What Is a Blank Check Company? How They Work, Risks, and Example

What Is a Blank Check Company?

A blank check company is a publicly-traded, developmental stage company that has no established business plan. It may be used to gather funds as a startup or, more likely, it has the intent to merge or acquire another business entity. Blank check companies are speculative in nature and are bound by Securities and Exchange Commission Rule 419 to protect investors.

How a Blank Check Company Works

Blank check companies are often considered penny stocks or microcap stocks by the SEC. Therefore, the SEC imposes additional rules and requirements on these companies.

For instance, they must deposit the raised funds into an escrow account until shareholders officially approve an acquisition and the business combination is made. Also, these companies are not allowed to use certain exemptions under Regulation D of the Securities Act of 1933. Rule 504 of Regulation D exempts companies from registration of securities in a 12-month period for offerings up to $10 million. The SEC prohibits blank check companies from using Rule 504.

A type of blank check company is a "special purpose acquisition company" (SPAC), which is formed to raise funds via an initial public offering (IPO) to finance a merger or acquisition within a certain time frame, typically 24 months. The money is held escrow until a combination transaction closes; if no acquisition is made after 24 months, the SPAC is dissolved and funds are returned. The SPAC managers normally hold 20% equity with the balance going to subscribers of the IPO.

Blank Check Companies Falling Out of Favor

The number of SPAC IPOs rose considerably in 2020 and then soared in 2021. which is when they reached a record 613. A combination of cheap money and the appeal of making going public fairly easy made SPACs really popular.

Then, in 2022, the record run stopped and the number of SPAC IPOs dropped considerably.This slowdown has been attributed to several factors, including rising interest rates and a broader slowdown of IPOs in general, tougher regulation, and negative media attention.

Some of these blank check companies have dragged down the reputation of others by building up excessive hype and then underwhelming. Forward-looking statements with lofty estimates have been pitched to investors only to turn out wide of the mark. This has led to accusations of investors being misled. A key risk is that investors don’t know ahead of time what company a given SPAC will acquire. At best, they may have an indication of the sector they intend to operate in.

These controversies have led to many lawsuits. A common complaint is that SPAC executives have been pushing through any old acquisition just so that they can cash in on their founder shares, which were bought for a deep discount and can be offloaded as soon as a deal has been made and the job is completed.

Examples of Blank Check Companies

After a successful public relations campaign run in 2014 that informed the public that the highly popular snack cakes known as Twinkies would no longer be made, the Gores Group, a Los Angeles-based private equity firm, created blank check company Gores Holdings in 2015. The company raised $375 million in an IPO and became the vehicle that facilitated the purchase of Twinkie-maker Hostess Brands that year with other institutional investors.

Other companies that Gores took public include Verra Mobility Corp. and United Wholesale Mortgage, which IPO'd in January 2021 for close to $16 billion, making it the biggest SPAC merger at the time. Like plenty of other IPOs, United Wholesale Mortgage was adjudged to have been overvalued by the market at the time of its listing. Its share price has since tumbled and investors sued, claiming the backers “hastily negotiated the merger through a flawed and unfair process.”

Gores, one of the main players in the blank check company arena, has since eased up SPAC deals due to a slower market and opportunities drying up. In 2022, Gores Holding shut down three of its blank check firms—Gores Holdings VII, Gores Technology Partners, and Gores Technology Partners II.

Digital World Acquisition Corp (DWAC) and Truth Social

Digital World Acquisition Corp (DWAC) is another example of a blank check company. It was formed as a SPAC with the goal of merging with Trump Media & Technology Group (TMTG), the parent company of the social media app Truth Social. The deal, currently valued at about $5.7 billion, would allow TMTG to become a publicly traded company without going through the traditional IPO process.

Here's how the process works:

1. Digital World Acquisition Corp was created as a SPAC and raised funds through an IPO.
2. The SPAC then identified Trump Media & Technology Group as a potential acquisition target.
3. The two companies agreed to a merger deal, which was recently approved by Digital World's shareholders.
4. Once the merger is completed, Trump Media & Technology Group will effectively become a publicly traded company, with its shares listed under the merged entity.

This deal is set to provide a significant cash infusion of $300 million to TMTG and values former President Donald Trump's majority stake in the company at around $3.3 billion. However, the merger has faced hurdles, including investigations by the U.S. Department of Justice and the Securities and Exchange Commission (SEC), leadership changes at Digital World, and lawsuits from former executives seeking more shares for their previous work on the deal.

The Bottom Line

Blank check companies are shell companies that are commonly set up to go public, raise funds, and buy a private company. The number of these IPOs boomed in 2020 and 2021 then came crashing down hard as economic uncertainty crept in, borrowing costs soared, investors got nervy, and the SEC grew more skeptical.

During the boom years, plenty of special purpose acquisition companies (SPACs) gave blank check companies a bad name. Shortly after deals were completed, disappointment followed and share prices started plummeting, leading to accusations of foul play from executives and lots of high-profile lawsuits.