Often referred to as “blank check companies,” special purpose acquisition companies (SPACs) have been around for decades. Typically created by investors with specific expertise in a particular industry or market sector, a SPAC is a company whose sole purpose is to raise capital through an IPO in order to acquire another company. Because of the capital and expertise a SPAC lends to the process, it can make it easier for many private companies to go public. Today, we’ll look at how SPACs work and some of the risks and benefits of investing in them.
How does a SPAC work?
While founders may have one or more companies in mind for acquisition when they form a SPAC, they don’t reveal this information until they identify a specific deal and bring it to their investors. Before IPO, SPAC founders recruit underwriters and institutional investors. After IPO, the SPAC can begin reaching out to potential target companies. It typically has two years to complete an acquisition. In the meantime, the funds raised are placed in an interest-bearing trust account, where they remain until a deal is made.
When the SPAC identifies an acquisition target, it goes to investors for a vote. If shareholders approve the deal, the acquisition moves forward. If a deal is not approved within two years of IPO, then the SPAC must liquidate and return funds to investors.
What are the risks and benefits of investing in a SPAC?
SPACs have earned a bad reputation due to a history of abusive practices. In the 80s, fraud was rampant in the SPAC space. Some stole cash from investors or made overvalued insider deals that left nothing for shareholders. Since then, however, regulation of SPACs has tightened, requiring them to register with the SEC, deposit investor money into a trust or escrow account, and return funds to investors if the SPAC fails to present an acceptable deal within two years. Even so, there is still reason to be cautious of investing in a SPAC.
Risks of SPAC Investment
- Since investors don’t know what company a SPAC will acquire, they must rely on the founders’ expertise and trust that they will invest the funds wisely.
- Even assuming a profitable deal is made, investors often have to wait a long time before seeing any return, resulting in opportunity costs.
- SPAC managers typically receive shares at a discount, making it more difficult for investors to realize returns. In some cases, managers can reap substantial rewards even if investors don’t see any gains.
- SPACs have a mixed track record. A report by Renaissance Capital found that among 89 SPACS that had completed mergers and taken a company public since the beginning of 2015, only 26 had positive returns, and the average loss was 18.8%. Traditional IPOs, on the other hand, had an average after-market return of 37.2% since 2015.
Benefits of a SPAC Investment
- They can allow retail investors to get into an IPO early.
- They’re affordable. Most SPACS trade for just $10 per share.
- SPACs allow you to invest with leading experts in a variety of industries.
- Some SPACs have done exceedingly well for their investors.
WRP helps clients reach their investment goals using evidence-based investment strategies. For regular updates on our investment insight and tips, subscribe to our blog.