A special purpose acquisition company (SPAC) is a public company with no commercial operations that exists purely to acquire or merge with an existing company.
- You can invest in a SPAC just like any other public company, though any share price movement will be down to speculation and potential business deals rather than operational performance
- At the time of the IPO, a SPAC will have no existing business operations and no stated targets for acquisition
- SPACs have two years to complete an acquisition before they must return their capital to those who invested it
What is a SPAC?
A SPAC is effectively a shell company that raises capital from investors with the aim of funding an eventual merger or acquisition with an existing company. They are typically created by investors or sponsors with expertise in a particular industry or business sector.
Another name that is often used for a SPAC is a blank cheque company. This refers to the fact a SPAC may well have its eyes on a target before going public, but it does not disclose this formally to avoid complications that could potentially arise.
Funds raised during a SPAC IPO go into an interest-bearing trust account, and they cannot be disbursed other than to complete an acquisition or return the capital to investors in the event of a liquidation. Sometimes, the interest earned on funds within the SPAC can be used to cover working expenses.
Can I invest in a SPAC?
Anyone can invest in a special purpose acquisition company, from financial institutions to average Joe retail investors, and in recent years, they have become extremely popular, attracting major-name underwriters like Deutsche Bank, Credit Suisse, and Goldman Sachs. Nearly $100 billion was raised by SPACs in Q1/21, surpassing the previous record and demonstrating that this Wall Street trend has become sustained.
Interestingly, SPACs have been around for decades, and they were previously regarded as a last resort for small companies that were struggling to raise capital. However, because of the increased level of market volatility – largely because of the COVID-19 pandemic – SPACs have become far more prevalent. In 2020, they accounted for 50% of newly listed companies in the United States.
Advantages of a SPAC
There are several advantages to SPACs in comparison to a regular stock. First and foremost, a SPAC merger allows companies to get an influx of capital more quickly than they would have with a conventional IPO. This is because a SPAC deal can be concluded in a few months, whereas the protracted process of registering an IPO with the U.S. Securities and Exchange Commission (SEC) can take up to six months. As a result, SPACs can experience share price growth more quickly and can cope better with volatility.
Moreover, in SPAC mergers, the target company can negotiate its own fixed valuation with the sponsors of the SPAC, giving it more control of its own destiny than simply handing over control to the public market. Often, the target company will be able to achieve a premium valuation because of the two-year time constraints that SPACs face.
It is also important to note that the heavy institutional presence in special purpose acquisition companies provides a sense of security to investors, adding credence to the strategy of the SPAC and creating market confidence in the future of the target company.
Disadvantages of a SPAC
There are risks associated with SPACs. Perhaps chiefly, target companies can have their acquisition rejected by shareholders of the SPAC, scuppering business negotiations. In addition, investors are putting a lot of blind faith into the promoters of the SPAC; if an acquisition is unsuccessful, capital loss is virtually inevitable. Moreover, SPAC sponsors are not necessarily incentivised to avoid overpaying for a target company, which can hurt shareholders in the long run.
On occasion, rumours surrounding a potential SPAC acquisition can fail to come to fruition, which can cause a brief share price surge followed by a crash that can catch out careless investors.
In addition, because of the potential for a lack of transparency, some SPACs have saddled investors with overhyped shares in recent years, and others have even served as a vehicle for fraudulent activity. Finally, it is important to note that once the initial hype driving a SPAC’s share price up wears off, long-term returns can be disappointing.
Examples of SPAC deals
In recent years, some well-known companies have experienced a successful public listing courtesy of a merger with a SPAC. This includes space tourism innovator, Virgin Galactic, and North American gambling growth player, DraftKings.
Should I invest in a SPAC?
If you are comfortable with the potential risks, investing in a SPAC can give you the opportunity to get involved in an exciting unknown company’s growth, with a reduced timeframe for returns and increased credibility provided by financial institutions and even celebrities. However, make sure to avoid getting caught up in the hype, and always do your own research before pulling the trigger on a SPAC investment.
Where can I learn more?
To find out more about SPACs, check out our investing hub page for links to all the resources you need. You can also learn more by completing our stock trading courses.
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