A Special Purpose Acquisition Company (SPAC) is a publicly traded corporation that has under two years to merge with another company.
SPACs are private companies attempting to be made public through acquisition or mergers and are formed to raise funds to buy another company.
In the initial public offering (IPO), units are typically priced at $10 per share for SPAC investment.
A Special Purpose Acquisition Company (SPAC) is not a new investment concept, although the SPAC market has moved closer to the investment mainstream in recent years. If you’re new to SPACs, this overview can help you understand how to invest in SPACs and why SPAC investments may offer an opportunity to add diversification to your portfolio.
“Investors need to pay attention to shifting sands in the SPAC market given regulatory changes. Hopefully, investors will move away from viewing SPACs as an investment category and instead evaluate the underlying companies’ individual prospects.”
Eric Freedman, chief investment officer at U.S. Bank
A SPAC is a shell company promoted by an investor or management team to take it from private to public. Third-party investors raise capital through an initial public offering (IPO). After raising funds, SPAC managers seek to put those assets to work by acquiring one or more companies not yet listed on a public stock exchange, eventually trading under their own stock symbol.
Simply put, a shell company serves as a transactional vehicle for raising funds via an IPO and doesn’t offer services or products. A shell company can be used for many purposes, including to buy real estate, move funds between bank accounts, and collect royalties.
A SPAC is a unique investment vehicle that raises capital through an IPO with the special purpose of acquiring another company. By law, companies targeted for acquisition are identified once the SPAC has completed its IPO and is fully funded. Therefore, SPACs have earned the moniker of “blank check” companies, as investors don’t know which company or companies a SPAC will ultimately acquire with the funds it raises through the IPO.
Once created, a SPAC will begin raising funds through an IPO. After the money is raised, that capital is held in a trust until the SPAC determines which private company it wants to acquire and make public. Once acquired, the SPAC’s investors will then decide if they wish to hold onto their shares, buy more shares at below-market value or cash out their shares.
Alternatively, if a SPAC doesn’t fulfill its mission to complete a merger within the time constraints, it will liquidate all funds raised and return them to investors.
As a public investor, SPACs allow you to partner with venture capital firms and investment professionals to get involved with a company early on. To buy SPAC stock, you’d take the same steps as you would for investing in current publicly traded companies – working directly with a financial advisor or visiting a retail brokerage website.
The surge in SPAC financing in 2020 and 2021 may have been an outgrowth of an exceedingly healthy global equity market. Investors became more interested in exploring different ways to put money to work, and SPACs appeared to offer an intriguing opportunity to get in on what many perceived as a “ground floor” opportunity with companies that have yet to go public.
“SPACs are not an asset class,” says Eric Freedman, chief investment officer at U.S. Bank. “SPACs are the byproduct of a corporate finance decision. Companies can raise capital in many ways, including through a traditional IPO, a direct listing or through a SPAC. We don’t look at a company’s growth prospects or its investment merits based on its capital raising methodology.”
There were 248 SPAC offerings in 2020 and 613 in 2021, but activity dropped dramatically, to 86 in 2022. Through April 2023, there were just 14 SPAC offerings.1
The drop-off in new SPAC issuances may be due partly to increased regulatory scrutiny of SPACs. The Securities and Exchange Commission (SEC) has focused on the following:
Warrants. Warrants are securities that give investors the right to purchase another unit of the SPAC at a certain price before a particular time. Most SPACs issuing these warrants treated them as assets on their balance sheet. In 2021, the SEC issued a determination saying that the SPAC must treat these warrants as liabilities in certain circumstances. Classifying warrants as liabilities could result in more regulatory reporting requirements for SPACs, which could affect offering activity and SPAC investment.
Disclosures. March 2022, the SEC proposed additional rules and amendments to increase disclosure and improve investor protection in SPAC IPOs. Doing so would require, among other things, disclosures about SPAC sponsors, their potential conflicts of interest and how share value can be diluted through features that reward specific investors or entities associated with a SPAC. Also proposed are disclosures relating to the fairness of these transactions.2
“The biggest driver of increased SEC scrutiny is likely the desire to create more visibility for investors,” says Freedman. “It’s placing tighter controls on how these firms can project out revenue and earnings growth.”
Another factor in the changing environment for SPACs may be underwhelming results from recent offerings. “Retail investors may have pulled back from SPACs due to some relative performance concerns,” says Freedman. He notes that several high-profile SPAC offerings performed well for insiders and sponsors, but not as favorably for the investing public. “This has likely taken some of the luster off of SPACs for those who look at them as a category, at least for now,” he adds.
During a challenging investment environment across the broad capital market spectrum, SPAC results suffered as well. The recent decline in new SPAC index activity may reflect waning investor enthusiasm for this part of the market. However, this may also be a short-term development, and activity could potentially recover over time.
A change in the investment environment may also be a contributing factor. “Some of what you see with SPACs is similar to the market for more traditional forms of stock IPOs,” says Rob Haworth, senior investment strategy director at U.S. Bank. “Investors attracted to these types of investments are looking for a chance to generate capital appreciation regardless of economic conditions.” He explains that in a slower-growth environment, which was predominant in previous years, SPACs and IPOs drew investor interest because they could potentially grow at a rate that outpaced a slower-growing economy.
“That wasn’t so easily accomplished when the pace of economic growth picked up as it did in 2021,” says Haworth. He notes the sectors that benefited from cyclical economic growth were more advantageously positioned for the current environment. Growing investor concerns with the speculative nature of SPACs may have dampened enthusiasm, with increasing regulatory oversight potentially adding to investors’ caution.
Because SPAC investors lack advanced knowledge of potential targeted acquisitions before they commit money to it, it’s crucial to approach SPAC investing with your eyes open. Exercise caution as you consider this an appropriate diversification tool and assess each offering to determine whether it’s worth investment. Selectivity in choosing individual opportunities is critical regardless of the types of investments you’re considering. With SPACs, you’re primarily judging the track record and expertise of the management firm making the offering.
“Well-managed SPACs that are focused on industries in a strong position can represent attractive opportunities for investors,” says Freedman. “Yet investors need to pay attention to shifting sands in this marketplace given regulatory changes that may impact disclosure and accounting rules. That could alter the landscape for how people view SPACs. Hopefully, investors will move away from viewing SPACs as an investment category and instead evaluate the underlying companies’ individual prospects.”
Depending on a SPAC’s specific features, there are different risk levels associated with investing, including the inflation impact on investment. Before investing in SPAC, take some time to familiarize yourself with investing strategies to help you work toward your financial goals.
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