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What is a SPAC? Everything you need to know

July 1, 2022 • 5 min read

What we'll cover

  • What a SPAC is and how it works

  • Why companies go public through SPACs

  • Advantages and disadvantages of investing in SPACs

A special purpose acquisition company (SPAC) is a publicly traded company created on paper for the purpose of acquiring or merging with a private company. Through the merger or acquisition, the private company becomes publicly traded and has access to the capital markets.

SPACs, sometimes called “shell companies” or “blank check companies,” increased in popularity in 2021. In 2021, there were 613 SPAC initial public offerings (IPOs), a significant increase from 248 in 2020. But exactly what is a SPAC and how could you potentially invest in them?

Let’s explore how a SPAC works, why companies go public through SPACs and the advantages and disadvantages of this recently popular investment opportunity.

What is a SPAC?

An individual or group of individuals may choose to go through the initial public offering (IPO) process using a SPAC. This means that a company raises capital to become a listed company instead of having to execute its own IPO. (An IPO occurs when a private company becomes public by selling its shares on a stock exchange.) Companies typically go the SPAC acquisition route to cut down on the time it takes to access an IPO.

How does a SPAC work?

Typically, a SPAC is formed by an experienced management team which usually has a specific skill set in a niche industry. After the SPAC is created, sponsors and/or investors will begin raising money for an IPO. In recent years, investors have gravitated toward sectors such as green energy, technology and other high-tech sectors.

This merger creates a single private equity entity that trades publicly and gives the private operating company a public listing. Private investors or sponsors, typically with expertise in a particular sector, buy units of the company, which are placed in an interest-bearing trust account. They may put a specific amount of money — such as $25,000 — into the SPAC.

To break down how this happens even further, a SPAC is formed by an experienced management team that invests about a 20% interest into founder shares of a SPAC, while the rest (approximately 80%) is held by public shareholders through SPAC unit shares. Each unit involves a share of common stock and a fraction of a warrant.

As soon as a SPAC lists and raises money, it typically has 18 to 24 months to find a private company to merge with. If it can’t, the money will go back to the investors.

If the merger is successful, the existing stockholders of the operating target company become the majority owners and that company becomes a publicly owned company by being listed on a major stock exchange. The goal is to execute an initial public offering (IPO) to raise money through the public markets.

If you want to invest in SPACs, how do you add them to your portfolio? Believe it or not, you can buy them by opening an online brokerage account. You can also consider purchasing SPAC ETFs, which means you’ll be more diversified because you’ll invest in more than one private company or target company.

Why do companies go public through SPACs?

SPACs create a long-term investor base via a private investment and offer an inexpensive (and more private) way to take a company public. Also, a company goes public faster through a SPAC because of the shortened auditing process due to a lack of necessary financial statements and related materials.

What are the advantages and disadvantages of investing in a SPAC?

As with any investment, there are specific advantages and disadvantages of investing in SPACs. It’s important to consider both the positives and negatives of these target companies before choosing this type of venture.

SPACs create a long-term investor base via a private investment and offer an inexpensive (and more private) way to take a company public.

Advantages of investing in SPACS

What are the advantages of investing in SPAC transactions? Let’s take a quick look.

  • Quicker path: SPAC mergers typically take three to six months. By contrast, an IPO takes longer to complete, usually 12 to 18 months.

  • Individual retail investors can get in on a SPAC: Most retail investors can’t participate in a traditional IPO. However, shares trade publicly on the stock exchange through a SPAC, allowing retail investors to participate in the process.

  • Experienced sponsor: Experienced sponsors can bring expertise, often through a board of directors, to help the management team execute the SPAC IPO.

Disadvantages of investing in SPACS

The downsides to SPAC investing include the following:

  • Shorter timeline: A shorter timeline means a company must prepare required financials and SEC filings, establish public company functions and hit financial goals in a shorter time frame.

  • Less red tape: While this may seem like a benefit, it still means that a traditional IPO has better oversight, especially for SPAC investors who want to make sure they’re making a sound acquisition.

Now that you know the answer to “What is a SPAC stock?” you may want to walk through the pros and cons before you choose the SPAC process as an investment opportunity. Investing in a special purpose acquisition company often involves strategic planning, including a decision about the role SPAC mergers play in your future goals.

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