SPACs typically offer investors units consisting of shares and warrants. Early investors often receive discounted warrants that could prove lucrative if the company finds an acquisition target to merge with.
However, many SPACs fail to find suitable merger targets, with even those that do underperforming against the market. When investing in such risky offerings, investors must carefully consider their investing styles and risk tolerance levels before proceeding.
SPACs offer private companies an efficient means of accessing public markets without going through the time-consuming IPO process, but investors must first understand its potential benefits and drawbacks before making their decision to invest.
Investors in Special Purpose Acquisition Companies (SPACs) typically buy shares of common stock as well as warrants (which give investors the right to buy more shares) when investing. When the SPAC finds a merger target, its warrants can be traded in for shares in the combined company.
Many SPAC targets are developing businesses with revenues under $500 million; however, they’re often valued for their future financial potential and overpay for acquisitions; this can result in disappointing shareholder results and has led to greater scrutiny by regulators; for instance the Securities Exchange Commission recently took steps to educate investors about potential warrant dilution risks.
Initial Public Offerings (IPOs)
Special-Purpose Acquisition Companies (SPACs) were a prominent force during Covid-19’s retail trading surge. SPACs provide experienced management teams and sponsors a vehicle for raising capital from investors through public markets before purchasing operating companies that align with their vision. Original investors may withdraw their shares after being identified as potential merger candidates by their sponsor and will get their money back plus interest when the merger takes place.
SPACs remain risky investments for individual investors despite the hype. SPACs tend to focus on early-stage firms with little revenue history or established track records – typically targeting companies generating under $500 million annually as their targets.
SPACs typically look for targets in technology, media and telecom; healthcare and life sciences; consumer retail and travel; or consumer media and telecom. Mature companies with track records may be especially desirable to a SPAC; those that are losing money may struggle to secure financing as size limits their options for potential targets.
An effective SPAC should aim to maximize value creation for investors, sponsors and target companies alike. The process should ideally balance profit opportunities for sponsors (who buy heavily discounted 20 percent interests in the SPAC), with appropriate risk-adjusted returns for investors – while providing an appealing way for private companies to access capital.
SPACs can be risky investments. Investors investing in SPACs receive their money back if the SPAC fails to find an acquisition target and warrants to purchase additional shares at a lower price point.
SPAC structures can be especially helpful to young companies that possess immense growth potential but don’t yet have enough revenue or growth track record to complete an IPO directly, since they allow them to bypass lock-up periods associated with an IPO that might turn away private investors.
Investing in SPACs
SPACs may allow investors to gain exposure to emerging companies in hot sectors, but they can be risky investments for retail investors. Their attractive returns could entice them to make investments that may only offer short-term gain potential and/or are more a fad than viable long-term businesses. Furthermore, SPACs can bypass more stringent disclosure rules applied during traditional IPOs.
SPACs raise capital on the stock market with shares priced at $10 each and deposit it into a trust account until they find and merge with an appropriate target company within two years, or else return their investments back to investors.
Critics argue that SPACs provide “less worthy” companies a path into public markets they would have not otherwise been able to access; and may dilute original investors’ shares through sponsor-owned shares and warrants, in addition to receiving large stock allocations within their combined entity that may dilute original shareholders’ stakes further.