SPACs: What Is There To Know About The Investing Craze

SPACs What Is There To Know About The Investing Craze, June 2021

When it comes to making money on the markets, the game is always changing and it can be difficult to stay up to date. Recently, the latest craze sweeping the markets by storm are SPACS. SPACS have exploded in the last while and have raised an incredible amount of capital in a very short period of time.

But what exactly are they? How do they work? Can you invest in them? Those who have never heard of SPACS most likely have those and a million other questions. Let’s talk about what SPACS are, how they work, and the potential earnings.  

Special Purpose Acquisition Company (SPACs)

These companies also known as “blank check companies” have no commercial operations and are created for the sole purpose of raising capital through an IPO (initial public offering) for the purpose of acquiring an existing company. 

This is an alternative way to make a company public by merging the target company with the SPAC company.

Using this method of making a company public is a way to alleviate some of the hurdles, regulations and conditions that companies need to hit in order to go public. 

In addition this method of going public tends to be on the cheaper side in comparison to the alternatives. 

This is a very basic breakdown of SPACS seeing as they are incredibly complex, and can differ in size, structure, and quality.

Contrary to popular belief this is not a new idea and it has been around for decades. The recent resurgence in SPACS may have a lot to do with celebrity and big name investors causing record amounts of money being raised. 

How Do SPACs Work?

Typically, SPACs are formed by investors or sponsors with expertise in a particular niche or business sector that intend to do further business in that field.

Usually, when creating a SPAC, there is a target company in mind for a merger however this information is rarely disclosed during the IPO process.

Essentially the IPO investors have virtually no idea what company they are ultimately investing in, but will have no idea of the niche. The blind investment is most likely where the term “blank check company” comes from. 

Once the IPO is complete and the money is raised, it is placed in an interest -bearing trust account. These funds cannot be put to use unless to complete an acquisition or return the money to investors.

If after 2 years, a SPAC does not complete a merger it will be liquidated and the funds returned to investors with the sponsors suffering the biggest losses. If a company has been acquired by the SPAC it is usually quickly followed by a listing on a stock exchange. 

Is Investing In SPACs Worth It?

There are some important details to note when it comes to investing in SPACs. Firstly, SPACs have seen a rapid rise in popularity and that may be a result of the number of celebrities and high profile managers and executives getting on board.

Typical SPAC timeline

This can lead to improved exposure, popularity and gains, further increasing interest and cash flow.

It is important to consider whether the success of a SPAC is due to any important or high-profile figure or if there is significant news and evidence to support a worthy investment. Take careful consideration of this when doing your due diligence. 

Secondly, contrary to the advertised low fee structure, there may be underlying fees that can dig into your profits.

For example the sponsor’s equity stake can be up to 20% and that’s not even mentioning any other banking fees. Unfortunately SPACs IPO fees and expenses to retail investors can be significantly more expensive than fees associated with a standard IPO investment.

Lastly, SPACs tend to do their best performance from the time of their IPO to the time they find a merger target. Interestingly, enough SPACs weakest performances usually follow a successful merger. 

Using this trading strategy of buying at IPO and selling prior to merger has yielded an average annual return of 9.3% over the 10 years spanning from 2010 to 2020. Conversely, SPACs held for a year after merger have seen a yearly annual loss of 15%.  Take note of these strategies before committing to an investment in SPACs.

Factoring In The Quality of a SPAC

Quality is also a very important factor when it comes to the performance of a SPAC. Having a team of all-stars from fortune 500 companies and professionals of merit associated with a SPAC has led to stronger returns than those SPACs that did not have high-quality management.

When doing your investment research on SPACs be sure to check for any noteworthy people associated with the SPAC, if you do find one or several people of importance then you may be onto a gem of an investment.

Keep your eyes peeled for news and high-profile people attaching themselves to certain investments as those investments tend to do better overall. 

SPACs in the Market Right Now

Early 2021 saw a decline in the SPAC index and deal announcements while the amount of SPACs not making deals have been relatively even across the board. It appears the craze for SPACs has taken a slight pause for now and the levels are moving sideways for the time being. 

There are investors who are unnerved by exponential growth and performance of the SPACs. Their concerns aren’t poorly founded either as it is true that SPACs trade on very little if any fundamentals prior to the merger.

This can be concerning as even after the merger or acquisition there is no guarantee of further gains or profit. 

I would like to mention the historical unwillingness for investors to hold onto SPACs shortly before and after a merger.

This is concerning as there is a clear pattern of performance and once that becomes obvious the jig is up and the pattern begins to change again. Be wary of falling into the trap of “it happened before, it will happen again.” 

Some speculators are comparing SPACs to the tech boom of the 90s which saw many unprofitable and companies going public only to have it all come crashing down shortly after.

In the current day, the SPAC frenzy has stalled and it seems some of the steeper losses have not translated to the greater market. 

Regulation on SPACs is Increasing

The Securities and Exchange Commission (SEC) has noted some “significant and yet undiscovered issues'' with SPACs seeing as the traditional IPO safeguards are being bypassed through this method.

Due to the increased surge in SPAC activity and the increased levels of investor attention, the SEC is taking a closer look in order to implement some needed regulatory changes.

The suggested changes coming into effect would not destroy SPACs, however it would certainly increase the amount of time required to reach a merger or acquisition deal. 

SPACs The Bottom Line

It seems we have hit the eye of the SPAC storm and are sitting in calm before getting back into some serious action.

Despite the brief pause in the SPAC index, interest in SPACS remains high. Keepin mind that each SPAC can be wildly different from the next one and risks can vary greatly as well. Given the increased scrutiny from the SEC and the recent halt in the market I would be hesitant to suggest SPACs as a safe investment. 

In fact, the historical data of SPACs only returning profits prior to merger has me concerned about their speculative nature as well. While SPACs are useful especially when navigating difficult regulations for certain companies.

The incredible increase in SPAC volume may also indicate an exploitable loophole in the system that the SEC is now looking more closely at. Regardless of the reasons, the speculative nature of SPACs and the increased regulatory pressure of the SEC put a strain on the viability of SPACS as a safe and profitable investment.

However, if you feel confident in your trading abilities, then SPACs can be a good way to make up to 10% return annually. 

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