SPACs 101 – What You Need to Know
Special purpose acquisition companies (SPAC) became a popular investment theme in late 2020 and early 2021. SPAC performance was strong through this period, gaining 56 percent from late October 2020 through mid-February 2021. Hoping to participate in outsized gains, investors purchased SPACs without abandon. As seen in past speculative environments, the good times rarely last for long. SPACs peaked in February 2021 and have lost nearly a third of their value since then. When such speculative fervor ignites in an area of the market, the underlying fundamentals and characteristics of specific securities are often thrown to the side. A basic understanding of SPACs could have saved many investors from ill-timed investments.
What Are SPACs?
SPACs are primarily a tool for corporate acquisitions and mergers. Initially, SPACs are shell companies with no ongoing operations, formed only to raise capital. The shell company issues securities via an initial public offering (IPO) to raise money with the express purpose of acquiring a company in the future. SPACs are traded and taxed like traditional equity securities. If an acquisition cannot be finalized within two years, the capital is returned to investors. SPACs also are known as “blank check companies” since investors do not know what firm the SPAC will attempt to acquire or the business plan for the acquired company. SPAC investors range from sophisticated private equity and hedge funds to retail investors. Once a target firm is identified, SPAC owners vote to finalize the deal. Once ratified, the SPAC effectively “de-SPACs” and carries on as a public company.
SPACs Are Becoming More Common
SPAC IPO issuance boomed in 2020 and 2021, with 671 new offerings. There were just 226 issued between 2009 and 2019.
SPACs have certain advantages over the traditional IPO process for private companies. Faster transaction timelines, a negotiated valuation for the acquiree (as opposed to market pricing), lower costs of marketing, and increased investor acceptance have supported increased SPAC usage.
What Are the Risks to Investors?
While speed and reduced costs are benefits to the SPAC and the acquiree, there also are unique risks for prospective investors to consider:
- Reduced time for due diligence efforts
- Potential for inaccurate financial reporting
- Reduced operational inspection, which can affect regulatory filings
- Management teams with little experience leading a public company
- Conflicts of interest within the ranks of sponsors, officers, directors, etc.
IPOs have outperformed SPACs so far in 2021 (through August 31); IPOs have returned +3.79 percent as opposed to SPACs -19.75 percent loss. As a rule of thumb, investors generally view companies that have gone through the traditional IPO process as higher quality investments as opposed to SPACs, due to increased scrutiny of their financials. However, some well-known firms like DraftKings, SoFi, and 23andMe have gone public through SPACs.
High-profile investors and celebrities have helped raise awareness of SPACs among retail investors, where many may have gone unnoticed in the past. For some investors, speculative investments may have a place in a well-diversified portfolio, but position sizes should be measured and limited. Thorough due diligence is a crucial part of the investment process and should be performed before purchasing any security. If you have questions about your portfolio, please ask your BKD Private Client representative about our wealth management services or submit the Contact Us form below.