SPAC Mergers: The Pros and Cons of This New Exit Strategy

/ / Business and Finance, Startups, Trending topics
SPAC mergers agreement

You’ve probably come across the term ‘SPAC merger’ in the past few months. Even if you’ve been working in finance for some time, a SPAC merger seems like something new.

And it sort of is.

Though originally popular in the 1980s, SPAC mergers have re-emerged in 2021 with newfound vigor and industry-based focus.

In this article, we’re going to dive deep into what SPAC mergers are, how they differ from traditional M&As and IPOs and offer some insights on recent mergers, particularly in Egypt and the Middle East.

What is a SPAC?

A special purpose acquisition company (SPAC) is a company that has no commercial operations or business plan.

Also known as a blank check company, a SPAC is formed only to raise capital through an initial public offering (IPO) to acquire or merge with an existing company and help it list on an international stock exchange.

A SPAC is defined as a “publicly traded corporation with a two-year life span formed with the sole purpose of effecting a merger, or “combination,” with a privately held business to enable it to go public.”

(Harvard Business Review (HBR).

In terms of structure, a SPAC is led by a sponsor team or company with expertise in a certain industry.

SPAC investors can range from well-known private equity funds to the general public.

They “rely heavily” on the sponsor team “to source the right acquisition target, negotiate a favorable valuation, assist in raising supplemental [private investment in public equity] PIPE capital and secure shareholder approval for the target acquisition,” explains Consultancy-me.

However, the funds raised “cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated,” says Investopedia.

A SPAC would have only two years to complete an acquisition. If it fails to do so, it must return the funds it received to investors.

The most-recently talked about SPAC in 2021 in the Middle East was Queen’s Gambit Growth Capital, which announced its SPAC merger with ride-sharing startup Swvl.

Cairo and Dubai-based Swvl also announced that following the merger its valuation would reach $1.5 billion.

A quick history of SPACs

We’ve mentioned that SPACs emerged in the 1980s. At the time, they weren’t well-regulated and cost investors billions of dollars in losses.

In the 1990s, the US Congress intervened and imposed regulatory measures for these companies. These new regulatory requirements resulted in the rebranding of blank-check companies into SPACs.

After that SPACs began to focus on “distressed companies or niche industries.” However, this direction changed in 2020 “as more serious investors began launching SPACs in significant numbers,” say two SPAC-experts in a Harvard Business Review (HBR) report.

In 2020 and beyond, special purpose acquisition companies turned their focus to startups and businesses “that are disrupting consumer, technology, or biotech markets,” adds HBR.

SPACs have helped many companies “raise more funds than alternative options would, propelling innovation in a range of industries,” it says.

SPACs vs traditional IPO

With SPACs making headlines, let’s highlight the top differences between a SPAC merger and its subsequent IPO and a traditional IPO.

Generally speaking, SPAC mergers are a kind of exit strategy and can be considered a faster alternative to a traditional IPO.

Once a company combines with a SPAC, the SPAC’s shareholders get a minority stake in the target company (the acquired firm). Meanwhile, the target company’s shareholders “exchange their shareholding for listed shares in the SPAC,” according to Consultancy.

“The end result is a publicly listed target company that has sold a minority shareholding for cash via a secondary sale or a capital increase,” Consultancy says, indicating that this is quite similar to a traditional IPO with the exception that the listing process is quite different.

In a traditional IPO, a company would have to list on an equity market, which can be unpredictable. But launching an IPO via a SPAC guarantees expert backing from the SPAC’s sponsor.

We’ll explain more differences in the coming sections on the pros and cons of SPAC mergers.

Benefits of SPAC mergers

There are various pros to creating SPACs and merging with them as they offer a viable exit strategy compared to traditional exits.

Research by Virtus shows that SPACs are becoming a popular investment, merger, and IPO strategy because they:

–        Fit the needs of small-and-medium businesses.

–        Help companies resolve difficulties.

–         Offer means for new financing to help companies grow.

–        Can be a good opportunity for institutional investors and venture capital firms.

–        Offer more price certainty in an IPO because the price is negotiated with the SPAC’s sponsor not the equity market, which can be unpredictable.

– Faster IPO process

Moreover, merging with or selling to a SPAC can “add up to 20% to the sale price compared to a typical private equity deal,” says Investopedia.

Consultancy notes that SPAC deals are great because they allow “regional high growth companies access highly liquid capital markets in the US, which are able to provide the appropriate value for business – particularly companies that are technology driven.”

In addition, a SPAC acquisition helps businesses enjoy a faster IPO process as the SPAC is usually seen as an experienced partner.

Downsides of merging with a SPAC

Despite the many benefits such as a faster IPO process and investment opportunities, there are some cons to joining forces with a SPAC.

One of those is “having to meet an accelerated public company readiness timeline as well as complex accounting and financial reporting/registration requirements that may differ based upon the lifecycle of the SPAC involved,” explains PwC.

This short time frame means companies need to focus on project management to “reduce execution costs, increase project efficiencies, and provide working group participants with enhanced accountability and transparency,” advises PwC.

It adds that the management team at the target company, the one that’s to be acquired and merged with the SPAC, would have to “focus on being ready to operate as a public company within three to five months of signing a letter of intent.”

This short time frame to get the target company ready is the opposite of what happens with a traditional IPO, where a company would have a longer period to ready itself to operate as a public company.

In addition, traditional IPOs offer a longer time for preparation, carrying out due diligence, drafting the prospectus, among other things. They are also costlier for companies looking to go public. 

“Public company readiness for a target company should cover cross-functional topics such as: accounting and financial reporting, finance effectiveness, financial planning and analysis, tax matters, internal controls and internal audit, human resources (HR) and compensation, treasury, enterprise risk management, technology and cybersecurity,” notes PwC.

PwC

Two-year SPAC stats

Despite existing for decades, SPAC mergers re-emerged vigorously in the US in 2019. That year, 59 SPACs were created at investments totaling $13 billion.

Overall in 2020, that number more than quadrupled to 247 SPACs with $80 billion invested across them. Not to mention, SPACs that year made up roughly 50% of new publicly listed US firms, according to HBR.

In the first 3 months of 2021, 295 special purpose acquisition companies were created with $96 billion invested.

Can you take a wild guess what numbers we’ll see by the end of the year?

In the Middle East, the SPAC situation is emerging and garnering attention as more startups seek funding.

And with the various SPAC benefits, it’s no surprise that more companies are looking to this method as a means of growth and investment. Especially, since companies that are part of a SPAC merger get to list on a major bourse.

In the case of Swvl, the SPAC will list on NASDAQ.

SPAC mergers in the MENA region

Merging with special purpose acquisition companies has been a rising trend in the United States. But in the past year, SPACs have made their way to the Middle East.

In addition to Swvl’s recently-announced SPAC merger, Abu Dhabi-based music streamer Anghami had said it was joining Vistas Media Acquisition Company in a SPAC merger in February 2021. The deal valued Anghami had $220 million with talks of a NASDAQ listing.

But these aren’t the only ones talking about SPAC mergers in the Middle East.

In July sources told Bloomberg that Dubai-based financial services firm SHUAA Capital was planning to set up “three blank-check companies of around $200 million each.”

If SHUAA, which currently manages nearly $14 billion in assets, follows through with this move, it would open many SPAC opportunities for Gulf investors and startups.

SHUAA reportedly approached investment banks to set up the SPACs to “pursue deals in the energy, finance and technology sectors,” the unnamed sources said.

Similarly, Abu Dhabi-based Mubadala Capital, which is owned by the emirate’s sovereign wealth fund Mubadala Investment Company, created a SPAC called Blue Whale Acquisition I.

The Cayman Islands-based Blue Whale Acquisition I has filed for a $200 million IPO in the US and is targeting entertainment and media companies.

Wrapping up

It’s clear that SPAC mergers will continue making headway in financial markets across the globe. Especially now that more Middle Eastern asset managers are looking to explore this merger-to-IPO type of investment.

The two HBR experts believe that “not all SPACs will find high-performing targets, and some will fail completely.” Still, SPACs will “stay and may well be a net positive for the capital markets.”

If you’re a company that’s considering a SPAC merger, you should be aware of the pros and cons of these deals and how they’ll affect your company. 

In addition, you’ll need to have a solid financial picture of your business that reflects your company’s strength and growth potential, which means you need a financial expert to verify this and create these documents for you. 

That’s where Stride Financial Advisors comes in. 

At Stride, we help startups with their financial needs such as analyzing your financial performance, creating financial scenarios and forecasts, and valuation. We also create your company profile, unique value proposition, detailed financial plans, and documentation for mergers, acquisitions, and SPAC mergers.

Need help? Get in touch with the Stride team at info@stride-co.com