Special purpose acquisition companies or SPACs for short are formed to raise capital through an initial public offering (IPO). The capital raised from investors is then used to acquire a private company. Also called shell companies or blank check companies, SPACS have become an increasingly popular alternative to the traditional IPO process. For example, between Jan. 1, 2020, and Aug. 21, 2020, SPACs raised $31 billion across 78 transactions, surpassing the capital raised by IPOs over the same time period. Interested in how to invest in SPACs? It’s important to weigh the pros and cons before diving in.
A financial advisor can help you sort through your options as you consider adding alternative investments to your portfolio.
What Is a SPAC?
A SPAC is a shell company that’s established in order to raise capital through an IPO, with the sole purpose of acquiring a private company. The target company doesn’t necessarily need to be identified right away; the SPAC can disclose which company they plan to acquire once the IPO is complete.
SPACs don’t have any ongoing operations, nor do they have products, services or revenue. Instead, the focus is on identifying a company that’s an optimal target for acquisition. For example, a SPAC may look for up-and-coming companies that are highly innovative or have significant growth potential but little revenue to speak of as yet.
Once the target company is acquired by a special purpose acquisition company, it’s able to have a publicly listed stock that can be traded on an exchange. This is a type of reverse merger since you have a publicly traded company purchasing a private company rather than the other way around. Essentially, a SPAC or blank check company does all the hard work of going through an IPO on behalf of another company without.
One notable difference between the traditional IPO process and SPAC IPOs has to do with speed. SPACs don’t go through the road show process, which involves pitching the company to investors. The requirements for financial reporting and due diligence are also less burdensome with a SPAC, all of which means the process can be completed in a much shorter time frame.
Why Invest in SPACS?
Investing in special purpose acquisition companies can appeal to investors who are interested in up-and-coming companies but may face obstacles to investing in them. For example, while some online brokerages are now offering IPOs as an investment option, not all of them do. That can represent a barrier to entry for many investors.
SPACs make it easier for the average retail investor to get in on the ground floor of a private company as it goes public, without having to invest in an IPO. It’s even possible to own a collection of them in your portfolio if you’re investing in a SPAC exchange-traded fund (ETF), which invests in multiple special purpose acquisition companies.
The hope, of course, is that the companies being acquired will grow in value over time, making your initial investment more valuable. Once the SPAC IPO is complete, you can choose to hold onto your shares or sell them. This requires a leap of faith on an investor’s part, however, since you don’t necessarily know which company you’re investing in until the SPAC process is complete. That’s one reason why they’re called blank check companies—you’re effectively writing a blank check and leaving it up to the SPAC sponsors to decide how to use it.
How to Invest in SPACs
If you’re interested in adding SPACs to your portfolio, it’s possible to buy them through an online brokerage account. Fidelity and Robinhood are two examples of online platforms that offer SPACs to investors. You can also look to an online brokerage account for SPAC ETFs as well.
Individual SPAC IPOs may be offered as units, which are designated by a “U” at the end of their ticker symbol. If you’re buying a SPAC unit, you’re actually buying one share of common stock and part of a SPAC warrant. This warrant gives you the option to buy an additional share of stock later. So if you’re taking this route to invest, you’d need to decide how many units of a given SPAC you want to purchase, based on their trading price and how much you have to invest.
Investing in SPAC ETFs works much the same as investing in any other type of ETF. The most important things to note are what’s included in the ETF and how much you’ll pay to own it. In terms of underlying holdings, you’d want to look at how much of a SPAC ETF’s portfolio is allocated to companies that have undergone the reverse merger process already versus those that haven’t. You may want to take note of how many individual SPACs the ETF holds and which market sectors they represent. Also, consider the expense ratio as SPAC ETFs may be more expensive to own compared to other types of ETFs.
Whether you invest in SPAC units or SPAC ETFs, consider how long you plan to hold them and your objectives for doing so. SPACs have a two-year window in which to announce an acquisition. So it’s possible that the money you invest in them could lie fallow for an extended period of time. The timing can influence how much of your portfolio you decide to commit to SPAC investing.
Know the Risks of Investing in SPACs
Central to the question of how to invest in SPACs is calculating the potential risks. SPACs generally offer less information and transparency than traditional IPOs. So you may want to do your own due diligence and research into the SPAC itself and the company that’s being targeted for acquisition if that information is available.
Remember that these are largely speculative ventures and you’re putting your trust in the expertise of the SPAC sponsors. It’s possible that a SPAC may underperform relative to expectations or that the deal may fall through if it isn’t approved by shareholders. Unlike traditional IPOs, SPAC share prices are typically not a reliable indicator of valuation. So it can be difficult to predict with any degree of certainty what type of performance you might be able to expect once the acquisition is complete.
The Bottom Line
SPACs might appeal to investors who want to invest in promising companies without jumping through the typical IPO investing hoops. While these investments have the potential to be rewarding, they can also carry a higher degree of risk. Aside from understanding how to invest in SPACs, it’s also important to consider where they fit in a portfolio, in terms of diversification.
Tips for Investing
- Consider talking to a financial advisor about whether investing in SPACs makes sense for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor, get started now.
- Be sure to take periodic advantage of a calculator to determine an ideal asset allocation and then deciding on how much to commit to SPACs.
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