Headline: What the heck is a SPAC?

Date: 1/9/2021

Body: I was on my way home from work yesterday and I was listening to  NPR, and on the Marketplace segment, they spoke in glowing terms of something called a SPAC.  (I know, it sounds vaguely racist, doesn’t it?)   But, I looked it up when I got home and found a great Motley Fool article on this subject: What Is a SPAC and Why Do Investors Like Them So Much? | The Motley Fool

What is a SPAC and what is it used for?

SPAC  stands for a “Special Purpose Acquisition Company.”   They are often organized as a Delaware corporation or organized abroad, usually in the Cayman or Marshall Islands.   It manufacturers nothing and provides no services; It exists with a sole purpose to acquire other companies.  Investors use it for potential capital appreciation, but, it should be noted what they are investing in.   Specifically, they are investing in a management team, and essentially betting on them to select profitable businesses to acquire.  Often, a SPAC will go almost immediately into an Initial Public Offering because, by regulation, if these companies do not do an acquisition within 2 years (with some legal wiggle room) they are supposed to liquidate.

Are SPACs REALLY that BIG right now?

In a word, yes, they are.  To give you some perspective, in 2019, there were $13.6 Billion in SPAC-related IPOs in the market.  In the third quarter of 2020 alone, 77 SPACs went public and have raised more than $31 Billion.  (One well-publicized SPAC in 2020 was Virgin Galactic.)  SPACs are attractive to these private companies because when they are acquired, they can forgo the regulatory and economic costs normally related to an IPO.  As can be seen in the following graph, this increasing interest in SPACs has been constant over a period of time.

When an investor buys a “unit” of this type of IPO, they are essentially buying a share of stock bundled with an “option” to buy another share or fractional share, sometime in the future.  (This “option” is really called a warrant, but I get a little nervous when I hear the word, “warrant.”)

How does a SPAC work?

A SPAC in usually created by a combination of “sponsors” (think investors) who all have strong academic credentials and business experience in a certain industry.  They work with other investors to acquire funding sufficient to purchase a private company.   The sponsors then take this company public through an IPO.  (It is important to note here that the sponsors often have a good idea for their target, but are careful to not produce any records of these discussions which would often have to be turned over to the SEC.)  The process follows the same steps as in any IPO including a “roadshow” where the SPAC management team meet with potential investors like hedge funds.  In the past, these “blank check companies” were often fraudulent setups that would disappear with investors’ money, so the SEC tightened restrictions on them.  You might be excused for thinking that most of these SPACs are backed by private equity, and in the past that was true.  Nowadays, private equity almost evenly splits SPAC ownership with other investors.

The lifespan of a SPAC really breaks down into 3 stages, as seen in the illustration below

Why would an investor find it to be interesting?

1.  They’re inexpensive.  à a unit of a SPAC is often trading for around $10 per unit.  Given that large companies  like Google or Apple are trading for hundreds of dollars per share, the “normal investor” can acquire a number of units for a modest price point. 
2. They invest in “hot” sectors of the marketà  SPACs tend to focus on areas like technology that people can easily get excited about. 
3. Usually, participation in IPOs is limited to sophisticated investors (read “wealthy”) and other people who are on intimate terms with Wall Street.  But, given the large number of units usually offered, ‘regular

Why might and investor NOT want to invest in a SPAC?

1. Blind Investment It is not transparent at all, just what the SPAC is going after.   This is why the investment is REALLY in the Management Team.
2. Lag time. There can be up to 2 years (perhaps more time) between investment and the acquisition of any company.
3. Mixed track record. The average SPAC will outperform the index (Either the S&P or the Russel 2000, usually) in the very short term.  But, go out more than a quarter beyond the first acquisition, and most SPACs underperform compared to the index.
4. Even if the SPAC performs poorly, the Management team will likely escape with a pretty sweet deal.  (Think “Golden Parachute.”)
5. On occasion, the SPAC might acquire a company many times larger than itself through a PIPE deal.   PIPE stands for “Private Investment in Public Equities” and have been around for a long while.  Be aware, when the SPAC makes a PIPE deal with an institutional investor, they often have to reveal their targets to that investor before anybody else in the market.   This asymmetry of information seems to be a strong reason against the individual investing in a SPAC.

The Verdict

Investment in a SPAC can be an extremely risky thing.   This means that you COULD make A LOT of money quickly, or lose it all, both are possible.  I guess my advice would have to be that investment in a SPAC can be responsibly done by an individual investor, if they first invest most of their money in retirement accounts and less risky assets.  Investing in a SPAC should be the cherry on top of the sundae, NOT the whole sundae.

REFERENCES

Special Purpose Acquisition Company (SPAC) Definition (investopedia.com)

What is a SPAC? Definition, risks, how to invest – Business Insider

Almost everything you need to know about SPACs | TechCrunch

Special Purpose Acquisition Companies: An Introduction (harvard.edu)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.