You may have heard the term “SPAC” a lot recently as they have become a hot investing topic, but what actually is a SPAC?
What are they?
A SPAC is a shell company set up by a group of investors with the sole purpose of acquiring a private business to take public. The SPAC raises money through an IPO, usually offered to institutional investors before individual investors. The SPAC will then place the capital raised through the IPO in an interest bearing trust account while it searches for a company to acquire. If a company cannot be found within a given time period, the trust is liquidated and investors’ money is returned.
Why use a SPAC to go public?
The typical process to take a company public through an IPO can be very burdensome, expensive and risky. Before a company can IPO, it must go through an intense and time consuming registration process with the SEC. There is also the risk of bad market timing or negative investor perception that could lead to a failure. This makes an IPO equal parts marketing, timing, and fundamental pricing.
If they are instead taken public by a SPAC, the registration process is simplified and can move more quickly. More importantly, private companies receive guaranteed amounts of capital from the SPAC because they work directly with a specialized executive team that knows the value of their business. They would not have the same reassurance if they went public on their own via IPO.
On top of that, there are advantages to going public through a SPAC for owners. For starters, they can sell a higher percentage of ownership due to the reduction of restrictions. Also, founders can avoid lockup periods that typically do not allow their shares to be sold to the public for a period of time.
In 2019, when WeWork attempted to go public, its IPO collapsed as investors criticized the business model and management. Today, we see WeWork merging with BowX in a deal that will net WeWork approximately $1.3 Billion. They are just one of numerous big name companies to go public with SPACs. Others include: Virgin Galactic, DraftKings, OpenDoor, SoFi, BarkBox, Hims and Hers Health, and Nikola Motor Co.
Why are they so popular recently?
SPACs have been around for almost 30 years, but it has not been until recently that we have seen a spike in popularity. One reason for this is because of the market activity caused by the global pandemic and the Biden administration proposed tax changes. The extreme volatility in the market made many companies hesitant to go public via the traditional IPO route. While some of those companies simply chose to postpone their IPO, others chose the route of merging with a SPAC due to the certainty of the process. This allows for a quick infusion of capital to help stay afloat during a prolonged period of economic decline and shutdowns.
Source: PitchBook, Data as of February 24, 2021
Are SPACs worth investing in?
As with most investments, there are risks when it comes to investing in SPAC’s. Remember, a SPAC only has a limited amount of time to find a company to acquire after the initial IPO. And not only does the IPO leave investors “blind” to which company the SPAC may acquire, but the time clock placed on managers to find a suitable acquisition that shareholders agree upon may lead to managers being pressured into taking less than optimal acquisitions, meaning your investment might not perform as well as you had hoped.
For these reasons, SPAC investing is considered speculative, so don’t invest more than you are willing to lose. If you are trying to decide if SPACs fit into your investment portfolio, ask yourself these key questions:
What is my investment goal?
What is my investment time-horizon?
How much risk am I comfortable with?
Once you know your answers to these questions, you can better determine if SPAC investing is right for you and your personal investing goals.
Looking for help with next steps? Our advisors at Finwell can help you understand all of your options and create a plan to reach your goals. Get started by emailing email@example.com or scheduling a consultation today.
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