Special Purpose Acquisition Companies: What Are SPACs and Why Are They Popular?

Investing is often confusing to the layman. There are several terms associated with finance and investing making it easy to get lost in this wave of jargon. One such term that is under the radar in the last year is SPAC or a special purpose acquisition company.

According to Investopedia, “A special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.”

While 59 companies went public in the U.S. via the SPAC route in 2019, this figure surged over 300% to 238 last year. SPACs raised approximately $70 billion last year, significantly higher than the $12 billion they raised in 2019.

This suggests each SPAC that went public raised $300 million on average.

 

SPAC 101: The basics of a special purpose acquisition company

SPACs can be likened to a shell company as it does not have any operations. Generally, SPACs limit themselves to a particular sector while others acquire companies across industries.

A special purpose acquisition company offers shares to investors via an IPO. These proceeds are then held in a trust as the SPAC targets a candidate ideal for a takeover. Generally, there is a time frame wherein the SPAC needs to complete the acquisition or merger.

One of the most common reasons that benefit a SPAC is that the IPO process is easier and comparatively less complex compared to the traditional route. In a nutshell, SPACs are formed with the purpose of acquiring other companies and is an entity that is provided funds by investors to acquire other firms.

You need to understand that when you subscribe to the shares of a SPAC, you do not invest in a business but in the management team and bet on them to make concrete decisions.

 

SPACs are popular though controversial

It is easier to list a special purpose acquisition company that may not be good news always. Investors may miss a few things that may be bought under the focus in case of an IPO.

For example, electric truck manufacturer Nikola (NASDAQ: NKLA) went public via a SPAC deal with VectorIQ Acquisition Corp. in 2020. However, Hindenburg Research then issued a report where it raised questions about the company’s ability to deliver on its promises (read: Nikola One Truck).

SPACs might take up to two years to acquire a company and take it public. In case the acquisition does not go through, the proceeds are returned to shareholders after deducting the transaction fees. While the fees may not amount to much, having your capital tied up in an asset that has not appreciated for two years is far from ideal.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.