As of late, lots of excitement (and controversy) has been generated by the financial press over the increase in SPACs. This is in part due to the large sums of money placed behind the revitalized investment approach.
In 2020 alone, SPACs raised more than $80 billion through nearly 250 initial public offerings. This accounts for more than half of the money raised through IPOs. By comparison, SPACs raised just $10 billion two years earlier.1
Just because the investment decision is gaining popularity does not mean that it is an appropriate investment for everyone. The decision to invest in a SPAC will depend on your unique financial situation. To help provide you with 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 due to the large amounts of money invested into them, the celebrity names attached to them or a combination of both factors. For example, famous athletes and celebrities like Alex Rodriguez, Shaquille O’Neil, Kevin Durant and Paris Hilton have all been linked with SPACs.
SPACs seek investments for the sole purpose of purchasing another company. The companies typically chosen for acquisition by SPACs are currently underperforming in one way or another but are believed to have the makings for potential success. SPACs then use their funds to acquire an equity stake in the underperforming company, with hopes of tapping into its potential and increasing its value. The end result is greater returns to shareholders.
Investing in a SPAC
Understanding how SPACs work, and the implications of your investment in one, can provide you with some extra context. It’s always important to remember that SPACs, like all investments, involve risk. Such investment decisions should be based on your financial and personal goals. At a minimum, consider the following factors when determining whether investing in a SPAC is the right decision 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 assist the company in going 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
Understandably, this can be an uneasy decision for investors being that they won’t know exactly 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 chosen business acquisition, they may choose to back out of the SPAC.
Blank check companies must complete their acquisition within a specified time frame.2 Due to the nature of a SPAC, the acquisition period can fluctuate, with most completing around a year and a half.2 This means investors may not see any 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. SPACs can also request additional funding from sponsors during the acquisition process, resulting in reduced equity value for the 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, from 2009 to 2021 SPACs have shown an average annualized rate of return of 2.3%, with some returns as high as 28%, while liquidating roughly 10% of the time.3
Like any other investment, there is inherent risk involved. As an investment choice, SPACs have grown in popularity over the years. However, understanding how a SPAC works, and the criticism surrounding them, is imperative before any investment should be made. You should always consult your trusted financial advisor before moving forward on any investment decision.