[What The Heck is a SPAC?]
Is this the first time you’ve heard the word? For many of you, it likely is. But good news, I’m here to change that! Although SPAC won’t replace Amazon or Netflix in your vocabulary, it’s worth a quick read to educate yourself on this suddenly very popular investment product.
For starters, SPAC stands for Special Purpose Acquisition Company, also referred to as a blank check company. Their general purpose is to find private companies and take them public, as an alternative to the traditional IPO routes. The reason you may have heard a lot about them recently is not due to their sudden emergence (they’ve been around for decades), but due to their recent massive increase in popularity. As a point of comparison, in 2016 they raised $3.2 billion, in 2019 they raised $13.6 billion, and in 2020 they raised a whopping $83 billion! Suffice it to say, SPACs are here to stay!
So how does a SPAC work? Essentially, they’re created by a sponsor with no specific company, rather an industry in mind. The sponsor raises money from outside investors and places that money in interest-earning accounts. Once formed, the sponsor typically has two years to acquire a private business and make it public, or else refund the money to the investors. Assuming they’re successful, the private company goes public and gets listed on an exchange. Those early investors now own shares of the newly public company, while the sponsor gets the very rich benefit of owning 20% of outstanding shares.
Pros of a SPAC?
What are the benefits of a SPAC? Generally, there are a handful of benefits to a SPAC. For starters, it’s a substantially quicker way for a private company to go public. Typically, it can take years to go through the normal IPO process, whereas a SPAC can get the job done in months (and is a major win for the company). For the sponsor, they get 20% of the outstanding shares for essentially brokering the deal and seeing it to completion. For those end investors who’re always looking for the newest fad, it’s an easier way to get in early on the IPO process. Otherwise, it could be difficult to get IPO access to these companies.
Cons of a SPAC?
What are the negatives of a SPAC? Despite all the positives, there are naturally many negatives of a SPAC. For the company, they’re giving up 20% of their outstanding shares to the sponsor (which ain’t chump change). There are several negatives for the end investor, as well. For starters, they’re essentially buying nothing. The sponsor raises money first, then targets their prey. Thus, the investor is buying completely on speculation and the ability of the sponsor to find a good company to take public. Additionally, the investor must remember that the incentive is for the sponsor to target their company of choice in two years, or else risk returning the hundreds of millions of dollars raised. The issue here is they sometimes rush to make a deal, which doesn’t always lead to the optimal target company. Finally, the sponsor is incented to make a deal where they can often “overpay” for a company while keeping 20% of the value. What’s the issue in that? If you’re an investor, it simply can lead to less upside, while taking all the risk of the downside.
That’s a SPAC folks.
It’s truly such a fun word to say, right?
In the end, the reality is SPACs do provide a decent alternative to the archaic IPO process. The concern our investment team has is how many are actually in existence today. If you’re an end investor, you have to choose wisely. It can be very difficult to do, as there’s not much to base your decision on during the capital raising process. Our team feels they’re a risky play. If you’re going to invest in them, do so through an actively managed fund (rather than a more passive vehicle) due to the complexities.
I hope you learned as much reading this as I did writing it. As always hope this finds you on your way to wealth, health, and happiness.