What is a SPAC?
Editorial staff, J.P. Morgan Wealth Management
- SPAC is the acronym for “special purpose acquisition company” and is often referred to as a “blank check” entity.
- A SPAC might be best described as a shell company looking for a promising private company to invest in.
- A SPAC is a public company having already gone through the IPO process.
- One of the main risks for SPAC investors is the competence of the SPAC management team in navigating the target company’s market.
- An obvious benefit of a SPAC to investors is the lure of potentially getting in on “the next big thing” before it becomes “the next big thing.”
What is a SPAC?
SPAC is the acronym for “special purpose acquisition company” and is often referred to as a “blank check” entity. SPACs exist to acquire or merge with promising private companies, which would take that company public without the need for an initial public offering (IPO). However, the identity of the target companies is unknown to the investors in a SPAC. So, in essence, investors are allocating money to invest in an unknown entity, which is similar to writing a “blank check.”
How do SPACs work?
A SPAC is formed when an individual, or a group of individuals, goes through the IPO process with the intent of investing in a particular arena. This may be a sector, like health care, or an economy classification, like emerging markets – or a combination of two or more investment spheres. The key is that there is a focus on where the SPAC intends to invest – but not the specifics – that is outlined in the IPO process and then marketed to investors.
The SPAC raises funds by pricing its shares at a reasonable figure, usually $10, and offers other incentives to entice investors. It then has a defined amount of time (usually around two years) to put the investors’ funds to work by identifying a suitable target (a private company) either to merge with or to acquire. Basically, SPACs are shell companies looking for a promising private company to invest in.
A successful acquisition validates the SPAC’s existence and allows the private company to be publicly traded when listed on the stock exchange under the SPAC’s symbol, also known as a ticker. Failure to acquire a company will result in the SPAC’s liquidation, with the funds being returned to the investors.
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Why would a private company turn to a SPAC?
A private company with ambitions of going public could benefit by going the SPAC route for a number of reasons. Chief among them is access to capital and operational expertise that a SPAC provides.
Additionally, going public through a SPAC is much less expensive. Normally, a private company goes public through an IPO, which can be quite costly. Finally, the timeline to going public is much faster under a SPAC setup as opposed to an IPO due mainly to fewer regulatory hurdles. A private company can bypass these obstacles by being acquired by or merging with a SPAC, which is already public.
What are the advantages and disadvantages of investing in a SPAC?
Risks of investing in SPACs
As with any investment, SPACs pose risks to investors. One of the main risks is the competence of the SPAC’s management in navigating the target company’s market. Typically, SPAC management teams include professionals, and most of them possess a credible investment background. However, if SPAC management lacks expertise in the target company’s market segment, then this could lead to less-than-desirable results for that company and its investors.
Another area of concern is the lack of available information on the target private company. These entities are not mandated to report financial data, which could lead to potential misrepresentation. The private company will be required to make its financials public once it is part of the SPAC, but by then it might be too late for the early SPAC investors. Additionally, unlike a company going public via an IPO, a SPAC target company is allowed to project future earnings, which can be misleading to the investor.
Benefits of investing in SPACs
The most obvious benefit to investors is the lure of potentially getting in on “the next big thing” before it becomes “the next big thing.” To this end, SPAC investors are willing to be a bit more risk tolerant. Also, while a SPAC searches for its target company, the funds raised will be invested in safe investments with modest returns and low risk profiles, like government bonds or highly rated (AAA) corporate bonds.
Frequently asked questions about SPACs
You can buy SPAC stock through a brokerage account. You can choose to purchase SPAC stock specifically, or you can invest in something like a SPAC exchange-traded fund (ETF).
After a merger, SPAC stock is automatically converted to the new business. Investors can also exercise their warrants or cash out their stock.
SPACs exist to acquire or merge with private companies. This takes that company public without the need for an initial public offering (IPO). SPACs usually have about two years to use the investor funds to find a company to merge with.
A special purpose acquisition company (SPAC) is a public company that exists for the purpose of acquiring a private company. In a SPAC merger, a private company will become publicly traded by merging with a SPAC. An initial public offering (IPO) is a process in which a private company can go public by listing itself on a stock exchange.
Yes, after a merger, SPAC shares convert automatically to the new business.
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Editorial staff, J.P. Morgan Wealth Management
