Occasionally, some new trend or craze tends to hit the capital markets and threatens to completely change ways of doing things. Perhaps you’ve heard of the term ‘SPAC’. Or maybe you’re hearing it for the first time

Whatever the case, NMTBP presents an overview of why SPACs are trending and why celebrity investors like former NBA player Shaquille O’Neal and rapper Jay Z are jumping on the bandwagon

What is a SPAC?

‘SPAC’ is an acronym for ‘special purpose acquisition company’

Also known as blank cheque companies, SPACs don’t have a business of their own. What they DO have is a stash of cash that they use to buy or merge with another company and then take it public

Investors invest in a SPAC under the agreement that it will find a target for a merger within a specific time, usually two years. If a target merger is not found within the set time period, the entity is wound up, and the money is returned to investors

How do SPACs work?

SPACs operate differently than traditional IPOs. Here’s a breakdown of the process.

1. The SPAC is formed. A group of investors, known as the company’s sponsors, begin the regulatory process of forming the special purpose acquisition company
2. The SPAC holds an initial public offering (IPO). The SPAC must undergo an IPO process or “float” on a chosen stock exchange, just like any other publicly traded company
3. The SPAC goes to market. The SPAC becomes available on public stock exchanges under its ticker symbol
4. Investors buy in. Once it’s live, public investors can start buying stocks
5. The SPAC seeks a target company. The SPAC begins to search for a company to merge with. This is the company the SPAC will acquire and bring to market. A target company must be acquired within a certain time, typically two years, or the SPAC will be liquidated, and funds will be returned to investors
6. The SPAC merges with its target company.Once a target company is named, the acquisition process begins
7. The merger completes. At completion, the combined company typically takes the name of the target business and updates its ticker symbol accordingly. Investors can choose to stay invested and hold onto their shares or sell them, ideally at a profit

What is their appeal?

According to experts, one main reason for the increased popularity of SPACs is a buildup of frustration among entrepreneurs looking for alternatives to the traditional IPO. This frustration stems from the large amount of work and time the IPO process requires

While an IPO can take years from start to finish, a SPAC merger typically takes three to four months

Due to underpricing, many IPOs also tend to leave a lot of money on the table. With a SPAC, a company is able to negotiate an exact purchase price purely based on business valuation. This ensures that no money is left on the table

It’s not surprising that SPACs are becoming trendy. High-profile businesses that have been funded through SPACs in recent times include Sir Richard Branson’s Virgin Galactic and DraftKings

What are the downsides?

• Blind investment.Most investors don’t know what they’re buying into when they invest in a SPAC, as SPACs aren’t required to declare a target company at their outset
• Low liquidity.It can take months, even up to two years, for SPACs to settle on a target company, leaving investor funds tied up in escrow throughout the process
• Mediocre performance.SPAC performance has been analysed numerous times and tends to yield mixed results

What’s the status of SPACs in the UK?

Right now, special purpose acquisition companies largely remain a US phenomenon. They are yet to catch on in the UK mostly because UK-listed SPACs are perceived as risky for investors

Unlike in the US, where shareholders can redeem their shares if they are unhappy with the target acquisition, UK SPACs do not have an opt-out. Once a UK SPAC has made an acquisition, its shares are suspended until an FCA-approved deal prospectus is published

Basically, this locks up investors’ capital limiting the ability of those who disapprove of the merger to get out

However, the government is said to be considering relaxing listing rules in the UK to encourage more SPAC flotation, so things could change down the road

How can I invest in a SPAC in the UK?

UK investors can invest in special purpose acquisition companies through a share dealing account or a stocks and shares ISA. Depending on your goals, you can choose to invest in individual SPAC shares or in SPAC funds, including ETFs

But keep in mind that the available options might be limited, as SPACs have yet to make a solid mark in the UK market

Should I invest?

Ultimately, the decision is yours

Remember that when investing in a SPAC, you’re essentially banking on the expertise and reputation of the sponsor of the SPAC and the management team. Before you take the plunge, make sure you’ve done your homework

Caveat Emptor!