Are you looking into diversifying your investments beyond the usual stock markets, equities, bonds, and commodities? Do you want to know how to invest in SPAC? In this article, we will discuss the advantages and risks of this investment class.
As a SPAC differs from your usual asset classes, you need to understand the advantages and disadvantages to decide if this fits your investment objectives.
Since all investments carry their own risk, we need to discuss the pros and cons of this investment product. Let’s dive into this in detail to check if you really want to invest your money in this asset class.
What Is A SPAC?
A Special Purpose Acquisition Company commonly referred to as SPAC, is a shell company that isn’t operating but is publicly listed. Its goal is to identify and buy private companies enabling the company targeted to be publicly listed on the stock market.
SPACs do not have any operations, and they don’t have a product, service, or revenue. Their primary goal is to find an optimal target company to acquire. For instance, they can find a high-growth and highly innovative company with high growth potential but minimal revenue.
After acquiring the target company, SPAC became a publicly listed company. This translates into a reverse merger as a private company is bought by a public company. The blank check company or SPAC handles all the handwork of making an Initial Public Offering (IPO) on behalf of another company.
How Do SPACs Work?
Investors generally start SPACs with knowledge about a specific industry to get a good deal in that area. When a SPAC is started, the founders often have a couple of target companies in mind that they want to buy and invest their money in.
However, to avoid publicity, they don’t disclose the company. That’s why SPACs are also called blank check companies, as the investors don’t always know what company they’re going to put their money in.
While anyone can invest in a SPAC, most SPACs first seek out institutional investors before opening the offers to the public.
Generally, the SPAC IPO structure comprises Class A common stocks and a warrant, and the holder gets the right to buy more shares at a predetermined price in the future from the warrant.
One of the reasons why SPACs are attractive to investors is the opportunity to exercise their warrant, enabling them to buy more shares after identifying the target and closing the transaction.
The SPAC common shares are usually traded for $10 per share, which isn’t based on the value of the business. And the IPO price is usually 15% lower than the exercise price. The warrant is usually exercised a few weeks after completing an IPO, and it trades independently of the SPAC stock.
There is usually an acquisition timeline that SPACS has to find its target and close the deal. In most cases, this period is two years. Where the SPAC sponsor cannot acquire a company in the given timeframe, money held in escrow is returned to shareholders. But when they find a potential target firm, the announcement is made formally.
From the announcement date, the sponsor of the SPAC is supposed to perform due diligence and negotiate a good acquisition structure.
How Is A SPAC Different From An IPO?
One of the significant differences between SPAC and IPO is that SPAC IPO happens faster. It can take as little as eight weeks from creating SPAC to listing the IPO. This also means that most of the financial reporting, disclosures, and due diligence associated with an IPO are skipped.
However, during the later steps of SPAC merging with the target company, all the due diligence associated with an IPO is done. The target company must provide audited financial statements and other disclosure items. Therefore, all that happens is for the SPAC process to backload documents required to a later stage, a practice known as de-SPAC transitions.
SPACs usually have 18 to 24 months to get a good company they can merge with once the IPO has been completed. If this doesn’t happen, SPAC will be forced to dissolve, with the remaining funds being shared with shareholders on a pro-rata basis.
Pros Of Investing In SPACs
There are several benefits of investing in SPACs. These include:
Opportunity To Invest In Private Companies
SPACs offer retail investors an opportunity to invest in privately held companies that are considered promising.
Opportunity To Partner With Industry Professional
With SPACs, public investors get an opportunity to partner with venture capitalists and investment professionals who search and perform due diligence on the companies. This kind of partnership can unlock additional capital resulting in the appreciation of their portfolios. SPACs enable IPO investors to benefit from the sponsor’s expertise.
Great Opportunity For Growth
SPACs are a great way of investing in promising companies without going through the traditional IPO investing hoops. These companies have the possibility of being extremely rewarding.
Risks Of Investing In SPACs
SPAC also comes with certain levels of risk. These include:
Companies that need to go through an IPO are supposed to disclose a lot of information, and they are supposed to perform due diligence before launch. But on the other hand, there is little or no documentation required in SPAC.
The early investors usually invest depending on the sponsor’s reputation, and the investments only provide part ownership of the deposit in the trust account.
Incentives And Fees
SPAC sponsors usually have a reputational risk. This means that the SPAC sponsors are typically compensated for the risk as they are given a bigger discount to the target company’s price.
By raising money for public investors, usually, 5.5% in fees are charged to the public investors. The sponsor of the SPAC is given 20% equity in the SPAC.
These fees make some observers consider SPACs to be more expensive than IPOs.
Fluctuation of Prices
In most cases, the price of SPACs is usually $10 per share during an IPO. However, there is fluctuation in the market price when they start trading, which can be significant even before identifying a target.
How To Invest In SPACs?
A SPAC investment takes a similar approach to other Exchange-Traded Fund (ETF) investments. It would be best to determine what is included in the ETF and its cost. You should consider the constitution and its price when it comes to the underlying holdings.
Consider the number of individual SPACs held and the market sector they represent. SPACs can also be more expensive than other ETFs, and so you may need to consider the expense ratio.
To invest in SPACs, you can choose individual securities or invest in the SPAC ETF. By selecting individual SPACs, investors can focus on promising opportunities. Since the proceeds of SPAC IPO are put in bonds till the completion of the merger, shareholders can exit SPAC due to liquidation or by selling their shares in secondary markets.
Another way to invest in SPAC is by buying immediately after an IPO and then selling it one week after the announcement date of the merger.
To start the process of adding SPACs to your portfolio, you should open an online brokerage account with platforms such as Robinhood and eToro.
If you opt for this investment route, you will want to decide the number of SPACs you will need to buy, depending on the trading price and required investment amount.
In Summary – Should You Invest In SPAC?
The risks associated with the product are always constant in any investment. Doing the necessary due diligence and research should help minimize the risks involved. You will assess if the inherent threats with this type of fund investment are within your risk appetite. Remember that any successful investment involves managing the risk and not avoiding the asset itself.
Diversification dictates that we look into other investment products and services available. If SPAC is within your investment objective and financial capacity, you may try to invest in this to help your financial plans in the long run. It is better to look into other investment products that will help you in your quest for financial freedom if it’s not. What matters is that investing in a sound and efficient investment product is an effective investment strategy for anyone.
Here are some articles for your other investment products to help you become independently wealthy. Check them out:
- Appreciating Assets – 23 Ways To Grow Your Wealth Successfully
- Investing In Stocks, Bonds And ETFs