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SPAC stands for Special Purpose Acquisition Company. It’s a company that launches through an IPO, with the express purpose of acquiring other companies.
SPACs have been around for decades, but they have become very popular in recent years – in the first three quarters of 2020 over 50 SPACs were formed in the US, raising a total of $21.5 billion.
Think of a SPAC as a blank cheque company that has no detailed business plan and no operations – it doesn’t actually do anything at the time it publishes its prospectus for the IPO.
If you invest in a SPAC you are banking on the expertise of the management team, a group of investors who will generally have a strong background in a particular industry or business sector.
When a SPAC launches it generally won’t disclose which company it plans to target for a takeover or merger. This could be because they don’t have a particular target in mind yet, or they might know which company they are after but not want to go through the paperwork that disclosure would require.
Advantages of Investing in a SPAC
SPACs give individual investors the chance to get in at the start of a potentially big stock, before the shares start to rocket as demand builds – unlike with normal IPOs where institutional investors snap up the shares first.
SPACs are cheap – many are priced at just $10 a share.
SPACs tend to focus on hot new trends in the tech or consumer field.
Regulations around SPACs have tightened up considerably since the 1980s, when there was a lot of fraud around blank check companies. Now, the money raised in the IPO of a SPAC cannot be used except to complete an acquisition. It’s put into an interest-bearing account, and in some cases the interest earned is used as the working capital of the SPAC. If the SPAC is liquidated because it fails to acquire a company, the money is returned to investors.
Disadvantages of SPACs
It’s impossible to evaluate the future profits you would get from a SPAC since you are investing blind, not knowing how the money raised in the IPO will be used.
It can take up to two years for a SPAC to target and buy another firm – so investors have to be patient.
SPACs have a mixed track record. While some have been spectacular successes – see below for an example – the average SPAC underperforms the market, according to research by Goldman Sachs.
Example of a SPAC Deal
One of the most high-profile SPAC deals in recent years involved Richard Branson’s Virgin Galactic. A venture capitalist, Chamath Palihapitiya, set up a SPAC called Social Capital Hedosophia Holdings, which bought a 49% stake for $800 million in Virgin Galactic, before the company was listed in 2019. Since it went public the shares have increased 146%.
