How to Invest in SPACs

In a year that the COVID-19 utterly defined and disrupted, another acronym — SPAC — provided investors with a much-needed distraction. Known as the special purpose acquisition company, this financial vehicle catapulted some of the best-performing stocks in 2020 and has the potential to do the same this year. 

But what exactly are SPACs and how can you benefit from them? We’ll guide you through the nuances before you dive in.

What is a SPAC?

SPACs, also called blank check companies, represent another method to take a privately held organization public — usually a hot technology startup. SPACs themselves have no underlying business, hence the term “blank check.” Instead, the SPAC exists to acquire a (hopefully) legitimate firm for the sole purpose of taking it public.

Compared to the traditional initial public offering (IPO), SPACs facilitate a quicker and direct approach for interested organizations to access capital markets. 

1. Initially, a sponsor of a particular SPAC takes the shell company public just to raise cash for an acquisition. Though specific rules vary, SPACs typically have two years to identify a merger target and close the deal.
2. To sweeten the pot, SPAC sponsors go on a roadshow, similar to an IPO. During this time, they make a pitch to institutional investors (like hedge funds or private equity firms) to spike interest and gain capital.
3. Following the funding process, sponsors must move the money into a blind trust until the time the SPAC's management team decides which company to acquire. While it's possible for retail investors to trade shares of the SPAC, the price usually doesn't move much until management publicly reveals the acquisition target.
4. This reveal occurs when the SPAC and its acquisition target sign a nonbinding letter of intent. These can cause rampant speculation among retail investors. If the two parties come to terms, they sign a definitive agreement. Next, it’s up to the SPAC's shareholders to vote for the deal.

Assuming approval, the ticker symbol of the SPAC changes to that of the acquired company.

Advantages of a SPAC

Learn more about the pros of SPACs:

• Convenience: SPACs offer startups interested in going public a quicker and easier method than the traditional IPO, which can be complicated.
• More interest: Although this financial vehicle has been around for a long time, it hasn't had the best reputation. SPACs have garnered interest among Wall Street's top power brokers recently, leading to high-quality SPAC management teams.
• Transparency: With a traditional IPO, you're dealing with multiple variables, including the pricing of the stock. In contrast, the merger target only negotiates terms with the SPAC interested in the deal. Therefore, the valuation is already a known fact.
• Less risk for shareholders: Prior to a definitive agreement, shareholders who don't want to invest in the revealed acquisition target can back out and get their money back.

SPACs Make a Comeback

Unlike popular perception, SPACs are not new concepts. During the 1980s and 1990s, however, they attracted nefarious agents interested in pump-and-dump schemes. It wasn't until recently, with disruptions such as the 2018 government shutdown and the current COVID-19 crisis, making the direct approach of SPACs attractive.

Examples of High-Profile SPAC Deals

According to the Wall Street Journal, 2020 was a record year for new SPAC listings. Notable high-profile SPAC deals include sports-betting firm DraftKings (NASDAQ: DKNG) and hybrid clean energy-fueled commercial transportation specialist Hyliion (NYSE: HYLN). Also, in 2019, space-tourism venture Virgin Galactic (NYSE: SPCE) went public via a SPAC merger.

Why Do SPACs Exist?

Essentially, SPACs provide an alternative for typically privately held startups to go public without having to endure the onerous and lengthy vetting process of a traditional IPO. SPACs can navigate around disruptions that impact federal institutions such as the U.S. Securities and Exchange Commission (SEC) — a relevant advantage during the pandemic-fueled shutdown.

Also, SPACs open opportunities to retail investors who wish to expand their portfolio to include assets similar in concept to private equity investing. In other words, regular folks get to have a "ground floor" opportunity.

SPAC Criticisms and Poor Performance

One of the most severe criticisms against SPACs is that they generously reward sponsors. For instance, shell company founders often receive 20% equity in the target acquisition firm, which is a hefty load for what basically is a one-shot endeavor.

Also, in arrangements where the founders (sponsors) receive 20% equity, there's little incentive for them to find the right deal. Instead, out of self-interest, they may seek any deal that will likely go through.

For retail investors, SPACs are not always hot performers. SPACs underperformed the broader market by about 3% annually in the first 3 years after their IPO, according to the Wall Street Journal.

Finally, retail investors should be extra careful with these shell companies because of the lack of scrutiny over a merger relative to a standard public offering.

How to Invest in SPACs

Although the concept sounds foreign or exotic to first-time investors, buying a SPAC is just like buying a "regular" stock: go to your online brokerage, search for the ticker symbol you want and execute a market or limit order.

Before a SPAC initiates a letter of intent with the proposed buyout target, however, you don't know what management is considering. You should treat SPACs as private equity ventures which are invariably high-risk, high-reward ideas.

At such an early stage, you're banking on the expertise and reputation of the sponsors and management team. Do your homework before climbing aboard.

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SPAC ETFs

Speaking of homework, no matter how much due diligence you perform regarding either traditional IPOs or SPACs, the overriding reality is that you don't know what you don't know. Even the best experts have been burned by public debuts gone bad.

To mitigate the risk, you may wish to consider SPAC exchange-traded funds (ETFs) featuring a basket of SPACs with startup prospects or shell companies seeking their target acquisitions. ETFs spread risk so that a calamity in 1 SPAC won't completely derail your portfolio. On the flip side, the gains are also spread wide, limiting upside potential.

What's the Downside to Going Public Through a SPAC?

Since SPACs are structured differently than the standard IPO process, the sponsors and institutional investors may have different incentives or motivations than retail investors. This may impact longer-term considerations.

Moreover, beyond the generous benefits for the sponsor, the overall fees associated with completing a SPAC deal ends up being more expensive than a traditional IPO. Put another way, startups interested in the SPAC route pay a premium for the convenience.

List of the Best SPACs

Though riskier than your typical blue-chip stock, SPACs offer the pivotal advantage of getting retail investors into an opportunity before the masses do. Many, if not most blank-check companies seek relevant tech firms, such as electric vehicle makers or fintech players.

Because of the explosiveness and high demand of such industries, it’s not unusual for some SPACs to trade well beyond their “paper” fundamental value. Take a look at a few of the hottest names to consider.

TWC Tech Holdings II Corp (TWCT)

Last August, TWC Tech Holdings II Corp filed with the SEC to raise $525 million in an IPO. This SPAC targets an enterprise within the technology-enabled services sector, specifically with a transaction value between $1 billion and $10 billion.

Previously, the team behind TWCT completed a deal with Open Lending (NASDAQ: LPRO), which has performed very well so far.

GigCapital2 Inc. (GIX)

GigCapital2 raised $285 million as part of its definitive agreement with UpHealth Holdings Inc. and Cloudbreak Health LLC. These form a combined entity — one of the few profitable and publicly traded global digital healthcare companies.

Churchill Capital Corp. IV (CCIV)

Perhaps the most exciting SPAC of this year, rumors circulated that Churchill Capital Corp. IV will merge with luxury electric vehicle manufacturer Lucid Motors. According to automotive analysts, Lucid may represent the first real competition for Tesla (NASDAQ: TSLA).

Social Capital Hedosophia IV (IPOD)

Shares of Social Capital Hedosophia IV have soared despite the underlying SPAC not finding a takeover prospect but for good reason — IPOD is famed venture capitalist Chamath Palihapitiya's 4th blank-check company. Considering Palihapitiya's previous successes, many pre-deal investors are banking on his golden touch.

Apollo Strategic Growth Capital (APSG)

Apollo Strategic Growth Capital has garnered significant interest largely due to Apollo's over 30-year history and strong management team.

SPACs Dominate

SPACs have taken over business headlines in large part because they provide startups with an easier, more straightforward path to going public. At the same time, these enterprises pay a premium for that convenience. Prospective shareholders should realize the pros and cons before getting involved.

Frequently Asked Questions