SPAC

A SPAC is an IPO in reverse. Instead of a company going public, a pile of money goes public — typically $10 per share, parked in a trust invested in Treasury bills — and then goes shopping for a private company to merge with. Find one within ~two years and the private company becomes public through the merger ("de-SPAC"); find nothing and the cash is returned.

The crucial retail-relevant feature: before any merger completes, every shareholder has a redemption right — hand back your share, receive your ~$10 of trust cash plus interest, regardless of what you think of the deal. Held to redemption, a SPAC share is essentially a T-bill in a costume. The speculation begins only when you waive that right and ride into the merger.

The 2020–21 mania — 600+ SPACs raising $160bn, celebrity sponsors, electric-vehicle startups with no revenue at billion-dollar valuations — ended the way manias do: the average de-SPAC'd company lost most of its value, while redeeming arbitrageurs and sponsors did fine. The structure survived, chastened and smaller.

The unit anatomy

SPAC IPOs sell units: one share plus a fraction of a warrant (say, 1/4 warrant exercisable at $11.50). Units later split; shares and warrants trade separately. The warrant is a free lottery ticket stapled to the T-bill — worthless if no deal or a bad deal, valuable if the merged company runs.

The yield arbitrage

Pre-deal SPACs trading below trust value offer a bounded trade: buy at \(P\), redeem at trust value \(T\) on or before the deadline:

Buying at $9.80 with $10.10 in trust and 10 months to deadline yields ~3.7% annualised worst case — plus the right to sell higher if a hot deal announcement spikes the price, plus the warrant. SPAC arbitrage funds run exactly this at scale, redeeming relentlessly; that is why redemption rates on mediocre deals run 80–95%.

The sponsor's economics — and the conflict

• The promote: sponsors receive ~20% of the SPAC's shares for a nominal sum — worth $50m on a $250m SPAC if any deal closes, near zero if none does.
• The incentive is structural: a bad deal beats no deal, for the sponsor. Every SPAC prospectus says so in its own words.
• Redemptions drain the trust, so sponsors backfill with PIPE financing (private placements at $10) to assure the target the cash will be there — PIPE participation became the market's quality signal.

Pricing the pieces

A pre-deal SPAC decomposes cleanly:

The trust floor prices off the bill curve; the deal option trades like a low-delta call whose implied vol spikes on rumour; warrants price on long-dated vol with a twist — most are redeemable by the issuer once the stock exceeds $18, capping the payoff, and de-SPAC vol is ferocious. Klausner, Ohlrogge & Ruan's dissection of SPAC costs (the "SPAC arbitrage" paper) showed median cash delivered per share was far below $10 once promote, warrants and fees were counted — the structural dilution that predicted the post-merger underperformance before it happened.

Regulatory and structural evolution

• SEC 2024 rules stripped the liability advantage: de-SPAC projections now face IPO-grade liability, killing the "we can promise 2028 revenue" pitch that differentiated SPACs from IPOs.
• Structural reforms in the surviving market: smaller promotes with earnouts, full-warrant coverage gone, trusts over-funded above $10 to attract the arb community.
• The lifecycle trade map: arbs own it pre-deal; event funds trade announcement to close (redemption-floor protected); post-merger it is small-cap equity with a known seller overhang — sponsor lockup expiries and warrant exercises are calendar events the market front-runs.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.