Norman Peltz is about to raise $750 million. Lazard is looking for $500 million. What are the funds for? The companies don’t know. If they did know, they could be in big trouble with the SEC.

Welcome to the wacky world of special purpose acquisition companies. Sometimes referred to as “blind pools,” SPACs are suddenly hot.

So far this year, they have accounted for 22% of all the IPOs done in the U.S., according to Dealogic. Despite the turmoil in equity markets, October was the most successful fund-raising month ever for SPACs, with more than $2 billion raised across 10 deals.

Here’s how it works. A management group gets together and decides to create a SPAC. By law, the group cannot have any inkling beforehand what acquisitions it will target with the money. Instead, after contributing some of its own capital and raising the balance through an IPO, the management team gets into high gear and has 18 to 24 months to find a suitable target for at least 80% of the money. The acquisition, of one or more entities, has to be done in a single transaction.

Eighteen months? The pressure is enormous.

As of last Friday, 54 SPACs had been launched this year, up from 37 in all of 2006 and 12 in 2004. The deals are also increasing in size, with a total of nearly $9 billion raised so far this year.

The CEO of a SPAC called GSC Acquisition Company (AMEX: GGA $9), Peter Frank, admits with a laugh that he marks the pages of a calendar with each day that passes. His firm raised $207 million in June, so the clock is ticking. Because the company was spawned by GSC Partners, a successful alternative asset management company run by former Goldman Sachs partners, GSC’s deal had orders for $450 million. Did I mention this area was hot?

Mr. Frank’s life is complicated by the fact that the SEC allowed the deal to go forward only if GSC promised not to buy any of the companies in which his firm has an interest, effectively ruling out more than 500 operations — and arguably the businesses that it knew best.

It is no secret that the SEC does not like SPACs. A senior banker who has managed a number of the deals says: “The SEC is confounded. They think they are missing something.” The regulators remember too well the bad old days when funds in blind pools were used for “pump and dump” schemes and other shenanigans. Deborah Quazzo, president of ThinkEquity Partners, one of the early managers of SPAC offerings, says she thinks the SEC is overly concerned. “No vehicle protects shareholders better,” Ms. Quazzo says. “To avoid a crummy deal, the shareholders can vote down any acquisition. The SPAC is collateralized by cash. It’s very successfully self-regulated.”

What investors look for is the quality of the management team, Ms. Quazzo says. A group headed by Eric Watson, who was chairman of several companies, including Floral Products, and Jon Ledecky, founder of U.S. Office Products, raised $129 million in December 2005 for a SPAC called Endeavor Acquisition Corporation (AMEX: EDA $13). Just about a year later, the pair announced its intention to acquire American Apparel, a fast-growing clothing manufacturer and retailer. The stock is up 77% in the past year, inspiring the team to launch two new SPACs, Victory Acquisition Corp. (AMEX: VRY $10) and most recently Triplecrown (AMEX: TCW $9).

By contrast, a group called Catalytic Capital filed to raise $125 million more than a year ago, with Merrill Lynch as underwriter, but has failed to woo investors.

Another safeguard for investors is that the management team today is typically required to invest heavily up-front. In the absence of a deal, the SPAC folds and the management team has to turn over all remaining cash — including the funds it has invested — to the public shareholders. These days, that can amount to millions of dollars. This funding is in addition to an initial stake of only $25,000, which by convention earns the team 20% of the deal.

Rarely does the management team fail to find a deal. As one banker puts it, “Before that happens they will throw just about anything up on the wall to see if it will stick.” Of the seven SPACs that have gone under, all failed to win shareholder approval or ran out of time to get the deal done.

One advantage of the SPAC structure, Mr. Frank points out, is: “You raise the money right away.” In other words, the acquirer goes out hunting with the money already in his pocket. Especially today, with credit markets in disarray, that gives the buyer an advantage.

Also, the targets of SPACs can be companies with low cash flow and high growth prospects that would not attract private equity buyers. Because those purchasers tend to leverage their equity stake in an acquisition by five or six times, they typically seek firms with excess cash flow that can be used to pay down debt. SPACs tend to use only one to two times leverage in completing a transaction.

Another difference between the two approaches is that the SPAC buyer does not typically justify the deal by promising to improve the performance of the underlying company. The gain comes from finding a company that is not sophisticated enough or not well enough financed to go public on its own. The buyer’s profit comes from the difference between what the existing management is willing to sell for and the value put on the concern by the markets.

That may seem like a shaky premise, and indeed, if the shareholders can’t see the rationale, they vote down the deal. In fact, because shareholders have become rather picky, deals today often require approval of only 60% to 70% of all shareholders; formerly, 80% approval was the norm.

Ms. Quazzo is not alone in seeing a great future for SPACs. While hedge funds are major investors today, another probable source of funds going forward could be the Chinese. The betting is that after the Beijing Olympics next August, the Chinese will become aggressive buyers of American companies. The buildup of dollars in Chinese coffers will inevitably fuel a tsunami of U.S. takeovers, which may encounter resistance in America. A less public approach to a straightforward takeover is to become major funders of SPACs. Chinese takeout anyone?

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