Many investors are constantly on the prowl for new options that could help them make a bit of cash. If SPACs have recently made their way onto your radar and you’re wondering if you should be investing in them, here’s what you need to know.
What Are SPACs?
SPAC stands for “special-purpose acquisition company.” Also referred to as “blank check companies,” SPACs are publicly-listed, but are considered non-operating. Instead, they exist solely to purchase private companies, allowing the company that has been acquired to have a connection with a publicly listed stock.
Generally, the process of becoming a publicly-listed is cumbersome. By going the SPAC route, a private company can avoid the challenges associated with an initial public offering (IPO). The SPAC is already public. Plus, by using a reverse merger after the acquisition, the once private company can transition to a public one while maintaining autonomy.
Are SPACs a Good Investment?
Like any part of the investment landscape, there is certainly risk associated with investing in SPACs, even if there doesn’t appear to be any on the surface. While it’s true that if a SPAC doesn’t find a private company to scoop up, investors get their money back after a set amount of time, your money may not be working for you as hard as it could going another route.
Additionally, there’s no guarantee that the private company a SPAC grabs is going to be successful once it is part of the market. As recent history has shown, not all IPOs go well. If the SPAC selects the wrong company, you can certainly experience losses.
Finally, by design, SPACs benefit the SPAC sponsors far more than individual investors. Generally, the sponsors get a significant stock allocation for the SPAC IPO, and the founder shares can dilute common stockholders.
In many cases, a SPAC’s performance can be subpar. When there is a high-valued private company serving as a potential target, it can generate competition among SPACs. When that happens, the price may inflate, causing the SPAC that “wins” to overpay, something that doesn’t work in investors’ favor.
SPAC Overpays
However, the sponsors – due to the nature of the arrangement – can still come out ahead even if the SPAC overpays, creating a level of conflict of interest. The decisions may not be in the best interest of individual investors. Instead, only the sponsors serve to gain.
Ultimately, it’s wise to be cautious about investing in SPACs. You may not know exactly what the SPAC will scoop up when you invest, which isn’t ideal. Additionally, there can be issues with transparency, as well as potential conflicts of interest.
In many ways, a SPAC is riskier than a traditional IPO. If you’re risk-averse, that’s far from ideal. However, even if you are open to some risk, the low historical performance should give you pause. If you do think SPACs are right for you, research is your ally, as it may give you an indication about the SPAC’s ability to choose the right private company. Make sure you really dig in, as that may be your only way to determine if a SPAC has potential.
Do you think investing in SPACs is a smart move? Do you plan on adding them to your portfolio? Why or why not? Share your thoughts in the comments below.
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Tamila McDonald is a U.S. Army veteran with 20 years of service, including five years as a military financial advisor. After retiring from the Army, she spent eight years as an AFCPE-certified personal financial advisor for wounded warriors and their families. Now she writes about personal finance and benefits programs for numerous financial websites.
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