SPACs—Yet Another Investing Fad to Avoid

Jay D. Franklin CFA, CFP, FSA | Clarity Capital Advisors |

“SPAC” stands for special purpose acquisition company, and it is a blank check shell corporation designed to take private companies public without going through the traditional IPO process. SPACs have a specified period of time (usually two years) to select and merge with a private company (the initial business combination). Otherwise, the funds are returned to the SPAC’s investors. The advantage to the acquired company is that it can go public with more certainty as to pricing and hence the amount of capital raised.

What to expect when you buy shares of a SPAC

Note that prior to the initial business combination, a SPAC is a non-operating company with no intrinsic value other than the cash that has been set aside for the future acquisition. The only reason for it to increase in value is the market’s expectation that a lucrative deal is likely to happen soon. SPACs should be regarded as very speculative investments. They can also be highly complex when sold in “units” consisting of shares and warrants (contracts that are similar to call options). Remember that complexity is not your friend in investing.

It is also worth noting that your position as an investor is very different than the sponsors of the SPAC, as they generally acquire equity in the SPAC at more favorable terms than investors in the SPAC’s IPO or subsequent trading. As noted by the SEC in a recent Investor Alert, “The sponsors will benefit more than the investors from the SPAC’s completion of a business combination and may have an incentive to complete a transaction on terms that may be less favorable to you.” By the way, we see a similar mismatch of incentives in hedge funds funds between the general partners and the investors.

Regarding recent celebrity endorsements of SPACs, the same alert reminds us that, “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.” This is true for all other investments as well. Other unreliable sources of investment ideas include social media, investment newsletters, advertisements, email, investment research websites, and internet chat rooms.

By the way, today’s (4/26/2021) Wall Street Journal has a highly relevant article entitled, “Insiders Gain in SPAC Deal While Investors Take Losses.” As the author notes, even though investors in the SPAC (Churchill Capital Corp. III) have lost about 30%, the SPAC promoters still stand to make millions due to their purchase of 20% of the SPAC shares at a deep discount. Remember the old adage, “If you can’t identify the sucker at the poker table, you’re it.”