It’s just a matter of time before the cops show up at a home party that becomes a bit too wild. And when there’s a party on Wall Street, the Securities and Exchange Commission is the one who receives the call.
SPACs, or special purpose acquisition firms, appear to be in this category. So far in 2021, SPACs have generated more than $106 billion in initial public offerings, which is more than the total acquired between 2003 and 2019. That type of rapid expansion attracts the attention of authorities, and the SEC has certainly interfered.
As the SEC’s actions, The regulator announced updated accounting advice for SPACs in a statement issued on April 12, 2021. While this may appear to be a tiny detail, it immediately had a significant influence.
Business Law Today managing editor Yelena Dunaevsky, vice chairman of transactions insurance at Woodruff Sawyer, believes the shift imposed an additional burden on accountants working on SPAC agreements and contributed to a downturn in the market.
Taking into consideration how huge the market had gotten, a pause may have been exactly what the SEC was looking for.
For retail investors, what are the implications of increased regulatory oversight? Could there be a place for this specific asset type in your portfolio?
Publicly traded non-operating corporations, Special Purpose Acquisition Companies (SPACs), are formed for the sole purpose of identifying and acquiring a private company, allowing the acquisition target to have publicly traded shares.
In addition, SPACs are often referred to as “blank check” firms. It’s termed a reverse merger when a SPAC or other publicly traded corporation buys out a private firm. In a conventional merger, a private firm takes a public company private, while the public company remains publicly traded.
It is estimated that 247 SPACs would generate $83 billion in the capital in 2020 through IPOs. A record number of SPACs were formed in 2019 and 2020, compared to those built in the 18 years preceding.
There are more and more SPACs and each of them is generating additional cash through IPOs in order to acquire larger firms. Compared to 2019, the average SPAC IPO in 2020 was $336 million.
This sort of shell business is meant to raise cash through an IPO. As a method to invest in private firms coming public, SPACs have grown increasingly popular. After the initial public offering, these shell corporations would utilize the cash obtained to combine with or buy another business.
Their significant level and poor historic performance make them inappropriate for most individual investors, notwithstanding their current appeal.
What is SPAC?
The term SPAC refers to a company that goes public through an initial public offering (IPO) despite having a comprehensive commercial operation in place prior to the public sale. These companies are in their infancy and exist with the purpose of merging with another firm or acquiring another company.
Its life cycle is considerably different from that of a typical corporation. They focus on a single product or service and work hard to establish the business model’s value. To obtain cash and grow its operations after completing this process, the firm may decide to list on a public stock exchange.
Unlike a real corporation, a SPAC is a shell company that exists only on paper. As part of its first business combination or reverse merger, the company sells public shares in order to acquire cash for the purpose of merging with or purchasing another firm.
Every penny of public cash raised by a SPAC is placed in a trust account. If the SPAC does not fulfill its first business combination, or if it liquidates and distributes the assets to the shareholders, the money stays in the trust. Investors can opt to stay in the newly merged firm or redeem their shares if the merger is successful.
Special purpose acquisition company is another term for a “blank check business”. It then combines (or buys) an existing private firm, therefore taking it public. A number of SPACs do not tell investors what sort of firm they want to combine with or acquire before executing a merger.
“Special objective” of a SPAC is to introduce a promising private firm to the public investment market. As complex as SPAC plans might be, they usually take less time to execute than typical IPO offerings and can be less expensive. Going public via a SPAC tends to have cheaper advisory costs than a typical IPO. In the early stages of a company’s lifecycle, it’s easier to comply with the standards of a merger than it is to successfully conduct an initial public offering.
What do you need to know before the initial business combination?
Understanding the terms of your investment is crucial. It is vital to understand the unique features of each SPAC, including the equity shares owned by the sponsor, which may have been acquired for minimal value. It is also necessary to analyze the business past of the SPAC’s management and its sponsors, given that there is no operational experience to evaluate. In the SEC’s EDGAR database, you may examine a SPAC’s IPO prospectus and periodic and current reports.
You can trust the account. As a rule, SPAC IPO profits are retained in a trust account. the first business combination—or, in the event of a SPAC, its liquidation—has been accomplished or a specific period of time has passed without an initial business combination being completed or a certain amount of time has elapsed without an initial business combination being completed. Investments by SPACs are typically in reasonably secure, interest-bearing products, but it is important to carefully analyze the exact conditions of an offering since there is no regulation mandating the proceeds to be invested only in those sorts of assets. Interest on trust account investments is a common source of funds for SPACs.
stockholders are entitled to their pro-rata portion of the aggregate money thereafter deposited in a trust account.
As a result, you should examine the prospectus of the SPAC’s initial public offering (IPO) to understand the conditions of its trust account, including your rights to redemption and the circumstances under which funds may be withdrawn.
The price of a trade. SPACs are generally priced at a minimal $10 per unit in the IPO process. Like a regular IPO, the price of a SPAC IPO is not dependent on an existing business’ value. These variations in market pricing may have little relevance to the eventual economic performance of the SPAC.
A first business combination must be completed within a certain time period. For the first company combination to be completed, a SPAC will generally allow for a two-year time frame. In other cases, however, SPACs have elected for shorter lengths of time, such as 18 months or 24 months. This term may be extended by the SPAC’s governing documents. It may be necessary for a SPAC to obtain shareholder approval before extending the time period. It must execute its first business combination within three years of its first public offering (IPO) if it issues its securities on an exchange. A SPAC’s initial public offering (IPO) funds are retained in trust until the SPAC consummates a corporate merger or liquidates itself.
SPAC Merger
A SPAC’s starting pricing for its stock is generally $10 a share, and it often offers warrants to acquire more shares or offers some other incentive for potential buyers. As a result of its IPO, the SPAC selects and negotiates with a private firm in exchange for a portion of the post-merger business. When a public institution merges with a private company, the financial structure may incorporate money from outside investors who offer extra capital in return for shares.
As acquisition targets are announced, SPACs’ share prices tend to jump, but if mood changes or if the deal includes too many new investors, a SPAC’s share price may drop after the deal is announced.
Virgin Galactic was the first high-profile SPAC transaction (NYSE: SPCE). Chamath Palihapitiya, a venture capitalist, created a SPAC named Social Capital Hedosophia Holdings late last year. Virgin Galactic merged with SPAC, bringing it public. An estimated 49 percent interest in the merged business went to Social Capital Hedosophia Holdings shareholders, while Virgin Galactic took home $850 million in cash and a public ticker symbol, according to a press release.
If an individual investor wants to invest in a SPAC, he or she will have to purchase shares or warrants in the secondary market.
SPAC units can be worth investing in after the initial public offering (IPO), but before a merger agreement has been disclosed. However, investors need to be cautious and know exactly what they are acquiring on the secondary market. After the initial public offering (IPO), the unit is generally divided into stock and warrants, which can be sold independently and have distinct return characteristics. The stock’s upside potential is considerably reduced if it is purchased without a related warrant.
The unit divide entails the following:
It is necessary to value the stock and warrant separately. Investors who acquire shares for more than $10 lose the premium if they elect to exercise their redemption rights at the time of the merger announcement.
Shareholders don’t yet know what the SPAC will fund in, how much it will pay, or how much more stock loss will occur as a result of the warrant. It requires two options to buy one share, with a strike price of $11.50 per share and a five-year maturity. The maximum price of the warrants is $18 per share.
Can investors in a SPAC be impacted by this?
As a result of the merger, the stock may trade at a greater price than its private market value, allowing the shares to trade up to its secondary-market value.
A warrant’s value rises when the stock price climbs, similar to buying a call option.
If the shareholder decides to sell the shares back to the SPAC, he or she would lose any premium paid over $10 in the initial public offering (IPO). Many SPACs were trading at between $12 and $14 per share in the secondary market before the merger. They would lose between 15 percent and 30 percent if they redeemed their shares when a merger target is revealed. It might also sell down if the merger price was too expensive or too dilutive if shareholders maintain their equity through the merger.
The option is possible that the stock’s value will not climb to its strike price, reducing its value over time as it nears its expiration. If you have a portfolio of warrants, you probably expect that some of them will expire worthlessly, some will break even, and a few others will be valuable enough to offer an acceptable return on the total portfolio.
SPACs are increasingly trying to purchase running firms, thus it is vital to assess if favorable initial company combinations may become less common.
s part of its initial public offering (IPO), SPACs typically offer investors a unit of securities that consists of shares of common stock and options to purchase stock. If you own warrants, you can acquire more shares of common stock at a future date, usually at a higher price than the current stock price.
Units of SPAC will continue to trade for a period of time following the initial public offering (IPO). Soon after the SPAC’s initial public offering (IPO), its common shares and warrants may begin trading independently with distinct symbols on a major stock market. When separate trading is to begin, the SPAC will often submit a current report on Form 8-K and send press releases to let investors know. An investor should be informed of whether he or she is acquiring units, ordinary shares, or warrants following the IPO.
What do you need to know at the time of the initial business combination?
Vote and share your redemptions. SPAC’s investors will have the chance to redeem their interests and, in many circumstances, vote on the initial business combination deal after the SPAC has identified an initial business combining opportunity. Upon the initial business combination, each SPAC investor can either stay a shareholder in the firm or redeem and get their pro-rata portion of the money kept in the trust account.
Investors should take this into mind when the SPAC transitions from a trust account to a corporation that really operates. If you are an investor, you can choose whether to repurchase your shares for a pro-rata portion of the aggregate cash then on deposit in the trust account or to remain an investment in the merged firm going ahead.
Whether it’s a proxy, information, or tender offer statement, you’ll find everything here. In this case, the SPAC will present shareholders with a proxy statement in advance of the public referendum on the first business combination. Since some investors, like the funder and its subsidiaries, have enough votes to approve a transaction, a SPAC may not seek the approval of public shareholders. In these instances, the SPAC can provide stockholders with an information statement prior to completing the immediate business transaction.
As part of the initial business combination, the proxy or disclosure statement will include information about a number of important topics, including a business description and financial statements, as well as a list of parties and their interests in the transaction. It will also include data about the initial merger, including the financial performance of the combined entity, and the terms of the transaction. Your shares of common stock will be redeemed for your pro-rata portion of the total money than on reserve in the trust account by following the instructions in the proxy statement or information statement.
The tender offer statement will provide information on the target firm and your redemption rights if a SPAC is not obliged to present shareholders with a proxy or information statement (for example, if a SPAC is not required to gain shareholder approval of the deal).
The sponsor’s interests are taken into consideration. These sponsors are able to get more advantageous conditions than investors in the initial public offering (IPO) and in the following open market. As a result, shareholders should be conscious that even though most of the SPAC’s assets has been supplied by IPO stockholders, the funders and possibly other initial investors will profit more than shareholders from the SPAC’s finalization of an original joint venture and may have an ability to keep a transaction on terms that may not be beneficial to you.
To support the initial business combination, the SPAC may require further financings, and such financings frequently involve the sponsors. It is possible that this will cause a greater divergence between the interests of the sponsors and yours. The additional money from the sponsors may dilute your stake in the merged business or may be delivered in the form of a loan or security that has different rights than your investments, for example
How to Invest in SPACs
You have two primary alternatives when it comes to engaging in a public market launch. Investors with significant connections or institutional investors can acquire SPAC shares on the primary market, where issuing corporations issue equity units.
The majority of investors, however, do not have access to this kind of information. It is thus necessary for them to acquire their shares on the public or secondary market, which is also called the public market. Equity units in SPACs are generally priced at $10 a pop, according to the businesses’ sponsors.
SPACs can become publicly listed stocks after they go public. You can acquire their shares just like any other publicly-traded company. There is no difference in terms of mechanics between a SPAC stock and a normal stock. Fundamentally, though, SPACs do not have any underlying commercial activities to support them. If they do, it’s usually because they’re in the process of merging with a privately owned company, which is generally but not always an early-stage startup.
If the merger fails, each blank-check business has its own set of rules. It usually takes 18 to 24 months to complete a project of this magnitude. It will repay the money received from early investors if it does not discover a suitable candidate.
SPAC acquires the identity of the private business after a successful merger. Also, the ticker symbol changes to one that matches the company’s identity or business. This is why many analysts refer to this procedure as a reverse merger or a backdoor technique of taking a private company public.
As with regular IPOs, SPACs share many characteristics, but they’re also unique from them. Investing in these businesses is tempting to ordinary investors since you may acquire them in the early stages, expecting that they will find a fantastic company. If you want to be an early bird IPO investor, SPACs are the closest thing you can do.
How SPAC Investors Make Money
Just as with other investment categories, SPACs provide a variety of strategies to generate money. Institutional investors and high-net-worth individuals have the largest advantages when it comes to blank-check companies.
First of all, SPAC sponsors are rewarded handsomely for their efforts. It is important to note that SPAC sponsors assume the reputational risk when they take a SPAC public and look for an appropriate target firm. They are compensated by a larger discount to the price that the target business would have received in an IPO.”
Just as with other investment categories, SPACs provide a variety of strategies to generate money. Institutional investors and high-net-worth individuals have the largest advantages when it comes to blank-check companies.
First of all, SPAC sponsors are rewarded handsomely for their efforts. It is important to note that SPAC sponsors assume the reputational risk when they take a SPAC public and look for an appropriate target firm. They are compensated by a larger discount to the price that the target business would have received in an IPO.”
Hedge funds have a restricted risk potential with SPACs, mostly because of their size. They receive their money back if a SPAC doesn’t succeed. Hedge funds can earn from both shares and warrants if the plan is successful and the stock price rises.
SPAC shares can also be purchased by ordinary investors before merger announcements. They may be able to acquire shares at or near the initial $10 price if the SPAC doesn’t have a lot of excitement behind it. On the secondary market, however, much-hyped SPACs tend to perform better because of their sponsors’ reputation.
Last but not least, public investors can potentially bet on the announcement of a SPAC once the merger has taken place. In this case, the objective is to speculate on a company with a high potential for growth. Because of this, this is the riskiest approach to profit from SPACs, as there are no safeguards if something goes wrong.
What are the Advantages of SPAC
There are a number of reasons why SPACs might possibly offer value to stakeholders, notwithstanding the criticism surrounding them.
Traditional IPOs exclude individual investors from buying shares on the primary market. How so? In terms of profitability, small retail investors are the least profitable source of capital. On the contrary, underwriters are more interested in finding institutional investors and wealthy individual purchasers. Due to all the hype built up, the typical investor has no choice but to engage in a secondary market. Anyone can acquire shares in a SPAC before the merger is announced.
Many startups choose to go public via the traditional IPO process, but some don’t have the means to do so. Processes that are considered “normal” require a high level of monitoring, such as financial disclosure. Moreover, this approach requires a lot of time and patience. SPACs expedite the process and make it initially inexpensive for startups (though giving up 20 percent equity to sponsors can be a long-term drag). Ultimately, ordinary individuals have more investing options.
There is no way to predict what will happen with a typical initial public offering, which often benefits from a phenomenon known as the “IPO pop,” where public investors in the secondary market bid up shares of eagerly anticipated IPOs. Sometimes, IPOs might be duds, according to the Wall Street Journal. With SPACs, individual investors can reduce some of the risks of the unknown by buying SPAC shares before a merger announcement has taken place. Shareholders receive their money back if a deal doesn’t go through for whatever reason.
Disadvantages of SPAC
Public investors may find SPACs attractive, but they may also find the dangers intolerable.
As a result, the average investor is fooled into thinking that he or she is getting in on the ground floor of an offering. If you’re trading in the lobby, you’re really doing it better than if you were doing an IPO. Priority investors in the primary market obtained the best offer (shares plus warrants) early, so don’t be fooled! SPACs are low-risk investments for the wealthy, but not for you.
Investors new to SPACs are often surprised by dilution. A blank-check firm’s warrants might be a minefield for people who don’t pay attention to the finer nuances. In case the market value of a SPAC rises considerably, the options become highly appealing. If warrant holders exercise them, they may extract more profit from the same deal, which results in a flood of shares on the second-hand market, putting pressure on the price of the stock.
SPACs have a questionable track record since institutional investors are enticed to pump, dump and flee from them. Virgin Galactic is one recent example (NYSE: SPCE). Chamath Palihapitiya, the chairman of SPCE, reportedly sold his entire personal ownership in the company in March, according to news sources. This resulted in the share price plummeting, which has not yet stopped at the time of this report. Sadly, many investors who bought into Virgin Galactic’s excitement lost their money in the end.
Should You Invest in SPACs?
Before a merger or acquisition is announced, investors rely on the SPAC’s sponsors, its management team, to select an appealing target. A SPAC’s sponsoring organization is important for this reason. Some are funded by prominent investors like Palihapitiya, while others are affiliated with celebrities or notable athletes to draw attention and raise their popularity among the public.
Prior to a merger, SPAC’s share prices tend to be very steady. To make a small return during the period it seeks for a merger partner, a SPAC generally invests the money it obtains when it is created in government bonds or other secure investments.
Purchase of fresh SPAC stock may require a leap of faith, but the return might be significant. It is only possible for an individual investor to completely benefit from a quick price increase if he or she invests while the SPAC is still looking for a bargain.
NASDAQ-listed fantasy sports firm Draftkings (NASDAQ: DKNG) will become a public corporation by combining with a SPAC in 2020. Over the course of a few months, the company’s valuation grew from $3 billion to $13 billion. SPAC investors are hoping to capture that kind of growth by investing early.
You’ll know exactly what you’re getting. SPAC’s share price reflects this information as well.
Which brings us to the question: Are SPACs a good investment?
Examine each SPAC. It’s possible to make huge profits by using the reputation of a trusted expert to discover high-value merger candidates. They provide big benefits for little risk if you’re able to engage in SPACs on the primary market, and they’re easy to understand, too.
Longer-term sustainability makes the situation murkier. As the Virgin Galactic disaster revealed, SPACs have not typically produced positive outcomes following their mergers. SPACs can still give long-term returns, but investors should be exceedingly cautious when investing in them.
How to Invest in SPACs
Investment in SPACs can be made through individual shares or through a SPAC ETF.
SPACs allow investors to focus on the possibilities that look most promising while still providing some downside protection owing to their structure.
Investors have the option to exit the SPAC through liquidation or by selling shares in the secondary market.
SPACs are therefore unlikely to fall below the IPO price until after a merger has been completed.
In the SPAC IPO, investors are given a warrant and a share of SPAC common stock. SPACs are frequently sold after their initial public offerings and their warrants are kept, which might grow in value if the SPAC stock approaches or exceeds the strike price at which a common stock warrant can be exercised.
Academics Tim Jenkinson and Miguel Sousa found a technique to profitably invest in SPACs, which they call the “SPAC Investment Method.” After the IPO, they purchased the SPAC and sold it one week before the merger announcement. As a result, this approach had a median return of 7.6 percent.
It is hoped that the management would transform the IPO into a successful merger down the line while investing in SPACs. You have nothing to compare against in terms of a product, service, or performance. Do as much information about the founder and their intentions that you can. As part of their prospectus, SPAC founders frequently select a certain sector or firm as a target.
Two years is the average time between the IPO and the first business merger. A firm will be liquidated if a merger hasn’t taken place within that time frame. Investing in a SPAC means you’ll likely have to wait at least two years before you see a return.
As speculative investments, SPACs and other blank check businesses are considered by the Securities and Exchange Commission (SEC) to carry a high chance of losing your original investment. It’s vital to invest in SPACs with money that you can afford to lose, as a result of these risks.
One of the most fundamental elements of investing is diversification. To reduce your chance of loss, consider investing in lower-risk investments in addition to SPAC shares.
A word of caution
It is crucial to recall that the disclosure standards for SPAC agreements are different from those for initial public offerings.
It is forbidden for corporations to forecast future financial success during their first public offerings (IPOs). Comparatively, a SPAC-listed business is authorized to give precise revenue and profit predictions that are five years or more in the future. If you are a new, pre-revenue company that would prefer that investors focus on your potential instead of your so far poor performance, this regulatory distinction can be a big help.
This is partially due to a desire to protect individual investors, but it is also due to the fact that the procedure is tedious and restricted. As a result, when investors invest through SPACs, they lose some of these safeguards. Portfolio risks are higher when you invest in younger, less-established firms.
An example of a SPAC merger that should be avoided is VectoIQ (NASDAQ: VTIQ) and Nikola Motors (NASDAQ: NKLA). As soon as the merger transaction was announced in March 2020, VectoIQ shares soared in value by more than 600 percent. The feasibility of Nikola’s products came into doubt later in the summer, after a merger was completed. Nikola’s stock price has subsequently reverted to its original level as additional unfavorable information has been published regarding the company.
If Nikola had gone public, it’s hard to say whether investors would have been alarmed enough by the situation. However, in retrospect, it’s apparent that not enough due diligence was performed before the SPAC transaction.
Things People Ask About Investing in SPACs
Are SPACs Safe Investments?
As a description of how SPACs function, the alternative name blank-check company is beneficial. As a result of their credentials and experience, deal makers generate money. Fintech businesses, for example, are an example of a sector in which they have specific ambitions to invest.
An acquisition target is sought after once a SPAC is fully funded and its war chest is created. Though SPACs are sometimes referred to as “blank check” companies, investors have some protections. In most cases, if investors don’t like the deal, they can sell their shares within a set time limit. If the deal doesn’t happen during that time frame, investors can get their remaining cash. Most investors own both shares and warrants in the SPAC in order to maximize their investment returns. They allow the investor to raise their ownership at a predetermined price if the transaction does well at the end of its lifespan.
As an alternative to a full IPO, SPACs can provide firms with a speedier and less complex route to market.
A SPAC is just a way for firms to go public. Similar to an IPO procedure, the quality of the firm being bought is a significant factor in the acquisition process. Heavily weighted historical data on SPACs is not particularly reassuring.
SPACs might fail to discover a viable acquisition candidate, which is the first problem. A return on investment can be equal to holding Treasury notes for a number of years, rather than investing the money in the market. That’s a significant opportunity cost if it happens. Your money will be put to good use with an IPO, but not so much with a SPAC.
The second reason is that historically, SPACs have not done very well. Research released in 2007 revealed that historically, SPACs had lost around 3 percent a year compared with the market. It’s important to note that these are old statistics and that more recent SPACs may have done better.
As a result, IPOs tend to lag the market in their first year based on data from 1975 through 2014. For the current crop of SPACs, this is not a good sign. While investors lose money in these agreements, managers of SPACs perform extremely well. Managers of SPACs can amass considerable wealth even if shareholders do not, depending on the conditions of their deals.
Can I lose Money After Investing In SPACs?
You can lose money after investing in SPACs, yes. Some of the takeovers that the SPACs have decided to make have failed, putting an end to what previously appeared like a surefire success. When volatility surges, the speculative sections of the market also tend to be heavily impacted.
A risk-off trend would hurt the IPO market more than other regions, said Justin Lenarcic, senior global alternative investment strategist at Wells Fargo.
This is an acronym for Special Purpose Acquisition Businesses (SPACs). These companies obtain funds in an initial public offering and then utilize the proceeds to merge with a private company and take it public, generally within 2 years. Excited investors poured into shares in these empty corporate shells hoping they would hit a home run, but instead they were left disappointed.
Bill Ackman’s $4 billion Pershing Square Tontine Holdings and two of Chamath Palihapitiya’s SPACs are among the high-profile transactions selling more than 40 percent above their IPO prices.
If you don’t like the offer, you may redeem your interest, but that only works if you buy early, says Lenarcic. Your investment’s success relies on when in the SPAC’s lifetime it’s made.
This implies that they would miss the early gains in common shares as well as the perks connected with warrants if they bought them on the secondary market. Buy-and-hold investors, on the other hand, who only join in after a transaction has been done, lose money nearly invariably.