SPACs: A Great Idea but a Potential Nightmare Investment
In a world where information moves so quickly, it’s very easy for sensations to reach “viral” status and catch the attention of people that normally would have never even heard of them. The sensation is not limited to a specific idea or trend either. It could be weird and sometimes inexplicable things, like eating a Tide-Pod or throwing cheese on your baby’s face. It can reach media, fashion, sports, dances, and also… financial services. When it gets to the financial services world, it can become dangerous. People hear about a new product or investment, they hear about it on the news, read a quick article, had a friend that made some money, but spending and investing your money is much different than buying a meme on a t-shirt. Although they have been around for some time, one of the latest crazes to hit the financial services world are SPACs and we’re going to talk about everything you need to know about ‘em!
Let us start with what a SPAC is. SPAC stands for a Special Purpose Acquisition Company. Simply put, these are shell companies that are created to acquire any business deemed worthy by the board of directors through investor capital. The goal of these investments is to offer smaller companies an opportunity for liquidity and to be listed publicly. When SPAC’s are created, they are born by raising capital through investors. This can be major institutions or even the retail channel. They will have an arbitrarily assigned dollar value, typically $10/share, and sell a finite amount of them. This is the SPAC’s IPO stage. So, an example SPAC could raise $200M from investors and then list on a public exchange. This will create an avenue for them to acquire companies that may not meet the requirements or be able to afford to jump through all the hurdles of listing publicly. It also allows the company being purchased to receive up-front capital to allow them to continue to grow through their “proven” business model rather than going through a traditional IPO on their own. On the surface, this looks great and exciting. A SPAC can raise money, purchase companies, give them an influx of capital, & allow said companies’ investors the opportunity for growth on their stock in public markets alongside other businesses the SPAC buys. This is just the tip of the iceberg though.
Now that we know how these investments are propositioned as great investment ideas, let’s look beneath the surface to discuss what every investor needs to understand with these. SPAC’s literally have the ability to purchase any business, from any location, & for any dollar amount. An ideal SPAC would have a targeted industry, targeted business model, revenue requirements, experienced management team but that is not always the case. When you are buying a SPAC, you are hoping the management team will appropriately use the capital it has raised to buy fundamentally sound businesses to encourage future growth. There is a significant amount of due diligence that comes along with understanding what was just said in that last sentence. If a SPAC has an initial share price of $10/share you are hoping that they are going to acquire businesses that will lead to a share price higher than that. What is often not disclosed to investors are the fees associated with these acquisitions, the valuation used for the purchase, innate conflicts of interest within the SPAC, and succession plans for when the original owner of the purchased company moves on.
It is very easy to get ‘hyped’ when you hear of pro-athletes, celebrities, and billionaires carrying these ideas through SPAC’s. What they won’t talk about is what happens to investor’s money when a bad purchase is made or they over-paid for a business that is now struggling. They do not discuss how a company that is now “trading publicly” through their SPAC has lost value and because of that, the original investors see stock holdings decline because they’re now sitting side-by-side with poor management decisions and high fees. There are probably some SPACs doing the right thing and buying the right companies but, when a trend like this hits the financial services world, all I can say is… buyer beware and do your due diligence.