Blank check companies, or special purpose acquisition companies (SPACs), have been on the rise over the past 15 months as an alternative to taking a company public. So what are they and what’s all the fuss about?
What Is a Blank Check Company?
A blank check company is a public entity listed on the stock exchange that doesn’t have any purpose or business plan. The purpose of a blank check company is solely to acquire or merge with a private company, taking the private company public while bypassing the traditional IPO process.
How Blank Check Companies Work
Blank check companies are formed purely to take a private company public without the stringent regulatory process as they have much less regulation than IPOs. However, because SPACs have lower regulation, they also tend to draw scrutiny since they come with more risk for public investors.
Standard IPO vs. Blank Check Company
In order to fully understand how SPACs work, it’s important to fully grasp how an IPO works.
When a company reaches a growth point where they need to raise more capital, they’ll decide to take their company public via an IPO. The traditional process of an IPO is lengthy and typically goes as follows:
- The company hires an underwriter and searches for an investment bank to take them public.
- The underwriter files regulatory paperwork and gets IPO approval from the SEC.
- The company begins to pitch to investors and build excitement around the potential for an IPO.
- Once investors are on board, the number and price of public shares is set.
- The company debuts on the open market and shares become available to the public for purchase.
However, SPACs bypass much of the regulatory process that IPOs are subject to, so their process is a bit more simplified.
- An investor or group of investors buys a blank check company with the intent on taking a private company public.
- The SPAC gets SEC approval, goes through an expedited IPO process, and hits the market.
- The public invests in the SPAC without knowledge of what company it is that they will acquire or merge with.
- An SPAC merges with the private company and the new, combined company continues to be publicly traded.
Because SPACs don’t have historical financial information to disclose, they can usually get SEC clearance and IPO much faster than an established private company. In doing so SPACs can help a private company go public in as little as five to six months, compared to the one- to two-year timeline of an IPO.
Example of a Blank Check Company
Nearly 200 SPACs went public in 2020, raising about $64 billion in total funding, nearly as much as all of last year’s IPOs combined, so you might be more familiar with SPACs than you realize.
An example of a blank check company that many people are familiar with is the fantasy sports contest and betting operator DraftKings. In order to go public, DraftKings merged with a publicly-traded SPAC called Diamond Eagle Acquisition and after the deal was finalized, the SPAC’s name was changed to DraftKings, and the stock ticker became DKNG.
Opendoor, a platform to buy and sell homes online similar to Redfin, went public in late 2020 through a merger with Social Capital Hedosophia Holdings, an SPAC founded by Chamath Palihapitiya and Ian Osborne.
Virgin Galactic, a space tourism company, merged with Social Capital Hedosophia Holdings in less than a month — stock below $17 could be the deal of a lifetime should the space travel industry take off.
Investing in a Blank Check Company
When it comes to investing in a blank check company, SPACs are a relatively risky leap of faith, as most do not disclose much information on who they plan to acquire. As an investor in a blank check company, you’re essentially buying shares in a shell company and hoping that it will merge with a desirable and profitable firm in the future, thus boosting the share price. Because of the often mysterious nature of these investments paired with a reduced regulatory oversight, investing in a blank check company comes with higher risks than investing in IPOs, so if you plan to invest in an SPAC there are a handful of considerations to pay attention to.
Tips for investing in an SPAC
If blank check companies are something you’re looking to add to your investment portfolio, it’s important to consider some risk factors and general tips as you look at SPACs.
- Limit how many SPACs you invest in: Because the acquisition target of an SPAC is unknown, it is wise to reduce risk by limiting yourself to how many SPACs you will buy.
- Have an SPAC focus: If you’re investing in more than one SPAC, pick a focus area. While specific acquisition targets are not typically announced, SPACs will give some kind of indication of which industry or sector the acquired company will be. Choose one as a focus area.
- Establish your holding period: Just as you would with any investment, it’s wise to establish a holding period of 18-24 months before buying stock in an SPAC.
- Choose an SPAC with a good management team: The most important ingredient in a successful SPAC is the management team running it, so do your research on the team and the success of their past SPACs.
- Don’t commit too much capital to SPACs: Unless your risk tolerance is above average, avoid sinking a lot of money into SPACs because there are a lot of variables at play once the acquisition is announced.
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