What is a SPAC?

There have been a series of arguments about SPACs (Special Purpose Acquisition Companies) over the years. For instance, there are those people who believe this is a great investment opportunity and as such, it should be explored to the fullest. On the other hand, some people feel they are not worth investing in. According to reports released by CNBC, SPACs have increased by almost 100% as compared to the number recorded in 2015. As of January 2021, the SPAC market in the US alone, was estimated to be worth billions of dollars (in IPOs).

Investing in a SPAC. Is it worth it?

We will try to explain everything about SPACs and if they are a good investment opportunity. As always be sure to read carefully, think rational and do more research about a specific company before investing.

What is a Special Purpose Acquisition Company (SPAC)?

These are non-operating companies (also known as publicly-listed) with the sole purpose of identifying and purchasing private companies. They lack commercial operations and have been formed with the goal of raising funds via an IPO (Initial Public Offering). They are acquiring existing private establishments. SPACs have been in existence for decades. However, most investors didn’t know much about them until recent years when they started gaining popularity.

Investors and underwriters are currently considering them as very attractive options. For instance, as of august 2020, over 50 SPACs have been founded. These have all managed to raise around $20billion. Don’t forget that in 2016, they were only able to raise $3.2billion. Under normal circumstances, SPACs have 24months (2years) for an acquisition to be completed. Anything more than this means that the funds may have to be returned to the investors.

The formation of SPACs is made possible by sponsors who have thorough knowledge in a particular field or industry. Funds will be raised through investors which will later be used in purchasing a private company within a space of 2years. Most times, the investors don’t usually have any idea about how such funds will be spent. They are only relying on the reputation and expertise of the sponsors to make profits eventually.

How do SPACs work?

SPACs work in a way that is very easy to understand. When they are formed, their founders usually have one acquisition as their primary target. However, they are usually unwilling to identify such targets due to avoidance of extensive disclosures. This is the reason why they are also known as blank check companies.

After funds have been raised via an IPO, they will be placed inside a trust account (interest-bearing). These funds will be used for completion of an acquisition and they can’t be disbursed. The only time funds can be disbursed is when the SPAC becomes liquidated. When interest is earned via trust, it can become part of the company’s working capital. Once an acquisition is completed, a SPAC is going to be listed on any popular stock exchange platform.

As every other investment opportunity, there are pros and cons that should be considered before investing. Here we will list a few of them:

Pros of SPACs:

Retail investor involvement

Under normal circumstances, traditional IPOs can’t be easily accessed by retail investors. These categories of investors are known as non-professionals. Their primary goal is to buy as well as sell securities. In a nutshell, they are individual investors.  However, they are allowed to get a piece of their pie given the way SPACs are being structured. For instance, acquired companies are given public listing thereby allowing individual investors to purchase securities and play a crucial part in their growth. There are some restrictions to such benefits though.

As a retail investor who wants to partake in the ownership of a private company, SPAC offers the chance for such to become a reality. All you have to do is invest in individual securities of SPACs. This can also be possible via SPAC ETF. The bottom line is that SPACs give individual investors the chance to acquire companies.

Redemption options

Initially, SPACs were not trusted by potential investors. During the 1990s, they took lots of sticks for their high risk and lack of transparency in terms of how funds were managed. Even during the early 2000s, this belief continued to wane its popularity before members of the public. However, it is a different case today. This is because investors are feeling much safer than the past years. This is one of the reasons why SPACs have raised around $20billion in 2020. Investors are beginning to believe the concept that it is operating on.

There is its redemption which comes into effect once the acquisition plan for a company fails to materialize within 2years. In this case, the funds of investors will be refunded. As an investor, you can redeem your shares thereby recouping your money back. Another instance whereby investors are free to recoup their funds back is when they are not satisfied or impressed with the acquisition process. This shows that to an extent, SPACs activities are very transparent.

Profit potentials

The profit potentials that Special Purpose Acquisition Companies tend to offer are quite impressive. It is the reason why they tend to be growing by leaps and bounds in recent times. If you are looking for an investment opportunity that is likely to yield maximum profits, these companies tick all of such boxes. They have a record of investing in hot areas which can grow and become better over the years.

Many companies are beginning to make the decision of going public via SPACs. One of the most notable is Luminar, a company that is into the field of autonomous vehicles. Of course, these vehicles have been predicted to be the future of the automobile industries meaning investors will earn lots of profits should such become a reality.

Other companies that have gone public through SAPCs are Nikola, Virgin Galactic, Clover Health, Open Door and DraftKings. Most SPACs are now focusing on consumer or tech fields since they are the hottest right now.

Cost-effective investment

This is one of the most notable advantages that SPACs seem to be offering investors at the moment. As a retail investor, one thing is always certain. This is the fact that your funds/resources are limited. Most SAPCs have discovered that pricing their shares low can attract lots of investors. For instance, a share can be valued at around $10. The best part is that this price can remain stable for a long period of time. Even when it increases due to market conditions and other factors, such effects may not be too obvious.

As compared to IPOs, SPACs shares are a much cheaper option to explore especially when you are limited in funds. The best part is that the process is even faster since it only takes about 3-4months. This is unlike the IPO process which took over 2years. As a retail investor, you will definitely get better deals via SPACs. It can help you save resources and time.

Cons of SPACs:

Uncertainty

If you recall, it was mentioned earlier that most times, a share is valued at $10 with SPACs. The reason for this is the high level of uncertainty. The acquisition is always based on assumption which means there is a chance of you experiencing losses. For instance, SPACs usually assume that when a company has been acquired and taken public, share prices are likely to soar.

Instead of initial investors betting on such companies, they will be putting all their hope on the sponsors to turn things around. In a situation whereby sponsors get it wrong in their analyses, losses are likely to be experienced. Apart from this being risky, sponsors can wield lots of power through such practice.

Time constraint problem

Even after SPACs have gone public, it is still possible for them to be liquidated. This happens when they don’t pick or target any company to acquire. At such points, funds are returned to investors. Again, this is another part of the uncertainty. They have only 24months to ensure funds are not just raised but a target company has been acquired. Anything short of this means the SPAC will be automatically liquidated.

There have been instances when sponsors can’t seem to reach agreement on vital matters related to acquisition of companies. This can threaten your investment since there is limited time.

Conclusion

Based on the above, it can be seen that SPACs (Special Purpose Acquisition Companies) have great investment opportunities which individual/retail investors can take advantage of. It is expected that in the nearest future, they will get better. Just ensure to weigh your options very well before signing up with any of them to ensure your investment is safe.

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