SPACs — special purpose acquisition companies — are having a moment. According to industry tracker SPACInsider.com, as of November 10, 172 SPAC transactions have raised about $63 billion in capital this year, with an average deal size of $367 million. Just five years ago, the corresponding numbers were 20 deals raising $3.9 billion, each deal averaging $195 million.

SPACs are making headlines, too. Playboy Enterprises is going public again by merging with Mountain Crest Acquisition Corp., and Richard Branson's Virgin Group has launched VG Acquisition Corp. Even former NBA star Shaquille O'Neal has teamed up with Forest Road Acquisition Corp. as a strategic advisor.

These recent headlines might suggest SPACs are Wall Street's latest bit of financial engineering, but that's not the case; SPACs have been around for more than 20 years, and some industry participants have been active in the industry for the entire duration.

"The SPAC structure has shifted over that period and there have been definitely different iterations of it, but it's certainly not a new phenomenon," says Tamar Donikyan, attorney with Ellenoff Grossman & Schole LLP. 

SPACs let companies go public without having to go through the IPO process; the SPAC does it for them. Once it has become a publicly traded company, the SPAC acquires other companies, bestowing public status upon them.

In effect, the SPAC is a fundraising machine. The capital it attracts is deposited in a trust fund, and the management team uses the money to finance acquisitions over a period of 18 to 24 months. The managers have experience in acquisitions or operating companies in a targeted industry, and the funds raised act as backstop for the future acquisitions.

Show me the money

SPACs' recent fundraising success masks their previous second-class status. Chris Wright, managing director with Protiviti, says SPACs weren't necessarily viewed as an ideal source of capital until recently.

In many instances, SPACs were often considered a way for companies to go public only if they had no other choice. The higher quality of companies involved and the larger dollar amounts raised recently have changed those perceptions.

"A CFO and a company should consider a SPAC now, unlike this time last year, the same way they would consider any other investment alternatives," Wright said.

Romeo Systems, Inc., an electric vehicle-battery manufacturer, had already done a Series A funding in 2019 in which Borg Warner was a strategic investor. Lauren Webb, Romeo Systems' CFO, explains the company subsequently needed to raise another large infusion of capital to fund its long-term growth.

"We looked at doing that a couple of ways," Webb said. "One was through a Series B and then also through the SPAC route. When we began the company, we always had the idea that we thought it would be terrific to take it public, and this would be an ideal company to take public. The SPAC route provides us all of the benefits of an IPO without such a protracted timeline or all of the restrictions and costs associated."

As Webb notes, a key selling point for the SPAC process is that it can be completed more quickly than an IPO. It took Romeo Systems about six months of discussions and negotiations to announce its deal with RMG Acquisition Corp. The costs to complete the SPAC nmerger with an existing company were also much lower because Romeo Systems was able to avoid typical startup IPO costs.

"There is certainly expense related to getting audited financials done on an accelerated time frame for the quarters, etc. (with a SPAC)," Webb says. "But we're talking $5 million to $6 million for financials, consulting fees, legal fees and registration fees — excluding underwriters and the acquirer's fees — versus tens of millions, which one might expect if you were going through a traditional IPO."

The fact that forward-looking projections may be used in SPAC transactions in conjunction with historical financials is another benefit for early-stage companies that saves on additional audit fees. In Romeo's case, the company already had significant contracted revenue from top automotive clients.

The compressed timeline with a SPAC is both a blessing and a curse, says Hai Tran, CFO of acute-care telemedicine provider SOC Telemed, which completed its SPAC merger in early November. Although the SPAC process offers a rapid approach to becoming public and the corresponding access to capital, companies must determine if their set of books, records and finance functions are up to public company standards. Consequently, preparing for the merger often requires bringing in additional accounting and legal experts.

Another difference between IPOs and SPACs is that the SPAC entity with which the private company is merging is already public, Donikyan says. Consequently, the clock with respect to Sarbanes-Oxley and being compliant with internal control requirements has already begun to run for the SPAC.

"It's more likely than not that by the time that you do an acquisition with a SPAC, you'll need your internal control procedures up and running as well," she says. "This is slightly different from an IPO where you may have an opportunity to phase in."

David Meniane, CFO of CarParts.com, says his company decided against using a SPAC for its financing. He agrees that SPACs work well in the right situations, but he cites several cautionary factors CFOs should consider. The standard SPAC deal tends to be expensive in terms of dilution, he maintains, citing the warrants often held by sponsors and investors.

Another factor is a possible mismatch between the SPAC sponsor's and the company management's long-term vision of the business.

"If you get an exceptional deal and the sponsor keeps 3% to 5%, it doesn't really matter who you partner with — what matters is the quality of the underlying shareholders," he says. "But if you do a SPAC deal where the sponsor keeps 20%, they may have a lot of control over the future of the company. It's kind of like a marriage; you just want to select your partner [carefully]."