Twitter lately.

Many handles have been speaking about SPACs (mainly @chamath).

So, what the hell is a SPAC?

Time for a thread.

1/ Let's say you have started a business.

You want to raise funds to expand.

The most functional way to do this without losing your life savings is to get a VC or an angel investor on board.

2/ If you're a first time entrepreneur, you are going to pitch to many many firms before someone says yes.

You'll most likely be rejected by everyone.

In this process, you will also have a lot of due diligence, lot of drilling from the VCs and the potential investors.

3/ But if you're like @kunalb11 who built and sold Freecharge for $500M, VCs and investors already know you.

So, they give you their money even without knowing what your next business is going to be about.

Whatever you decide to start, they will back you.

4/ A SPAC is analogous to that.

Let's clear something first.

A "SPAC" is just jargon these industry people want to make you feel like an outsider about.

It stands for

"Special Purpose Acquisition Company".

Let's simplify that further.

5/ A SPAC is a shell company.

When it's formed, there is nothing in the company, no operations going on.

What the company has is cash - bucketloads of it.

The company's motive is to find a worthy private company to merge with.

6/ Before we understand why SPACs exist, we need to understand how traditional IPOs work.

Traditional IPOs are a PAIN IN THE ASS.

You start with the IPO roadshow.

You will have to get investment banks and investors interested in taking your company public.

7/ You'll also negotiate with many institutional investors on the entire IPO deal structure.

Then there are investment banks you want onboard to help with the IPO.

This is usually a long, complex, frustrating process.

8/ Also, when you're private, your valuations are quite stretched.

We all know that the private valuations by VCs are usually not very close to true value.

From the time you start the IPO discussions until the IPO goes through, you face uncertainty around your valuation.

9/ If you're like WeWork, and you want to raise few Billion dollars, you may end up facing a public backlash of your S-1 filing.

Your IPO could get canceled too.

The IPO's success/failure also highly depends on the economic conditions and investors risk appetite.

10/ With an IPO, there's also a limit on how much the founders and other major shareholders of a company can sell.

There's also a post-IPO lock-in period until when you can't sell your shares.

Also, there's a lot of drilling from SEC, and the regulatory hassles are endless.

11/ SPACs provide relief from these exact pain points.

So, who creates a SPAC?

Typically

- a Private Equity investor
- a former industry executive
- a syndicate of well known investors
- an industry expert backed by investors

12/ The key here is that you'd know the people spearheading the SPAC. They are usually quite well known in their respective industries.

You just don't know which company they will end up acquiring.

In that manner, you're writing a blank-check as an investor to the SPAC.

13/ What's the process behind the inner working of SPACs?

So, the kind of people mentioned on (11) start a SPAC.

They go ahead and list the company in an exchange (like NYSE/NASDAQ).

Since it's only a shell company, it usually lists at around $10 per share.

14/ While listing, it gives the investors of the SPAC IPO a combination of Class A preferred shares + warrants.

These warrants can be whole or fractional, but are usually out of the money.

The warrants give the right to buy more shares at a specific price on a later date.

15/ The general public can subscribe to the IPO or invest in SPAC shares after the IPO in the secondary market.

The SPAC usually has upto 2 years to find a worthy company to merge with.

The money it raises through SPAC IPO sits in an escrow account until then.

16/ At least 85% (practically around 90-95%) of the funds raised through the SPAC IPO sits in an escrow account.

The rest goes towards underwriting fees, operational expenses, legal expenses, etc.

The funds in the escrow account are invested in government bonds.

17/ If a SPAC can't find a worthy enough company within the stipulated time, it must return the money raised (through the IPO) back to the investors.

A SPAC usually trades close to its listing price until an acquisition target is found.

18/ SPACs that trade at a premium to the IPO listing price, usually do so based on the level of faith investors have on the SPAC management.

It's people like @chamath @BillAckman @mcuban who pull in the crowd of investors due to their credibility.

19/ SPACs target companies sized 2-5x the amount raised in the IPO.

For the additional capital, they bring investors from leveraged buyout firms.

This is also called as Private Investment in Public Equity (or PIPE).

SPACs could also raise debt financing to get funds.

20/ Once the SPAC identifies the company it's going to merge with/acquire, it announces the same to the public.

The day on which this happens is the "announcement date".

21/ After the announcement, the SPAC first does its due diligences about the company it's buying.

Then, SEC comes into the picture and reviews the deal terms.

Once SEC gives a go ahead, the decision is put to shareholders vote.

22/ If >50% shareholders approve the deal, and <20% shareholders want to liquidate, the deal will be approved.

If >50% shareholders approve, but >20% shareholders want liquidation, the deal will be called off.

And, the shareholders will be given their money back.

23/ What has made the SPAC an attractive investment and hot topic in recent times?

Many silicon valley startups have been private for so long, and have multi-billion dollar valuation.

They don't want what happened to WeWork happening to them.

24/ It's a pain in the ass to be negotiating and discussing with many different parties. That's what happens if you go through an IPO listing.

On the other hand, with a SPAC acquisition, you only have to negotiate with only ONE party - the SPAC that's willing to acquire you.

25/ After a startup has raised early and mid-stage funding, some late-stage startups could still need to raise money.

But, they may not want to go through the hassle of going public, and all the scrutiny/regulatory hassles from SEC.

With SPACs, the IPO has already happened.

26/ So, if I wanted to create a SPAC, i'll put together an investor roadshow for the SPAC IPO.

I'll then go and convince people to join my SPAC as investors.

It helps if I am a somebody, a big shot in the field.

27/ I'll say I am looking for "mature unicorns" or "high-quality late stage companies" in so and so sector/field, usually leaving it open-ended.

And due to my expertise in the field, I'll end up convincing investors to help fund the venture.

28/ Looking at the past SPACs, I found a strategy that a couple of researchers have tested.

Invest in a SPAC just after the IPO, and hold it until a week after the announcement date. Then, exit.

This has apparently yielded 7.5%+ CAGR in the last 4-5 years.

29/ What are the SPACs you're looking forward to?

Who are your most favorite SPAC sponsors apart from @chamath?

Comment below!

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