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A Special Purpose Acquisition Company – also known as a ‘blank cheque company’ – is essentially a shell company that seeks to raise capital through an IPO in order to purchase an existing company that isn’t currently publicly traded but is looking to do so.
A SPAC has no commercial operations until it acquires an existing company, and the share holders won’t know initially what the SPAC is going to invest in. They will, however, know the types of areas and industries they’re focusing on potentially investing in.
SPACs are generally created by industry and investment professionals who have expertise in a particular sector, and have typically 2 years to use the capital collated from investors otherwise this will be returned (potentially at a loss depending on the share price).
SPACS have become incredibly popular over the last year or so. Over $21.5billion was raised through SPAC IPOs in the US alone.
This has been supported even more recently with Rishi Sunak announcing plans to make it easier for ‘blank cheque companies’ to list on the London Stock Exchange.
A brief history
The history of SPACs dates back to around the 1990s, beginning with investment bank GKN Securities, who would create the initial template for the formation and implementation of SPAC investing.
Interest in SPACs didn’t really take hold until around 2003 with entrepreneurs seeking to back experienced managers in high risk/ high reward equity opportunities. This came as a result of the growth in hedge funds and assets under management, as well as a lack of compelling available returns through traditional investment means.
Since 2014 the growth of SPACs has rocketed; from $1.8bn across 12 SPAC IPOs in 2014 to $83.3bn across 248 SPAC IPOs in 2020 worldwide. Just 3 months into 2021 and already over $73billion has been raised through SPACS.
Some notable companies that went public through the SPAC route include:
- Burger King (went public in 2012)
- Virgin Galactic (went public in 2019)
- DraftKings (went public in 2020)*
The largest ever SPAC – Pershing Square Tontine Holdings – raised over $4billion in July 2020.
Pros and Cons
- The SPAC IPO process can be a lot cheaper and easier for companies looking to go public. Going through a SPAC IPO could mean companies go public as quickly as 8 weeks compared to roughly 6 months through the traditional IPO route
- If the share price of the SPAC rises upon the announcement of an acquisition, the investor can purchase more shares at a cheaper price by exercising their right to purchase more through a ‘partial warrant‘
- They give retail individual investors access to IPOs where they may not be able to through the traditional IPO route
- Investors who purchase shares in a SPAC don’t immediately know where their money is going to end up
- The 2 year deadline – when a SPAC needs to use its capital by – could result in a rushed acquisition if they can’t find a more suitable company to purchase within that time just to make sure the sponsors get their compensation. This could result in investors unintentionally investing in a less desirable company and/ or overpay for overvalued companies
- SPACs have an incredibly volatile history. Excluding DraftKings and Nikola in 2020, new SPAC IPOs averaged returns of -10.5% between Jan and July**
- Questions have been raised over the due diligence carried out on the private company about to be acquired (see Nikola as an example case study)
- The huge increase in SPAC investments has been argued by many that this could be an indication of a ‘market top’ owing to the huge inflation of tech companies going public via this route
- Because a retail investor has little idea which company the sponsors will end up investing in, it could be argued this is veering more towards a gamble rather than an investment
The popularity of SPACs has exploded exponentially over the last couple of years.
But their lack of transparency and reliance on the SPAC sponsor finding a quality company, means this sort of investment can be incredibly risky.
The rise of SPACs has caused some concerns and acknowledged similarities between now and dot com bubble, but this is by no means a given and purely speculation and media chatter.
Given that interest rates are looking to remain incredibly low for the foreseeable future, investors might see these alternative investment opportunities as a reasonable substitute for for places to put their cash.
This was a recent feature on the latest Money to the Masses podcast episode. Find links to this great personal finance podcast and many more <<here>>.