SPAC vs. IPO: Do Special Purpose Acquisition Companies Live Up to the Hype?
Special-Purpose Acquisition Companies (SPACs) are shell companies that raise money from investors and then merge with private companies. SPAC mergers have become increasingly popular routes for private companies to make their debut on the stock exchange. Once the merger is complete, the company can use the money raised by the SPAC to expand and improve its operations.
Investors, however, may not reap as many benefits as private companies and celebrity sponsors. SPACs are difficult to evaluate before the merger, and SPACs typically have two years to choose a company to acquire. If investors do not like the selected company, SPACs often give investors the chance to redeem their shares. Even so, SPACs are speculative investments and may be a waste of investors’ time.
SPAC Timelines: What Investors Need to Know
SPACs usually have two years to identify an emerging company it wishes to acquire, although SPAC timelines vary. If the SPAC does not choose a company by the deadline, it must return money to its investors.
- When a SPAC starts selling units on a public stock exchange, it is only a shell company.
- After the SPAC chooses a company with which it wants to merge, the investors typically have the chance to redeem their investments.
- In some SPACs, the shareholders vote to approve the merger. Investors can find out if they have that right by looking up the SPAC in the SEC Edgar database.
- Once the merger is complete, the SPAC company will start trading under the acquired company’s name. For instance, after a SPAC acquired Buzzfeed, the company began trading under the ticker symbol BZFD.
Why are SPACs So Popular?
Also called “blank check companies,” SPACs have made headlines recently because of celebrity sponsors like Shaquille O’Neal, Serena Williams, and Donald Trump. SPACs might also find sponsors in financial stars like Bill Ackman and Chamath Palihapitiya.
SPACs tend to go after trendy private companies. Electric car companies, social media platforms, and space travel startups have all been acquired by SPACs. These factors give SPACs a buzzy appeal, which can distract from the fact that they are speculative investments.
SPAC Stock Prices
Initially, SPAC shares trade at $10 per unit. Units usually consist of stock shares and warrants. Warrants give investors the right to buy shares at a certain price at some point in the future. The warrants and the stock may trade separately and use different stock symbols.
SEC Warning for Investors
The SEC has put out an investor bulletin warning investors not to invest in a SPAC solely based on a celebrity sponsor. Recent SPAC deals suggest a strong conflict of interest for SPAC sponsors since they often acquire equity in a company at favorable terms that protect them from losses. On the other hand, investors are taking on the risk that the value of their shares will plummet once the SPAC completes its acquisition.
SPAC vs. IPO: What is the Difference Between a SPAC and a Standard IPO?
Investors do not know what they are signing up for when they buy shares of a SPAC. With a standard IPO, the investor or a broker can evaluate the prospectus, including the company financials and the management teams’ experience. With a SPAC, initial investors must wait up to two years before the company takes its final form.
The prospectus may have information about what type of business the SPAC will seek to acquire, but SPACs usually have no obligation to stick to the initial criteria. Once the SPAC announces which company it intends to acquire, the investors can redeem their shares. This allows investors to opt out if they disapprove of the selected merger.
Unfortunately for SPACs, this means they often lose a ton of money once they announce the merger. For instance, when a SPAC acquired Buzzfeed, 94% of investors withdrew. This is a common phenomenon—The Wall Street Journal reports that the average SPAC loses 60% of their funding once they announce their merger.
This is just one of the many risks that investors should consider.
In an IPO, business owners are not allowed to make projections to the public. This is meant to curb false promises and overly optimistic future earnings estimates. SPAC sponsors, meanwhile, can say whatever they want about their target company’s earning potential. As a result, SPACs are especially likely to be over-hyped by their celebrity sponsors once the merger is announced. At this point, there might not be any information about the merger released to the public to counter any of the claims made on social media.
Investors need to know if they are buying their SPAC shares at the IPO price. If an investor buys shares of a SPAC on the open market, they might cost more than the IPO price of $10. If an investor decides to redeem their shares, they will be redeemed for the IPO price and not the price they purchased on the market. The SEC warns that this could result in a loss.
Questions to Ask Before Investing in a SPAC
Are you considering investing in a blank check company? The SEC wants investors to ask the following questions before investing:
- When can you redeem warrants, if ever? How will you be notified that the redemption window has opened? If you miss the redemption window, your warrants may no longer have any value.
- Will you be able to vote on the merger, also known as the “initial business combination”?
- Can your portfolio afford to wait two years to find out if the proposed merger fits your investment strategy?
When to Speak with a Securities Attorney
SPACs are flashy investment vehicles that have suddenly increased in popularity. Did your broker recommend investing in a SPAC because of your stated financial goals, or did they simply want to hop on a trend? If you lost money on a SPAC, take advantage of the free case evaluations offered by Kurta Law.