A Kellogg professor offers his perspective on why these investment vehicles can be losing propositions for many casual investors
SPACs are very complicated investment vehicles that mostly benefit everyone involved in the merger deal—except retail investors, themselves
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Special purpose acquisition companies (SPACs)—which are listed investment vehicles for taking private companies public via mergers, as an alternative to traditional IPOs—have exploded in volume and popularity over the past two years. In 2020, 248 SPACs were listed on public exchanges for an average listing size of $336 million and a total amount of capital raised of $83 billion. In contrast, in 2021, 613 SPACs were listed at an average listing value of $265 million and gross proceeds of $162 billion. Currently, there are 575 listed SPACs that are actively looking for target companies with which to merge and, in 2021, 312 mergers were announced and 199 mergers were completed at a gross value of more than $450 billion.
All this activity is attracting investor attention, but too many of them fail to understand that SPACs are very complicated investment vehicles that mostly benefit everyone involved in the merger deal—except retail investors, themselves. Therefore, it is imperative that investors understand the finances behind SPACs before investing in them.
SPACs are exchange-listed shell companies with the sole purpose of targeting and merging with a private operating company, whereby the target becomes listed. The rationale for SPACs is that they offer private companies a quicker, easier, and more certain way to become publicly traded versus a traditional IPO.
The life cycle of a SPAC is straightforward: The SPAC is incorporated, is listed on an exchange, looks for a target with which to merge, and negotiates a merger deal, which is then voted upon by the SPAC shareholders; if approved, the SPAC then merges with the target company. Once a SPAC closes its merger, the target company is listed, replacing the SPAC shell company on the stock market. Note that, once listed, the SPAC has two years to merge with a target or it must be liquidated.
At the start of its life, the SPAC conducts an IPO by selling units at $10 each. A unit consists of one share of stock in the SPAC and typically a fraction of a warrant, which grants the owner the right to purchase a SPAC share at $11.50 after the SPAC merges with its target. After its listing, the SPAC simply holds the cash received from its IPO in a trust account. The trust cannot be drawn until closing its merger with a target company, except in very specific conditions. After a merger deal is approved, if the SPAC shareholders do not think the merger will create value, they can redeem their shares from the SPAC for $10, if they wish, while keeping their warrants.
[This article has been republished, with permission, from Kellogg Insight, the faculty research & ideas magazine of Kellogg School of Management at Northwestern University]