Security design for a non-standard IPO: The case of SPACs

A Special Purpose Acquisition Company (SPAC) is a public entity set up by a founder for the specific purpose of acquiring another firm, typically a private firm. The acquired firm is publicly traded after the acquisition, and the acquisition in effect represents a non-standard approach for the private firm to go public. In this paper, we develop a theoretical framework to explain several unique features of the SPAC design such as the prevalence of unit offerings and the use of equity and warrants in the founder's contract. The founder in our model undertakes costly effort to learn about the characteristics of the acquisition target and delivers a good quality firm to the SPAC shareholders. We show that the warrants play a unique role in limiting the level of risk of firms that the founder selects for acquisition. We also show that the equity grant given to the SPAC founder pre-commits the SPAC shareholders and firms to a pre-determined level of underpricing for the non-standard SPAC IPO process.