SPACs and Blank Check Companies

Both the IPO and the acquisition target are unknowns at different points in a SPAC's life: investors buy in before the target exists, and the target only becomes public once the merger closes. That two-stage structure is what the exam's SPAC questions test.

What Is a SPAC?

• Special Purpose Acquisition Company (SPAC): A shell company with no commercial operations that raises capital through an IPO with the sole purpose of acquiring or merging with an existing private company
• Also known as a blank check company because investors buy shares without knowing which company will be acquired
• The SPAC goes public first, then uses the IPO proceeds to acquire a private target

How SPACs work, step by step:

1. SPAC IPO: The sponsor creates a shell company and takes it public through a standard IPO
2. Capital in trust: IPO proceeds are held in a trust account (typically invested in U.S. Treasuries) while the sponsor searches for a target
3. Target search: The sponsor identifies a private company to acquire (typically within 18-24 months)
4. De-SPAC transaction: The SPAC merges with the target company, taking the target public without a traditional IPO
5. If no acquisition: If the SPAC fails to complete an acquisition within the deadline, it is liquidated and funds are returned to investors

A SPAC is like a blank check from investors to a management team. The team says "trust us to find a good company to buy," raises money through an IPO, then goes shopping. If they find a target, the private company becomes public through the merger. If they strike out, investors get their money back.

What Are the Key SPAC Terms?

What Risks Do SPAC Investors Face?

• Uncertain target: Investors don't know which company the SPAC will acquire at the time of the IPO
• Dilution from sponsor shares: The sponsor's "promote" (typically 20% of shares) dilutes other shareholders
• Potential loss of value post-merger: Many de-SPAC companies have underperformed after the merger
• Opportunity cost: Capital is locked in the trust for typically 18-24 months

Exam Tip: Gotchas

• SPAC investors are buying a shell with no operations. The SPAC goes public first, then acquires a private target. This means IPO investors are betting entirely on the sponsor's deal-making ability, not on any existing business.
• Dilution is the hidden cost. The sponsor's "promote" (typically 20% of shares) is received at a nominal price, so existing shareholders are diluted even if the acquisition succeeds.

Founder shares are generally the sponsor's primary payoff for running the SPAC, and those shares are worthless if the SPAC liquidates without a deal, so the promote compensates the sponsor for the at-risk startup capital and the time spent on the search.

In the conventional SPAC structure, founder shares equal about 20% of the SPAC's total post-IPO share count, with public investors' units making up the other 80%. The sponsor pays a nominal amount for those shares (often around $25,000 total) while public investors paid $10 per unit into the trust, so founder shares add roughly 25% on top of the public share count in this typical structure.

Founder shares generally waive any claim on the trust, so they do not dilute the per-public-share redemption value. Instead, the dilution shows up in the combined company after a deal closes, since the sponsor's stake comes at essentially no cost.

Example: a SPAC sells 20 million public units at $10 (a $200 million trust). The sponsor's founder shares (20% of the total) come to 5 million shares, bringing total shares to 25 million. Public investors can still redeem their shares for roughly $10 each from the trust; the sponsor's 5 million shares are 20% of the pre-merger SPAC, obtained for a nominal cost, before any warrants are counted. The sponsor's actual stake in the combined company can differ once target-company shares, PIPE financing, warrants, and redemptions are factored in.

How Does a Blank Check Company Differ From a SPAC?

SPACs are a specific type of blank check company, but the broader category has additional regulatory requirements:

• Blank check company: Any entity that raises capital without disclosing a specific investment plan or acquisition target
• Higher risk due to lack of transparency about how funds will be used
• The SEC's penny-stock blank-check escrow rule applies to blank check companies offering penny stocks (generally stocks priced below $5); notably, the rule's usual $5-price exclusion is expressly turned off for this rule, so a low price alone does not trigger it and a price above $5 alone does not escape it

Penny-stock blank-check rule requirements:

• Investor funds must be held in escrow or a trust account
• The issuer must file a post-effective amendment to the registration statement once an acquisition agreement meeting the fair-value threshold is signed
• The acquired business or assets must have a fair value of at least 80% of the maximum offering proceeds
• Each purchaser then has 20 to 45 business days after the amendment to elect in writing to remain an investor; anyone who does not respond gets their funds returned
• If no qualifying acquisition is consummated within 18 months of the initial registration statement's effective date, funds must be returned to investors within 5 business days after that deadline

Memory Aid: SPAC = Shell company Purchases Another Company. The SEC's penny-stock escrow rule turns off its usual $5-price exclusion, so SPACs cannot rely on price alone to avoid it.

SPAC vs. traditional blank check:

• SPACs are typically listed on a national securities exchange, which is a separate, independent exclusion from the penny-stock definition (unlike the $5-price exclusion, exchange listing is not turned off for this rule)
• Because an exchange-listed SPAC is not a penny-stock issuer, it is not subject to the penny-stock escrow rule, though SPACs follow similar investor protection mechanisms voluntarily (trust accounts, redemption rights, time limits)

Exam Tip: Gotchas

• SPACs and blank check companies are related but not identical. The SEC's penny-stock escrow rule applies specifically to penny stock blank check companies. An exchange-listed SPAC avoids penny-stock status through the exchange-listing exclusion, not through its share price.
• SPACs voluntarily adopt similar protections. Even though the penny-stock escrow rule does not apply to an exchange-listed SPAC, SPACs use trust accounts, time limits, and investor redemption rights through their governing documents.

What Should You Check on Exam Day?

• A SPAC is a shell company that goes public before it has an acquisition target; the target is unknown at IPO
• SPACs typically have 18-24 months to complete an acquisition or they liquidate and return trust funds to investors
• The sponsor's promote (typically 20% of post-IPO shares, at nominal cost) dilutes public investors even on a successful deal
• The SEC's penny-stock blank-check escrow rule requires escrow or a trust account, an acquisition worth at least 80% of maximum offering proceeds, written purchaser reconfirmation, and a refund (within 5 business days) if no qualifying deal is consummated within 18 months
• A SPAC's exchange listing, not its share price, is what typically excludes it from penny-stock status, so the penny-stock escrow rule does not apply to an exchange-listed SPAC