If you’ve been paying attention to the stock market in the last year, you have learned many things. Elon Musk, Reddit, cryptocurrencies, inflation, and Cathie Wood have taken up most of the headlines, but that’s just a smidge of the new market we are seeing. Since the market has been very bullish, many companies have filed for IPOs too, with some of our favorite companies like DoorDash and Airbnb entering the New York Stock Exchange and the Nasdaq. However, a new method of entering the market has become very popular in 2020 and 2021, something you might be slightly familiar with: SPACs.
A SPAC, or special-purpose acquisition company, is a blank-check company with the purpose of raising capital to merge with a private business. The only asset these companies contain is the capital raised as they have no service or product to provide. These are often created by institutional investors, especially private equity firms who bring experience that leads to people buying the SPAC. This plays an important role because retail investors, most of the time, don’t know exactly what private company they will invest in when they put their money into a SPAC. The acquisition companies have targets in mind, but those aren’t released to the public, which makes institutional backing important. When a merger occurs, the SPAC sponsors often get a 20 percent stake in the company, and retail investors who bought the SPAC can swap their shares for the merged company or redeem their investment back with the interest it has gained. Interest? Yes, the funds the SPAC raises goes into an interest-bearing trust, which provides a benefit to investors. Certain companies prefer SPACs instead of IPOs because it’s quicker, and the company can get capital much faster.
Many companies you know have entered the market through a SPAC. Virgin Galactic merged with Chamath’s SPAC, Social Capital Hedosophia, DraftKings merged with Diamond Eagle Acquisition Corp, and Bill Ackman created Pershing Square Tontine Holdings, which is the largest SPAC. These companies often fall into the speculative category, with many of these private businesses recording losses. There have been success stories like DraftKings, but companies who have entered through a SPAC have often lagged behind the overall market, while IPOs have stood their ground.
This has been amplified recently. In the market selloff, SPACs have taken a major hit, with companies like QuantumScape down nearly 50 percent from its highs. This also comes after regulators are scrutinizing the idea of SPACs, which cooled the SPAC market down. This selloff is the first obstacle that SPACs have faced as 2020 was a great year for them, along with other speculative assets. Volatility is a major problem, with many SPACs having heavy derivatives volume in the form of options and stock warrants. SPAC bulls are still confident, but these stocks have been put aside with investors shifting to either value or other speculative investments, but it’s still a fact that SPACs are performing worse than most assets now. What do you think about SPACs?
I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.