Special purpose acquisition companies (SPACs) have emerged as a popular way for private companies to go public on the stock market. But before a company can evaluate whether or not it makes sense to go public via SPAC, the SPAC itself must “go public” and list on an exchange.
Generally, a group of individuals form a shell company and nominate a board of directors, with the hopes that investors have enough faith in their ability to source an attractive deal. They can then sell shares in this new “blank check” company.
As an additional incentive for being an early investor when the SPAC debuts on an exchange, the shares, or “units”, may be comprised not only of common stock in the company, but also a warrant (whole or partial) to go along with each unit.
This benefit is only offered to early investors who buy the SPAC generally within its first 52 trading days. After the first 52 days1, units will usually split into the common shares and the warrants, with the two trading separately under different tickers.
How to Evaluate SPACs
When evaluating whether or not to invest in a SPAC IPO, potential investors often look at the qualitative aspects previously mentioned: who is the sponsor? Have they launched other SPACs before? Have those SPACs found targets and completed a successful company merger? Do the board members have the experience and track records that you would expect to evaluate investment opportunities?
However, it’s just as important for investors to understand the quantitative terms, or “structure,” of a SPAC deal. All SPACs are typically priced at $10 per unit, but the makeup of the units can be vastly different.
Read on for a closer look at warrants and how their inclusion, or absense, in a SPAC unit can affect investor profits. We will break down the mechanics of a SPAC unit with the following compositions:
• one share + one full warrant
• one share + no warrant
• one share + partial warrant
SPAC Warrants 101
Stock warrants are financial contracts that give holders the right to buy shares at a later date. Compared with stocks, warrants can be a relatively inexpensive way for investors to wager on an underlying asset, usually a stock, because they offer leverage–putting up a small investment for a potentially bigger payout.
Just like in options trading, warrants have an expiration date, so investors will need to pay attention if they want to exercise them. Another nuance worth noting is that when warrants get exercised, the action can be dilutive to shareholders since a flood of new shares can enter the market.
But warrants have the potential to be incredibly lucrative for these early SPAC investors because as explained before, essentially they’re buying for $10 one share plus the right to buy additional shares at a set level–what’s known as the strike or exercise price. Also importantly, even if an early investor decides to redeem their shares in the SPAC before a merger is completed, they get to keep the warrants that were a part of the SPAC units.
If the company doesn’t want to issue additional shares, they may not include warrants in their SPAC units. Market conditions may also dictate whether warrants are unnecessary. Remember: warrants are meant to entice investors to put in their money early. If demand for the SPAC is strong enough, the company may not feel the need to issue units with warrants.
Examples of SPAC Investments With Different Warrant Compositions
It’s important for investors to examine the deal structure of each SPAC closely, and they can do this by reading the IPO prospectus. The information around the composition of the shares or units being offered is usually on one of the first few pages, but reading the entire prospectus is essential for investors to make the right investment decision for them.
In general, here are some other pertinent pieces of information relating to warrants that potential investors should be looking for when reading through the prospectus:
• the strike price
• exercise window
• expiration date
• whether there are any specific conditions that can trigger an early redemption.
Investors should also inspect the exact composition of a SPAC unit. Does it offer one whole warrant, no warrant, one-quarter, one-third, or one-half?
The strike price or exercise price of SPAC warrants is often $11.50 a share. Investors sometimes have until five years after the merger before the warrant expires. However, the terms of different SPAC deals can vary vastly. It’s possible that the deal terms call for an early redemption period, and if investors miss exercising their contracts in that period, the warrants could expire worthless.
SPAC Unit With Whole Warrant
Let’s say an investor buys 1,000 units of a SPAC. In this case, each SPAC unit is composed of one whole share plus one whole warrant. That means the investor now owns 1,000 shares of the merged company stock plus 1,000 warrants to buy shares at $11.50 each.
If the SPAC completes its merger and the shares jump to $20, our investor can buy additional shares for just $11.50 each. So that’d be at a significant discount to where the existing shares are trading.
Here’s a hypothetical step-by-step example of how an investor could profit from exercising their whole warrants.
1. Investor buys 1,000 units at $10 each, spending a total of $10,000.
2. SPAC shares jump to $20 each.
3. Investor exercises warrants, purchasing 1,000 shares for $11.50 each and spending an additional total
of $11,500.
4. Investor sells all 2,000 shares immediately for the market price of $20 each, so for $40,000 total.
5. Our investor pockets the difference, so $40,000 minus $21,500 = $18,500.
SPAC Unit With No Warrant
Now, imagine that same investor bought into a SPAC where the units had no warrants. That means, while the investor’s 1,000 shares doubled in value, they didn’t have the right to buy an additional 1,000 shares.
1. Investor buys 1,000 units at $10 each, spending a total of $10,000.
2. SPAC shares jump to $20 each.
3. Investor sells the 1,000 shares immediately for the market price of $20 each, so for $20,000 total.
4. Our investor pockets the difference, so $20,000 minus $10,000 = $10,000
SPAC Unit With Partial Warrant
Let’s say our hypothetical SPAC has units with partial warrants. So in each unit, there’s one share attached to one-half warrant.
1. Investor buys 1,000 units at $10 each, spending a total of $10,000.
2. SPAC shares jump to $20 each.
3. Investor exercises warrants. Every two warrants converts to one share, so the investor buys 500 shares for $11.50 each, spending an additional total of $5,750.
4. Investor sells all 1,500 shares immediately on the market for $20 each, so for $30,000.
5. Our investor pockets the difference, so $30,000 minus $15,750 = $14,250.
Here’s a hypothetical table that lays out different profit scenarios depending on the warrant composition, assuming once again that an investor has bought 1,000 units, that the exercise price of the warrants is $11.50, and the underlying shares hit $20 each.
| Warrants Attached to Each SPAC Unit | 1 Whole Warrant | ½ Warrant | ⅓ Warrant | ¼ Warrant | No Warrant |
|---|---|---|---|---|---|
| Units Purchased | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
| Number of Shares That Can Be Bought With Warrants in SPAC Unit | 1,000 | 500 | 333 | 250 | 0 |
| Cost of Exercising Warrants at $11.50 Strike Price | $11,500 | $5,750 | $3,829.50 | $2,875 | $0 |
| Proceeds From Selling Shares Acquired Through Warrant Exercise | $20,000 | $10,000 | $6,660 | $5,000 | $0 |
| Net Proceeds from Selling Shares Exercised From Warrants | $8,500 | $4,250 | $2,830.50 | $2,125 | $0 |
| Net Proceeds From Selling All Shares | $18,500 | $14,250 | $12,830.50 | $12,125 | $10,000 |
The Takeaway
With SPAC investments, whether units come with full warrants, no warrants, or partial warrants is a quantitative consideration. All else being equal, SPACs that provide full or partial warrants offer more potential profit than SPACs that offer no warrants.
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1Investors should read all documents related to an offering as the terms of each SPAC can differ vastly.
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