What Is a SPAC Reverse Merger and How Does It Work?

Companies looking to go public have traditionally done so through an initial public offering (IPO), but in recent years, many have opted for a different route: merging with a special purpose acquisition company (SPAC). This method, known as a SPAC reverse merger, has gained popularity due to its faster execution and fewer regulatory hurdles compared to a traditional IPO.

Understanding how a SPAC reverse merger works is essential for investors and businesses considering this approach. It involves multiple stages, from forming the SPAC to selecting a target company and completing the necessary approvals.

Formation of the Sponsor

A SPAC reverse merger begins with the creation of the sponsor, the entity responsible for launching and managing the SPAC. Sponsors are typically private equity firms, hedge funds, or former executives with industry expertise. Their role is to provide the initial capital required to establish the SPAC and guide it through the process of identifying and merging with a private company.

To form a SPAC, the sponsor contributes capital to cover regulatory filings, legal fees, and underwriting expenses. In return, they receive “founder shares,” usually amounting to 20% of the SPAC’s post-IPO equity. This structure incentivizes the sponsor to complete a merger, as their shares only gain value if a deal is finalized. If the SPAC fails to merge within the required timeframe—typically 18 to 24 months—the sponsor loses their investment.

Raising funds for the SPAC’s IPO is another key responsibility. Sponsors work with investment banks to market the offering to investors, emphasizing the management team’s expertise and the potential for a lucrative acquisition. Unlike traditional IPOs, where investors know the company they are buying into, SPAC investors commit capital without knowing the eventual target. This makes the sponsor’s reputation a major factor in attracting investment.

Target Company Selection

Once a SPAC has raised capital, the focus shifts to identifying a private company to merge with. The selection process is guided by the SPAC’s stated investment criteria, which can range from broad industry sectors to specific market niches. Sponsors analyze financial statements, revenue growth, profitability, and market position to determine whether a company aligns with investor expectations.

Valuation is a central factor in this decision. Unlike traditional IPOs, where market demand helps establish a company’s worth, SPAC mergers require direct negotiations between the target company and the SPAC. Comparable company analysis, discounted cash flow models, and precedent transaction data are used to justify a fair price. If a target’s valuation is too aggressive, the SPAC risks investor pushback, leading to redemptions—where shareholders opt to cash out rather than participate in the merger.

Due diligence is another key phase. Sponsors review the target’s financial health, legal standing, and operational risks. This includes audited financials, outstanding liabilities, regulatory compliance, and potential litigation. Any material weaknesses in internal controls or undisclosed risks can jeopardize the deal or lead to post-merger complications, such as restated earnings or SEC investigations.

Shareholder Approval Process

Before a SPAC merger can be finalized, shareholders must vote on whether to approve the transaction. The process begins with the SPAC filing a proxy statement or registration statement with the SEC, detailing the terms of the merger, financial projections, and associated risks. This document is reviewed to ensure investors have sufficient information to make an informed decision.

Once the SEC review is complete, the SPAC schedules a shareholder meeting where investors vote on the proposed merger. Approval typically requires a simple majority, though specific charter provisions or state corporate laws may impose stricter thresholds. If a large number of investors choose to redeem their shares instead of approving the merger, the SPAC may need to secure additional financing, such as PIPE (Private Investment in Public Equity) deals, to keep the transaction viable.

Timeline of the Merger

Once a SPAC announces its intended merger, the process typically spans several months. It begins with the execution of a definitive agreement between the SPAC and the target company, outlining the transaction’s terms, governance structure, and financial arrangements. This triggers a period of financial modeling and integration planning, during which both parties assess the post-merger capital structure, potential synergies, and operational strategy.

Investor outreach intensifies during this phase, as the SPAC and target company work to build confidence in the deal. Roadshows, investor presentations, and one-on-one meetings with institutional investors help articulate the long-term value proposition. At the same time, investment banks and financial advisors structure any additional capital commitments, such as PIPE financing, to ensure sufficient liquidity post-merger.

Regulatory Filings and Disclosures

Once shareholders approve the merger, the final step before the target company officially becomes publicly traded is completing the necessary regulatory filings and disclosures. The SEC requires the combined entity to submit financial statements, risk factors, and governance structures to ensure compliance with public market standards.

The most significant filing in this process is the Super 8-K, which must be submitted within four business days of the merger’s closing. This document serves as the new public company’s first official SEC filing and includes audited financial statements, management discussion and analysis (MD&A), and any material agreements related to the transaction. Failure to meet these disclosure requirements can result in regulatory scrutiny, trading halts, or even delisting. The newly public company must also adhere to ongoing reporting obligations, such as quarterly (10-Q) and annual (10-K) filings, ensuring continued compliance with SEC regulations.