With IPOs and secondary offerings covered, let's look at an alternative path to the public markets: Special Purpose Acquisition Companies (SPACs). The Series 66 exam tests how SPACs work, their risks, and how they differ from traditional blank check companies.
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:
- SPAC IPO - The sponsor creates a shell company and takes it public through a standard IPO
- Capital in trust - IPO proceeds are held in a trust account (typically invested in U.S. Treasuries) while the sponsor searches for a target
- Target search - The sponsor identifies a private company to acquire (typically within 18-24 months)
- De-SPAC transaction - The SPAC merges with the target company, taking the target public without a traditional IPO
- If no acquisition - If the SPAC fails to complete an acquisition within the deadline, it is liquidated and funds are returned to investors
Think of it this way: 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.
Key SPAC Terminology
| Term | Definition |
|---|---|
| Sponsor | The management team that creates and runs the SPAC; typically receives founder shares (the "promote") |
| De-SPAC | The merger transaction between the SPAC and its target company |
| Trust account | Escrow account holding IPO proceeds until an acquisition is completed or the SPAC is liquidated |
| Promote | Sponsor shares (typically 20% of post-IPO shares) received at a nominal cost; a key source of dilution |
| Redemption right | Investors can redeem shares for their pro-rata share of the trust if they don't approve the target |
SPAC Investor Risks
- 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 up to 18-24 months
- Limited transparency - Less due diligence disclosure compared to a traditional IPO
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.
Blank Check Companies and the Penny-Stock Escrow Rule
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)
Penny-stock blank-check rule requirements:
- Investor funds must be held in escrow
- The issuer must file a post-effective amendment to the registration statement upon executing an acquisition agreement
- Funds must be returned to investors if no acquisition is completed within 18 months
Memory Aid: SPAC = Shell company Purchases Another Company. The SEC's penny-stock escrow rule covers penny stock blank checks only. SPACs price above $5, so the rule does not apply.
SPAC vs. traditional blank check:
- SPACs are structured to avoid the penny stock classification (they raise more than $5 million in firm commitment underwriting and price shares above $5)
- Because SPACs are not penny stock issuers, they are not subject to the penny-stock escrow rule, though they 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. SPACs are structured to avoid penny stock status, so the rule does not apply to them directly.
- SPACs voluntarily adopt similar protections. Even though the penny-stock escrow rule does not apply, SPACs use escrow accounts, time limits, and investor redemption rights through their governing documents.