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Over the trailing year, you have likely witnessed the rise of shell firms as a medium to take private enterprises public. Market analysts often use the term “reverse merger” to describe this phenomenon. But what is a blank check company, and should you partake in Wall Street’s hottest trend?
From the textbook view, a blank check company simply refers to a corporate entity that has no operations. Typically, these shell companies’ sponsors intend to merge with a privately-held firm for conversion to a public entity.
Blank Check Company: An Overview
Based on the term “blank check firm,” this implies an organization that has free reign to do whatever it wants. In reality, this assumption is not far from the truth.
Perhaps the most popular category of blank check firms is the special purpose acquisition company or SPAC. A SPAC exists for one purpose — to take a private enterprise public. To accomplish this, a SPAC first becomes a publicly traded entity, then merges with a target enterprise, effectively converting the privately-held firm into a public corporation.
SPACs represent a backdoor alternative to the rigorous process involved in the traditional method of integrating with the public capital markets. Therefore, they attract many ambitious but smaller organizations seeking expansionary opportunities.
As a result, blank check companies facilitate increased options retail investors may not ordinarily enjoy. For instance, in 2019, blank check company SC Health Corporation filed for an IPO of up to $150 million, which shook up Wall Street.
More recently, Uber Technologies (NYSE: UBER) indirectly generated SPAC-related headlines. This was due to former Uber CEO Emil Michael seeking a $250 million IPO for a blank check company.
Based on the momentum and many deals that SPAC sponsors brokered, the blank check company is likely here to stay.
Blank Check Company: Words to Know
While blank check companies ultimately serve the same end goal as the traditional initial public offering, the mechanism is different. So before you start wagering on blank-check investment categories like SPACs, it’s important to understand these basic terminologies.
- IPO: An initial public offering is the moment when a corporation’s equity shares are available for public procurement. For a private firm to go public, the underlying management team hires an underwriter (investment bank) that acts as an intermediary between the stock-issuing company and the investing public. During the IPO process, underwriters go on “roadshows” to convince institutional investors to consider buying shares. Additionally, the Securities and Exchange Commission assesses the IPO proposal, which either provides the green or red light.
- Trust account: In the context of SPACs, a trust account is an escrow account that houses proceeds from the SPAC-based IPO process. This trust account only releases funds when the SPAC fulfills its obligation — finding a merger target and securing a deal. A SPAC IPO is different from a traditional IPO in that the underlying blank check company is already public. Therefore, retail investors can buy shares of a SPAC, speculating that its sponsor will find and secure a profitable enterprise. If not, the proceeds held in trust will return to their investors.
- Shares: SPAC shares represent equity ownership in the blank check company in question. As well, they offer important voting rights. Once a SPAC sponsor identifies a potential merger target, the decision to go through with the deal rests with the shareholders. If they vote to approve the deal, that SPAC’s investors can either exchange their shares for the stock of the merged entity or get their money back from the trust account plus accrued interest.
- Warrant: A warrant gives the holder the right to buy stock of the combined entity at a specific price and before a certain time. When you exercise a warrant, the action increases the total share count, causing dilution. Under the context of a SPAC IPO, the warrant is a complicated topic. Therefore, you want to understand all the nuances of a prospective SPAC’s shares and warrants before considering a position.
- Rights: Rights refer to redemption rights, which give SPAC shareholders the option to redeem their shares for their proportional rate of the money held in the trust account. Typically, you exercise this right if you are not happy with the SPAC’s proposed merger target.
- Deal period: The deal period refers to the time frame in which a SPAC sponsor must find and secure a merger target or return the IPO proceeds back to shareholders. Usually, the deal period is 2 years.
Examples of Blank Check Company
A recent example of a SPAC is Compute Health Acquisition Corp. (NYSE: CPUH.UN). Backed by Medtronic (NYSE: MDT), a medical device firm, Compute Health is a blank check company that seeks to merge with an enterprise that specializes in data-driven healthcare solutions.
Again, as a shell company, Compute Health has no business of its own and therefore, its value comes from the proceeds of its own IPO. Furthermore, CPUH.UN stock is a speculative investment because shareholders do not know what company this SPAC intends to merge with.
It’s crucial you realize that while Compute Health’s sponsor will seek the most appropriate target, the SPAC is on the clock to close a deal, not necessarily a good one. Therefore, make sure you understand your redemption rights and under what conditions you can exercise them before buying CPUH.UN or any other SPAC.
How Blank Check Companies Work
By virtue of going public and merging with a private enterprise, the acquisition target can essentially back into an IPO and avoid much of the regulatory scrutiny involved in the traditional approach. Nevertheless, because of the unique nature of going public via a blank check company, you must be aware of certain risk factors.
- Dependency on sponsor: As mentioned earlier, a successful SPAC is one that seals a deal. Hopefully, the target acquisition represents a viable long-term opportunity. But if not, it doesn’t really matter to the SPAC sponsor as they’ve already made their money. Therefore, you must have substantial trust in the sponsor to secure the right deal.
- Confusion abounds: Due to variables such as sponsor compensation and warrants, SPAC IPOs can be confusing. Further, they can entice investors into bad decisions, particularly when shareholders exercise their warrants, creating a share dilution effect that pressures the combined entity’s stock price.
- Too easy to go public: While the appeal of the SPAC is its direct approach, this can be a double-edged sword. Especially with so many SPACs hitting the market this year, a good chance exists that many of them are duds.
Benefits of a Blank Check Company
Although participating in SPACs entails risk, you may find that the platform gives you an expanded window of investment selections.
- Facilitates ground floor access: Unless you’re a well-connected investor with a sizable trading account, you will most likely not be able to buy shares of a traditional IPO at the initial offering price. But with a premerger SPAC, you can speculate on the ground floor and hope that your blank check sponsor delivers the goods.
- Avoiding the business end of the pop: For a traditional IPO, it’s not unusual for an underwriter to price the offering at a far lower value than what the market might bear. Thus, it gives a nice pop for institutional investors but forces retail investors to buy the pop if they want to participate on launch day. With SPACs, everyday speculators can potentially benefit from the pop, not be “victimized” by it.
- Expanding the field: Because of their rigorous and expensive process, many startups find they can’t meet the requirements of a regular IPO. However, through a SPAC, these same firms can potentially go public cheaper and quicker. Obviously, this is good for the startup, but it also provides fresh opportunities for retail investors.
How to Invest in Blank Check Companies
While SPACs initially sound like exotic vehicles, they are publicly traded stocks just like the blue-chip names listed on the S&P 500. The main difference is that SPACs have no operations of their own, but you can buy them like you would any other stock. The proceeds from the SPAC IPO go toward securing a reverse-merger acquisition.
Also, you can now buy exchange-traded funds that focus on SPACs. One headline that caught investors’ attention was “SPAC ETF Could Have Its Moment In 2021 as Blank-Check Fever Continues.”
Best Online Brokers for Blank Check Companies
Most major brokerages offer the ability to buy SPACs. Though they are unique, they provide similar accessibility to retail investors as garden variety stocks.
Therefore, you should pick a broker that appropriately suits your needs and investing ambitions. Below is a list of the best brokers to consider.
- Best ForInternational Trading
- Best ForIntermediate Traders and Investors
- Best ForTrading Ideas
- Best ForMomentum traders
- Best ForActive Traders
- Best ForFutures Trading
SPACs Open new Doors for the Prepared Investor
Currently one of the hottest trends on Wall Street, SPACs represent an alternative IPO method. By providing a quicker, cleaner and cheaper way to go public, they attract ambitious startups and investors looking for new opportunities. However, it’s important to do your homework as the SPAC structure is more complicated than a traditional IPO.
Frequently Asked Questions
Questions & Answers
Blank check companies allow you to speculate on an investment proposal early in the game, potentially delivering ample profitability. However, you must perform due diligence and be prepared for volatility risk.
Because the blank check company is a public shell firm, by the time it merges with a private enterprise, the merger target effectively becomes a publicly-traded company. Further, the blank check firm loses its identity and assumes that of the target company.