Spac: What it is and how it works

Singapore's first special purpose acquisition company (Spac) started trading on the mainboard of the local bourse yesterday.

Vertex Technology Acquisition Corp (VTAC) began trading at 2pm at $5.25 per unit, up from its initial public offering (IPO) price of $5. It closed at $5.05, with about 21 million units changing hands.

VTAC's debut on the Singapore Exchange (SGX) will be followed by the listing of Pegasus Asia today and Novo Tellus Alpha Acquisition on Thursday next week.

The first round of Spac listings comes after the SGX launched a new rules framework in September last year that offers companies an alternative route to raise funds by listing on its mainboard with greater certainty as to pricing and control over deal terms as compared with traditional IPOs.

The framework also provides guardrails to protect the interest of investors in Spacs.

A Spac, also known as blank-cheque company, raises capital through an IPO for the sole purpose of acquiring an unlisted operating company. Subsequently, the publicly traded Spac merges with its acquisition target which, in turn, becomes the publicly traded entity on the stock exchange.

In other words, a Spac can be best described as money looking for a promising private company to invest in. An obvious benefit of a Spac to investors is the lure of getting in on "the next big thing" before it becomes that.

The Spac will acquire or merge with the private company, often many months or more than a year after the Spac has completed its own IPO. This transaction is called a "de-Spac".

A Spac is formed when a group of individuals referred to as sponsors go through the IPO process with the intent of investing in a particular arena.

A Spac's IPO prospectus typically identifies a specific industry or business that it will target as it seeks to combine with an operating company, such as a technology company in South-east Asia. It also includes the sponsors' experience and background.

The Spac raises funds in the IPO by offering "units" that consist of shares and warrants. The warrant is detachable from the share and works like an incentive, or an equity kicker, as it allows investors to buy additional shares in the de-Spac entity at a predefined price based on a conversion ratio.

Spacs have a defined amount of time - SGX rules allow two years, with an extension of 12 months - to put the investors' funds to work by identifying a suitable target to merge with.

Failure to do so will result in the Spac's liquidation, with the funds being returned to investors.

A private company with ambitions of going public could benefit by taking the Spac route for a number of reasons.

Chief among them is the access to capital that has already been raised in the Spac's IPO. Merging with the Spac shields it from market volatility and other conditions that may limit its ability to raise funds.

Sponsors of the Spac usually include professionals from private equity and venture capital firms and successful businessmen with a credible investment background. Hence, the target company benefits from the operational expertise the sponsors may provide even after the de-Spac.

Normally, an IPO transaction can cost a company a few million dollars in fees and expenses paid to bankers, lawyers and IPO managers. The merger expenses are also taken up by the Spac.

Finally, the timeline to going public is much faster under a Spac set-up as opposed to an IPO due mainly to fewer regulatory hurdles. A private company can bypass these obstacles by being acquired by or merging with a Spac, which is already public.

In a traditional IPO, the company going public broadcasts the benefits of investing in its ambitions.

For Spacs, the sponsors directly negotiate with target companies in sectors and geographic regions it had already specified in its IPO prospectus. The process brings in more transparency on the potential of the target company's future earnings.

Meanwhile, as the Spac searches for its target company, the funds raised will be invested in safe investments with modest returns and low risk profiles, like government bonds or high-rated corporate bonds.

However, discerning sponsors are likely to target a company for de-Spac that has already proved its worth and potential and requires only a less expensive and swift route to go public so that it can finance the next stages of its growth.

According to Refinitiv, seven Singapore-based companies went abroad to de-Spac last year. The combined value of those transactions was US$42.8 billion (S$57.7 billion), led by the merger of Grab and Altimeter Growth Corp which was valued at US$31.1 billion.

As with any equity investment, Spacs pose risks to investors, including volatility in Spac's unit prices or the shares of the merged entity.

Many Spacs have experienced significant bouts of volatility throughout their lifespans because of hype over a potential target or because the sponsor is a well-known celebrity or private equity firm.

The United States experience is that some Spacs have seen their share prices triple in value in a matter of days or weeks, only to fall back quickly to below their IPO prices. Grab shares, for instance, lost over a third of their value on their first trading day on the Nasdaq last month.

Other risks include the competence of the Spac's sponsors in navigating the potential of the target company's market and earnings.

If the sponsors lack expertise in the target company's market segment, then this could lead to less-than-desirable results for that company and its investors.

Private companies enjoy less strict disclosure and reporting requirements versus listed companies. Hence, there is also the risk that the target may try to misrepresent its financial standing and future earnings projections for the chance to go public.

SGX's Spac framework focuses on the quality and track record of the Spac's sponsors to see if they are qualified to select the best target private company for acquisition.

Also, under the SGX rules, a de-Spac can proceed only if more than 50 per cent of independent directors of the Spac approve and more than 50 per cent of shareholders vote in support of the transaction.

If investors still do not like the proposed business combination, they can opt to redeem their Spac shares, regardless of how they voted when the merger was proposed.