What are SPACs?

Special purpose acquisition companies, or “SPACs” are companies that are formed to raise capital to acquire an existing company – it’s all about the intention to take the company public rather than taking over any executive roles.

They’ve been around for a while, but have recently become more popular – most recently, with the SPAC Fintech Acquisition Corp which will be taking brokerage platform eToro public. SPACs create a unique opportunity for retail investors, but it does have drawbacks. Here’s what you should know before you jump on the bandwagon.

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. These 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 generally know beforehand which companies the SPAC intends to acquire or how the sponsors will allocate funds. SPAC’s tend to trade quite cheaply, 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, known as the company’s sponsors, begin the regulatory process of forming the special purpose acquisition company.
2. The SPAC holds an initial public offering (IPO). The SPAC must undergo an IPO process, or “float” on a chosen stock exchange, just like any other publicly traded company.
3. The SPAC goes to market. The SPAC becomes available for purchase on public stock exchanges under its own ticker symbol.
4. Investors buy in. Once it’s live, public investors can start buying stocks.
5. 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 two years, or the SPAC will be liquidated and funds returned to investors.
6. The SPAC merges with its target company. Once a target company is named, the acquisition process begins.
7. The merger completes. At completion, 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.

Why do companies use SPACs?

Companies use SPACs because they’re typically easier, quicker and less expensive than going the traditional IPO route – for companies it’s like a ready-made public company, all they need to do is merge. For private companies interested in going public, particularly 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.

Are SPACs a new kind of investment?

Not at all. But as we explore further down, they’re more regulated nowadays. They’re also less paperwork and general faff for companies.

SPACs vs 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 and a pretty lengthy 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.

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:

1. Check out some SPACs. Have a little search to find some that you’re interested in. They typically have something like “acquisition corp” in their name, but not always.
2. Research sponsors. Found a SPAC? Now check out 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.
3. Open a brokerage account. You’ll need a brokerage account to invest in a SPAC. If you don’t have one, compare some here to find the platform that best meets your investment needs.
4. 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.
5. Submit your order. Once you’ve found the SPAC, enter the number of shares you’d like to purchase and choose your order type.
6. Wait it out. Once you’ve invested in the SPAC, you’ll need to wait for it to declare a target company to acquire – check out our timeline for how it works above.
7. 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.

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.

Is it safe to invest in SPACs?

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 regulation has improved over time and there’s the “money back” element that can be quite attractive to investors – essentially if the SPAC doesn’t make an acquisition within the set timeframe, which is usually 24 months, then the investors get their funds back.

But SPACs do 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 – imagine if you’re vegan or vegetarian and the company that the SPAC chooses to back is a pork sausage company. You’d be backing a company that doesn’t align with your own values. 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.

Here are some SPAC examples:

The fantasy sports-betting operator DraftKings went public by merging with Diamond Eagle Acquisition Corp in April 2020. The stock performed well, debuting near $10 per share (about £7) and rising to $63.78 (about £46) in October 2020. 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 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 (about £9), but in the months following its release, prices fell to $7.25 (just over £5) in November 2019 before bouncing to a high of $33.87 (£24) in February 2020. 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.

Pros and cons of investing in a SPAC

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

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 or years, and there’s no guarantee the acquired company will perform well.

Frequently asked questions

• What are SPAC warrants?

  SPAC warrants are a type of security that allows the bearer to purchase more stock at a fixed price at a later date — similar to an options contract. They’re typically offered to institutional investors that buy into SPACs.

• What happens if a SPAC doesn't acquire a company?

  If a SPAC doesn’t acquire a company within its allotted time frame, the SPAC is dissolved and funds are distributed to investors.