Special purpose acquisition companies – or SPACs – have been around since the 1980s, but regulatory and market trends of recent years have caused an uptick in their popularity. This investment vehicle constitutes a unique opportunity for retail investors, but isn’t without its drawbacks. Here’s what investors should know before they buy in.
What is a special purpose acquisition company (SPAC)?
A special purpose acquisition company is a publicly traded company formed with the exclusive intent to purchase another company. SPAC acquisitions serve a distinct purpose: they aren’t interested in taking over daily operations or assuming an executive role. Instead, SPACs acquire privately held companies for the sole purpose of taking them public.
SPACs are also called shell or blank check companies, as investors who back SPACs don’t often know how the sponsors will allocate funds or what company will be acquired. Most SPACs trade at USD $10 per share, with the general assumption that once the target company is acquired and goes public, share prices will rise.
How do SPACs work?
SPACs operate differently than traditional IPOs. Here’s a breakdown of the process.
1. The SPAC is formed
A group of investors begin the regulatory process of forming the special purpose acquisition company. These are the company’s sponsors. The SPAC must undergo an IPO process with the U.S. Securities and Exchange Commission (SEC) before it can be listed on a US exchange — just like any other publicly traded company.
2. The SPAC goes to market
Once the SPAC has completed its IPO process, it becomes available for purchase on public stock exchanges under its own ticker symbol. It’s at this time that public investors can start buying in. Investor proceeds from the IPO are held in a trust or escrow account.
3. The SPAC seeks a target company
The SPAC begins to search for a company to merge with. This is the company the SPAC will acquire and bring to market. A target company must be acquired within a certain time frame — typically 2 years — or the SPAC will be liquidated and funds returned to investors.
4. The SPAC merges with its target company
Once a target company is named, the acquisition process begins. When the merger is complete, the combined company typically takes the name of the target business and its ticker symbol is updated accordingly. Investors can choose to stay invested and hold onto their shares or sell them — ideally at a profit.
How to invest in SPACs
Public investors can invest in SPACs, but the process is a little different than the traditional buying and selling process:
Research sponsors. Once you’ve found a SPAC that catches your eye, start investigating the track record of its sponsors. Do they have a prior SPAC experience? Have they taken part in profitable investments in the past? When you invest in a SPAC, you essentially invest in the market savvy of its sponsors. Do your homework and make sure the people who formed the SPAC know what they’re doing.
Open a brokerage account. You’ll need a brokerage account to invest in a SPAC. If you don’t have one, explore your brokerage account options by features and fees to find the platform that best meets your investment needs.
Search for the ticker symbol. Log into your brokerage account and use your platform’s search tool or stock screener to locate the SPAC’s ticker symbol. If you don’t know the ticker symbol, you can often search by company name.
Submit your order. Once you’ve found the SPAC’s ticker symbol, enter the number of shares you’d like to purchase and indicate whether you’d like to make a market or limit order.
Wait. Once you’ve invested in the SPAC, you’ll need to wait for it to declare a target company to acquire.
Stay invested or sell. Once the merger with the target company is complete, you can elect to hold onto your existing shares or sell them.
Why do companies use SPACs?
Companies use SPACs because they’re typically easier, quicker and less expensive than going the traditional IPO route. For private companies interested in going public — especially smaller companies — merging with a SPAC can bring them to the market in less time and with less paperwork.
A SPAC merger can be lucrative, too. The acquisition process has the potential to add up to 20% to the company’s sale price than a typical private equity deal.
SPACs vs. traditional IPOs
SPACs and IPOs are often mentioned in tandem, but they’re not the same thing. And while SPACs do file for IPOs during the acquisition and merger process, a SPAC’s IPO isn’t the same as the traditional IPO used by most companies that enter the market.
Traditional IPOs are undertaken by private companies preparing to go public. They require extensive paperwork with the SEC — not to mention the process of drumming up investor interest and negotiating with institutional investors. It can be a frustrating and time-consuming process, and not all companies that undertake the IPO process actually go public.
SPACs also file for an IPO, but the process tends to be simpler. Since the SPAC’s purpose is so singular and straightforward, there are rarely any hiccups with the SEC. Additional paperwork and negotiation is required during the acquisition process, but a merger is still easier and quicker for most private companies than filing for a traditional IPO.
Are SPACs safe to invest in?
SPACs are safer than they once were — but they’re far from foolproof. In the 1980s, when SPACs first came into fashion, they developed a poor reputation for trading illiquid penny stocks and making insider deals that devalued investor funds — essentially: pump and dump schemes.
But the SEC has revamped the regulations that govern this investment vehicle, leading to an uptick in SPACs as investors seek opportunities to get in on the ground floor of freshly public stocks. SPACs are safer than they were 30 years ago, but still have their risks. Namely: that they constitute a blind, illiquid investment. Investor funds are safely held in trust or escrow, but investors won’t know what they’re buying into until the SPAC declares a target company.
This leads us to a secondary risk to consider: the company acquired by the SPAC may not be one you’d like to back. SPACs tend to target newer companies with growth potential. Continuing to hold the stock in the acquired company may expose your portfolio to unforeseen risk, as there’s no guarantee the acquired company will perform well once it hits the market.
What happens after a SPAC merges with another company?
After a SPAC merger, the newly formed company typically assumes the name of the operating company it acquired and its ticker symbol is changed to reflect the merger. As an investor, you have the option of continuing to hold the stock, or you can sell it as you would any other security through your brokerage account. What happens to the stock price depends on what company the SPAC merges with.
For example: the fantasy sports-betting operator DraftKings went public by merging with Diamond Eagle Acquisition Corp in April 2020 (NasdaqGS: DKNG). The stock has performed well, debuting near $10 per share and rising to all-time high of $71.98 in March 2021. Some investors speculate that the stock will continue to gain traction owing to the rise in online gaming and sports betting in the wake of the coronavirus pandemic.
On the other hand, Virgin Galactic (NYSE: SPCE) exemplifies exactly how tenuous and unpredictable SPAC mergers can be. The commercial spaceflight company went public via a SPAC merger with Social Capital Hedosophia in 2019. Shares launched at $12.34 apiece, but in the months following its release, prices fell to $7.25 in November 2019 before bouncing to an all-time high of $59.41 in February 2021. The stock has continued to rise and fall as traders hesitate on the market viability of a SPAC tourism investment.
Ultimately, there’s no way to predict what will happen to a SPAC stock following a merger. Before you invest, find out if the SPAC you’re interested in has a target industry or market sector, as this may help guide your decision.
How do I find SPACs to invest in?
One of the best ways to identify SPAC investment opportunities is to stay informed. SPACs aren’t as well-advertised as traditional IPOs. Hedge funds and institutional investors are typically the first to learn about SPACs, but you can stay abreast of upcoming SPACs by subscribing to investment news sources or by searching the NASDAQ website for ticker symbols that end with a “U” — a common identifier for publicly traded SPACs.
Pros and cons of investing in a SPAC
Pros
Open to public investors. Because SPACs trade on public markets, individual investors have the opportunity to buy in.
Accessible pricing. Most SPACs are priced at USD $10 per share.
Ground floor investing. Investors can be first in line to back a private company going public.
Cons
Blind investment. Most investors don’t know what they’re buying into when they invest in a SPAC, as SPACs aren’t required to declare a target company at their outset.
Low liquidity. It can take months — even years — for SPACs to settle on a target company, leaving investor funds tied up in escrow throughout the process.
Mediocre performance. SPAC performance has been analyzed on numerous occasions and tends to yield mixed results. According to a report from Renaissance Capital, SPAC IPOs from 2015 to 2020 have underperformed post-merger, with only 93 of the 313 SPAC IPOs filed since the start of 2015 actually completing a merger.
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Bottom line
SPACs offer retail investors the opportunity to buy into a privately owned company as it goes public for the first time. But funds may be locked up for months — even years — and there’s no guarantee the acquired company will perform well.
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Shannon Terrell is a lead writer and spokesperson at NerdWallet and a former editor at Finder, specializing in personal finance. Her writing and analysis on investing and banking has been featured in Bloomberg, Global News, Yahoo Finance, GoBankingRates and Black Enterprise. She holds a bachelor’s degree in communications and English literature from the University of Toronto Mississauga. See full bio
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