Special Purpose Acquisition Company SPAC Explained: Examples and Risks

The U.S. had more than 30,000 publicly traded companies in 1996. That number was more than halved to just 13,330 by the start of 2017. That has meant fewer options for long-term investors and shorter-term traders alike. One criticism is that “less worthy” companies that might not have been able to launch a successful IPO can more easily reach the public markets via blank-check companies.

However, investors must always weigh the risks and determine how the SPAC fits in to their overall portfolio strategy. Because there’s no company to start with, no assets, no product, and no track record, investors are betting on management. Compared with traditional IPOs, SPACs often offer targets higher valuations, less dilution, greater speed to capital, more certainty and transparency, lower fees, and https://www.topforexnews.org/news/turkey-braces-for-yet-another-currency-crisis/ fewer regulatory demands. A prolific financial writer, Andrew Packer has helmed newsletters on small-cap value investing, early-stage investments, special situations, short-selling, covered call writing, commodity investing, and insider trading, among others. And as with most financial innovations, some will abuse the market for blank-check companies, and some will create tremendous wealth for investors.

1. Some studies have found that, for a large majority of SPACs, post-merger share prices decrease.
2. If a SPAC is overwhelmed by redemptions, it may cancel the deal.
3. Venture capitalist Chamath Palihapitiya’s SPAC Social Capital Hedosophia Holdings bought a 49% stake in Virgin Galactic for $800 million before listing the company in 2019.
4. “SPACs could generate more than $700 billion in acquisition activity in the next two years.”

Special purpose acquisition companies, or SPACs, have been around in various forms for decades, but during the past two years they’ve taken off in the United States. In 2019, 59 were created, with $13 billion invested; in 2020, 247 were created, with $80 billion invested; and in the first quarter of 2021 alone, 295 were created, with $96 billion invested. In 2020, SPACs accounted for more than 50% of new publicly listed U.S. companies. Once it goes public, the SPAC typically has between 18 and 24 months to seek out a “target company” and negotiate a buyout.

SPACs 101: What Is a SPAC, And How Does It Work?

These funds are usually invested in government bonds while the SPAC sponsor seeks acquisition targets. Once the IPO raises capital (SPAC IPOs are usually priced at $10 a share) that money goes into an interest-bearing trust account until the SPAC’s founders or management team finds a private company looking to go public through an acquisition. A SPAC—which can also be known as a “blank check company”—is a publicly listed company designed solely to acquire one or more privately held companies. The SPAC is a shell company when it goes public (i.e., it has no existing operations or assets other than cash and any investments). SPACs are publicly traded corporations formed with the sole purpose of effecting a merger with a privately held business to enable it to go public. Compared with traditional IPOs, SPACs often offer targets higher valuations, greater speed to capital, lower fees, and fewer regulatory demands.

That’s because when a SPAC raises money, the people buying into the IPO do not know what the eventual acquisition target company will be. Institutional investors with track records of success can more easily convince people to invest in the unknown. That’s also why a SPAC is also often called a “blank check company.”

What changed with SPACs?

They then merge with that target, which allows the target to go public while avoiding the much longer IPO process. At that point, the entity usually is no longer known by the SPAC moniker, but by the name of the acquired company. Now just like any startup, the SPAC management team needs to put up some money in order to get that eventual payoff. That money is referred to as the “risk capital.” This capital funds the SPAC from its inception until its eventual merger with a private business. SPAC shareholders should carefully evaluate the target company when an acquisition is announced.

For instance, on March 1, Rocket Lab agreed to merge with blank-check firm Vector Acquisition (VACQ). The company will trade as RKLB after the deal’s close, which was expected to happen during the second quarter. That’s one of the risks that comes with investing in SPACs — its investors don’t know what company they’ll eventually be investing in. NerdWallet, https://www.day-trading.info/best-stocks-to-buy-and-watch-now/ Inc. is an independent publisher and comparison service, not an investment advisor. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances.

Insights from Fidelity Wealth Management

If it does so, it usually will change its ticker to reflect the new entity it has merged with, and shareholders will now be invested in the acquired company. When a blank-check company does go public, it usually sells “units,” almost always at $10.00 per share. These units often include a share of common stock, but also a fraction of a warrant allowing investors to buy a common share at some point in the future, typically with an exercise price of $11.50 per share. Investors who pony up that initial sawbuck will see their capital go onto the company books as cash. A SPAC is a shell company, or a company that doesn’t produce any products or offer any services.

Many companies chose to postpone their IPOs (for fear that the market volitlity could spoil their stock’s public debut). But others chose the alternate route to an IPO by merging with a SPAC. The time from announcing a deal to receiving shareholder approval typically takes about three months.

In most cases, the SPAC will be created by a group of institutional investors, Wall Street investors, or professionals at a hedge fund or private equity firm. Because of how SPACs are structured, investors typically get back the par value of the shares (usually fundamentals of web application architecture $10 per share) but may lose out if they buy shares at higher prices in anticipation of closing a deal. Indeed, investors are only entitled to the pro rata share of the trust account and not the price at which SPAC shares are bought on the market.

The deal itself is known as a “reverse merger.” This is a term outside of the SPAC world, too. If a public company isn’t doing so well, for example, a private company could take over, using the public entity to enter the market. In a SPAC merger, the private company is using the SPAC to take it public, instead of going through the traditional IPO process itself and risking a failed offering or a bad opening day on the market when it starts trading.