The financial press has generated excitement and controversy over the increase in SPACs, due to the large sums of money placed behind the revitalized investment approach.
SPACs raised more than $80 billion through nearly 250 initial public offerings in 2020, accounting for more than half of the money raised through IPOs. By comparison, SPACs raised just $10 billion two years earlier.1
But, just because the investment decision is gaining popularity does not mean it’s right for everyone. The decision to invest in a SPAC will depend on your unique financial situation. To help provide some clarity, we’ve broken down how a SPAC works and the implications of investing in one.
What Is a SPAC?
The acronym “SPAC” stands for Special Purpose Acquisition Company. SPACs often receive attention for the large amounts of money invested into them, the celebrity names attached to them or a combination of both. For example, famous athletes and celebrities like Alex Rodriguez, Shaquille O’Neil, Kevin Durant and Paris Hilton are all involved with SPACs.
SPACs seek investments for the sole purpose of purchasing a private company and taking it public. The companies chosen by SPACs for acquisition are typically underperforming but believed to contain potential success. SPACs thus use their funds to acquire an equity stake in the company, with hopes of tapping into its potential and increasing its value. Therefore, providing greater returns to shareholders.
Investing in a SPAC
Understanding how SPACs work, and the implications of your investment, can provide you with some extra context. It’s always important to remember that SPAC’s, like all investments, involve risks. And such investment decisions should be based on your financial and personal goals. Consider the following factors when determining whether investing in a SPAC is right for you.
Investment Structure and Transparency
SPACs are also known as blank check companies. SPACs come public as a “shell corporation,” meaning they have no specific business plan or purpose. They look to acquire a private company and help it go public without going through the stages of a traditional initial public offering. Due to the structure of a SPAC, investors and sponsors won’t know which company the SPAC plans to acquire when they invest and must trust the SPAC’s management team to determine the right course of action.2
This can be an uneasy decision for investors since they won’t know where their money is going. After a company has been selected for acquisition, a SPAC will distribute either a proxy statement or information statement, depending on whether the SPAC needs shareholder approval before moving forward. If a shareholder does not like the selected business acquisition, they may choose to back out of the SPAC.
Blank check companies, and therefore, SPACs, must complete their acquisition within a specified time frame.2 But the speed of a SPACs acquisition period can fluctuate, with most completing around a year and a half.2 This means investors may not see a return on their investment until that time.
In addition to standard investors, SPACs often have sponsors. Sponsors, according to the SEC, often have divergent interests and receive better equity terms compared to standard investors. This was also evidenced in a Stanford and NYU study that suggested SPACs are better deals for sponsors than investors.3 SPACs can also request additional funding from sponsors during the acquisition process, resulting in reduced equity value for standard investors.
Return on Investment
ROI on a SPAC may depend on factors like the chosen company for acquisition and market performance.
According to SPAC Insider, SPAC’s from 2009 to 2021 have shown an average annualized rate of return of 2.3 percent, with some returns as high as 28 percent, while liquidating roughly 10 percent of the time.4 A Stanford and NYU study found the average returns versus an IPO Index and the Russell 2000 Index were all negative in the 3, 6 and 12 month period following the merger.3
Like any other investment, there is inherent risk. As an investment choice, SPACs have become more popular over the years. However, understanding how a SPAC works, and the criticism surrounding them, is necessary before any investment can be made. Make sure to always consult your financial advisor before moving forward on any investment decision.