How Do SPACs Work: Mergers, Redemptions, and Warrants

A special purpose acquisition company, or SPAC, is a shell corporation that raises money in an IPO for the sole purpose of buying a private company and taking it public, and understanding how SPACs work means following that money through four stages: the IPO, the trust account, the target search, and the merger vote. The SPAC itself has no products, no revenue, and no operations. Its sponsors have a deadline, usually 24 months, to find a target and close a deal. If they don’t, the SPAC dissolves and the money goes back to investors.

Formation and the IPO

A SPAC starts with one or more sponsors, typically experienced executives or investment professionals, who put up seed capital for legal fees and regulatory filings. In return they receive “founder shares” that give them roughly 20 percent of the SPAC’s equity after the IPO. This stake is called the sponsor promote, and it’s the main financial reason sponsors do the work of finding and closing a deal.

To raise money from the public, the SPAC files a Form S-1 registration statement under the Securities Act of 1933.¹ It then sells “units” to public investors, usually priced at $10 each. Each unit contains one share of common stock plus a fraction of a warrant, which is a contract giving the holder the right to buy another share later at a set price, typically $11.50.² After a short period, the shares and warrants separate and trade on their own.

Keep the math in mind. Sponsors get 20 percent of the equity for a small outlay while public investors pay $10 per unit. That gap dilutes public shareholders’ ownership of whatever company eventually emerges from the merger. It’s a built-in cost of the structure, not a surprise.

The Trust Account

Nearly all of the IPO proceeds go into a segregated trust account, invested in short-term U.S. Treasury securities. The money cannot be spent on sponsor salaries, operating costs, or anything else other than closing an acquisition or returning funds to shareholders.³ Small amounts of interest earned can be released to pay income and franchise taxes, but the principal stays locked.

This trust is the main investor protection in a SPAC. If no merger closes by the deadline, the trust liquidates and each public shareholder gets a pro rata share of what’s in it, including interest. And even when a merger does go forward, shareholders who don’t want to participate have a right to pull their money out.

The Target Search and Deadline

Once the IPO closes, the sponsors start looking for a private company to buy. The governing documents set a hard deadline, commonly 24 months but sometimes up to 36.³ If the clock runs out without a signed deal, the sponsors can ask shareholders to approve an extension, or they must dissolve the SPAC and return the trust money.

During the search the management team reviews candidate companies’ finances, debts, tax obligations, pending litigation, and operations. When a target looks promising, the two sides typically sign a non-binding letter of intent before negotiating final valuation, deal structure, and governance.

The De-SPAC Merger and Your Rights as a Shareholder

Once the SPAC and target sign a merger agreement, the deal enters the “de-SPAC” phase, in which the private target merges into the SPAC’s public shell and begins trading on a stock exchange. Three things determine what happens to your money at this stage: the shareholder vote, your redemption right, and the minimum cash condition.

The Proxy Statement and Vote

The SPAC files a proxy statement on Schedule 14A describing the proposed merger, the target’s financial condition, and the deal terms.⁴ Shareholders then vote at a formal meeting. If they reject the deal, it doesn’t happen.

Your Redemption Right

No matter how you vote, you can redeem your public shares before the merger closes and collect your pro rata portion of the trust, which is essentially your original $10 per share plus a share of accumulated interest, minus amounts released for taxes.³ Voting yes and redeeming are not mutually exclusive. You can approve the merger and still take your money off the table.

The Minimum Cash Condition

Most merger agreements require the SPAC to have a specified amount of cash on hand at closing.³ That cash can come from what’s left in the trust after redemptions, from outside financing, or from both. If redemptions are heavy and the remaining cash drops below the threshold, the deal can fall apart even after shareholders approve it.

PIPE Financing

When sponsors expect redemptions to eat into the trust, or when the target needs more capital than the trust holds, the SPAC lines up a private investment in public equity, or PIPE. Institutional investors like hedge funds, mutual funds, or private equity firms agree to buy shares at a negotiated price, with the investment closing at the same time as the merger. PIPE investors usually get a discount and sometimes extra warrants. The money helps close the deal, but the new shares add further dilution on top of the sponsor promote.

Warrants and Lock-Ups After the Merger

If you kept the warrants that came with your units, they typically become exercisable 30 days after the de-SPAC merger closes or 12 months after the IPO, whichever comes later.² The strike price is usually $11.50. If the post-merger stock rises high enough, the company can call the warrants for redemption and force holders to exercise or forfeit them. A common trigger is the stock trading at or above $18 for a specified number of days. Once a redemption is announced, you generally have 30 to 45 calendar days to exercise before the warrants become worthless. Pay attention to those notices.

Sponsors and certain insiders are usually locked up from selling their shares for a set period after the merger, often 12 months. Some lock-ups include early-release triggers if the stock trades above a specified price for a defined number of consecutive days. The point is to prevent an immediate flood of insider selling and to keep sponsor incentives aligned with public shareholders.

SEC Rules and Sponsor Liability

Throughout its life a SPAC files quarterly and annual reports (Forms 10-Q and 10-K) and discloses major corporate events on Form 8-K under the Securities Exchange Act of 1934.⁵

Sponsors, directors, and officers face personal liability for false or misleading statements. Rule 10b-5 makes it unlawful to misstate or omit a material fact that would influence an investor’s decision to buy or sell.⁶ Rule 14a-9 separately bars false or misleading statements in proxy materials sent out before the merger vote.⁷ Breaches can trigger SEC enforcement, fines, or private shareholder suits.

Projections are a particular pressure point. In traditional public offerings, federal law provides a “safe harbor” that shields companies from liability for forward-looking statements accompanied by meaningful cautionary language. The Private Securities Litigation Reform Act, which created that safe harbor, explicitly excludes blank check companies like SPACs.⁸ In January 2024 the SEC adopted final rules, effective July 1, 2024, that reinforce the exclusion and require SPACs to disclose all material assumptions behind any projections included in de-SPAC filings.⁹ The result is more legal exposure for sponsors and target management when forecasts miss.

Taxes on Redemption and Warrants

Redeeming your SPAC shares, whether because you opted out of a merger or because the SPAC liquidated, is treated as a sale. Your gain or loss is the redemption proceeds minus your cost basis, and whether it’s short-term or long-term depends on how long you held the shares.

Warrants have their own treatment. When you buy a unit, your cost is split between the stock and the warrant based on their relative fair market values at purchase. If you later exercise the warrant, your basis in the new share equals the amount originally allocated to the warrant plus the strike price you pay, and exercising itself is not a taxable event. Warrants received as compensation for services work differently: the spread between strike price and market value on the exercise date is ordinary income.

If the SPAC liquidates and your warrants expire worthless, you can claim a capital loss equal to the portion of your investment allocated to them. SPAC tax rules get complicated quickly, especially with stock-for-stock exchanges or when the SPAC is classified as a passive foreign investment company, so it’s worth running the numbers with a tax professional before you redeem or exercise.

1
U.S. Securities and Exchange Commission. Form S-1 Registration Statement Under the Securities Act of 1933
2
FINRA. SPAC Warrants: 5 Tips to Avoid Missed Opportunities
3
U.S. Securities and Exchange Commission. Special Purpose Acquisition Companies, Shell Companies, and Projections
4
U.S. Securities and Exchange Commission. Proxy Rules and Schedules 14A/14C
5
U.S. Securities and Exchange Commission. Form 8-K Current Report
6
GovInfo. 17 CFR 240.10b-5 – Employment of Manipulative and Deceptive Devices
7
eCFR. 17 CFR 240.14a-9 – False or Misleading Statements
8
Office of the Law Revision Counsel. 15 U.S. Code 78u-5 – Application of Safe Harbor for Forward-Looking Statements
9
U.S. Securities and Exchange Commission. SEC Adopts Rules to Enhance Investor Protections Relating to SPACs, Shell Companies, and Projections