What exactly are SPACs? And should you invest?

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It seems like every month there’s a new investing trend taking the investing world by storm— short squeezing, NFTs, and now, SPACs.

SPACs, aka special purpose acquisition companies, have seen a huge increase in popularity just over the last year. In fact, in 2020, there were 237 SPAC IPOs that raised US$79.87 billion, compared to US$13.6 billion raised in the previous year from only 59 IPOs.

So what is a SPAC (pronounced spack), and how should you get on board with the booming investing trend? Let’s break this down.

What’s so special about a SPAC?

Even if you’re brand new to investing, it’s likely you’re familiar with the term IPO. An Initial Public Offering is when a company finally goes public and has its shares of equity available for purchase by—you guessed it—the public. The shares are bought for an exchange in capital in order for the company to raise money.

SPACs have been disrupting the world of IPOs, because in a nutshell, they provide a faster way forward for companies to sell their shares to the public without all the red tape than an IPO involves. But SPACs are attractive to privately-held companies for numerous reasons. 

Simply put, a SPAC is a publicly-traded shell that is made for the sole purpose of merging with a privately held business. And they’re not new, either. SPACs have been around for decades, they just have a bit of a sketchy past, with a reputation for misleading investors into buying into shady companies. Since then, however, the SEC has been regulating SPACs to reduce fraud, and SPACs have been surging big time.

So, what’s all the buzz about? Are SPACs a worthwhile investment? And how exactly does it all work? Let’s take a look.

Check, please

Here’s how a SPAC works. A group of ‘sponsors’ (typically experts in a certain field so they’re clued into good deals) decide to form a management group. They raise money through an IPO by selling units (which are typically $10 each and usually made up of one share and a warrant). A warrant allows investors to buy a certain amount of shares of a common stock at a certain price sometime in the future. Like stocks, investors can buy or sell shares for the current market value after the IPO.

You might have heard of SPACs being used interchangeably with the term ‘blank check’ companies. This is because the nature of a SPAC is that the investors or the sponsors don’t know which company they are going to be purchasing until they make the deal.

Done deals

Once a privately-held company has been acquired by a SPAC, the money goes into an interest-bearing trust account. This means that the money they get from the IPO can only be used to acquire that specific private company they want to acquire. Typically, if the money isn’t used, it’s then liquidated back to the investors. After this acquisition, the company is then listed on the major exchanges.

Some noteworthy SPACs recently include Draft Kings, the American daily fantasy sports company and bookmaker, that went public via SPAC Diamond Eagle Acquisition Corp and gambling tech business SBTech. Another big company that was acquired via a merger with a SPAC is electric vehicle company Nikola Motors (aka Tesla 2.0) that went public last summer, as well as Richard Branson’s Virgin Galatic.

Why are SPACs more appealing to companies than IPOs?

You might be wondering, what other benefits does a SPAC have over an IPO? Well, firstly, SPACs allow privately-held companies to avoid jumping through as many regulatory hoops as traditional IPOs. They’re also a fast-tracked way of going public. 

Secondly, SPACs are typically more attractive than private equity for the owners of the privately-held company because the owners can get about 20% more for their company when exiting these deals and taking them public.

There’s also a greater price certainty and control because there’s less guesswork in determining which price to offer the shares at. And lastly, since the sponsors are often experts in their area, the management expertise can offer an advantage in helping companies grow.

Exhibit A: A SPAC in space

A good example of an ideal SPAC situation is Richard Branson’s Virgin Galactic merger. The company didn’t have a lot of public companies as a precedent to pave its way, and its massive projections may have made traditional IPO investors nervous. It’s likely that a SPAC was appealing to the company because it provided an easier way in, without the risk of rejection, insider selling, or the typical 180-day lock-ups of traditional IPOs.

WeWork is another example of a company that didn’t succeed at going public via the traditional route due to its shaky management and business model, and is now considering merging via a SPAC. It’s also a good example of why you should always do your due diligence when researching SPACs to invest in, as the more rigorous regulations from the IPO route are what revealed WeWork’s shortfalls.

So, should I start SPACing? 

SPACs might be new and exciting, but like all investments, the results are unpredictable and depend on a lot of factors. Just because a company has merged with a SPAC, doesn’t mean you shouldn’t do your research before you start investing. Always check in to see how it fits in with your own personal portfolio.

If you are looking for ways to do some sleuthing before you invest, have a look at the SPAC’s terms of the investment by looking at its IPO prospectus, as well as its reports with the SEC. It’s also a good idea to look into the SPAC’s management team to see how much expertise they actually have in their fields.

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