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All You Need to Know About SPACs

Oct 6, 2020 11:30 AM 4 min read

Not many people outside the investing community know much about Bill Ackman. Albeit, if you Google him, one of the first entries you’ll see is “how he managed to turn a $27m bet into a $2.6bn investment”. 

That’s got to turn a few heads, no? 

Ackman and others like him have built their wealth by pursuing a habit of betting on opportunities that went from being latent to pliant rather quickly. One of the ways they have done so is by raising capital through Special Purpose Acquisition Companies (SPACs). And 2020 has been stellar for SPACs, having already raised in excess of $30bn this year -  an annual record with more in the offing.

What are SPACs?

SPACs are popularly called “blank-check companies”, considering their purpose of being built to attract investments into an undecided business. Investors’ money poured into SPACs is deployed in an interest-bearing blind trust while the management team searches for a business or businesses to acquire, preferably within a two-year window.   

The earliest instances of SPACs date back to the 1980s. They have, however, undergone many changes structurally. But there are bigger questions that need answering.


Isn’t It Bizarre to Invest Blindly?

Well, yes and no. Even though SPACs don’t offer specific strategies or targets initially, they usually know where their focus is, or more precisely, what kind of businesses they wish to acquire. In case the sponsors decide to go in a direction drastically away from this focus later on, the investors have the option of redeeming their shares in the company. 

Having said that, the most important criteria behind investing in a SPAC is investee-faith. The institutional investors (hedge funds, private equity funds, etc.) approached by SPACs decide on the latter’s merit by considering the credibility of its sponsors and their past enterprises. 


What are the Advantages of SPACs?

Well, for one, they offer a better incentive structure between the sponsors and the target company. Sponsors being underwriters themselves typically share a long-term outlook for the target company with their own reputations on the line. 

Two, since the money is in a trust, it can be used whenever. Let’s say the sponsors are looking to invest in an idea that is expected to yield better results two years down the line, they can sit on that money. Typically, SPACs will sit on pools of cash and wait for when target companies require liquidity. 

Three, although their money is locked in an interest-generating trust, if any of the investors aren’t satisfied with the course their investment is taking, they always have the option to redeem their capital. Conversely, if they wish to further their investment, they can typically do so by availing the warrants assigned to them. A warrant is basically a security that entitles the holder to buy more stock in the company at a fixed price on a later date i.e. A sweetener! 

Four, from an IPO-angle, SPACs are golden. When the SPAC decides to acquire a business by taking it public, it will involve a lot fewer regulatory shenanigans and smaller time frame that are prescribed through the usual route. Although the goals are similar in both, SPACs are simpler, more efficient and more resembling a corporate merger.


Why are they All the Rage Currently?

The biggest names who have launched SPACs this year include Paul Ryan (former Speaker, the US House of Representatives), Gary Cohn (former Director, National Economic Council) and Reid Hoffman (LinkedIn Founder). Then there is Chamath Palihapitiya, Founder of Social Capital who has already seen success with two prior SPAC plays and launched a third one with a deal yet to be announced. 

One could argue that the index of uncertainty in SPACs fits perfectly with the economic uncertainty in the face of the pandemic. Which is why, perhaps, investors have embraced selective opportunism expecting miracles!

The truth is, investors have been actively seeking more innovative ways to generate returns and this volatile market is enabling their adventurism. In addition, the current low-interest environment has made investments in SPACs look more appealing with the prospect of solid returns, notwithstanding a hard to gauge risk-profile. 


How Safe are the SPACs?

Overlooking the morbid uncertainty, they are definitely unconventional. And they receive lesser regulatory scrutiny than traditional IPOs. Many of them do not even have an operating history, which poses investors with a heightened risk.

Interestingly, SPACs are also called ‘shell companies’ and ‘zombie funds’, which doesn’t indicate plausibility right off the bat!

However, after all the accounting is said and done, stock market trends are nothing if not defiant in the face of convention. Investing in SPACs may be risky, but without risk there wouldn’t be any Michael Burry or George Soros plucked out of the ether of Wall Street now, would they?


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