S.P.A.C, or Special Purpose Acquisition Company, is one of the new trends on Wall Street gaining popularity in issuance and investor interest. Spam, the food, not the annoying junk email, may not be as popular, or at least I hope not. Surprisingly or not, there are plenty of similarities between S.P.A.C.’s and Spam, which I will share later.
Let’s begin with defining how a S.P.A.C. functions.1 A S.P.A.C. is a shell company set up by investors to raise money through an Initial Public Offering (I.P.O.) to acquire another company. The S.P.A.C. vehicles are often created by institutional investors, hedge fund titans, or other investment professionals that have usually demonstrated prior investing prowess. That last point is critical, as the acquired company is yet to be determined by the sponsors.
The original S.P.A.C itself makes no products, software, or services that generate any revenue. There is no value beyond the intangible investing skills of the S.P.A.C. sponsor. Initially, the only assets are the funds raised in its own I.P.O. Investors are putting their faith in the sponsors of the S.P.A.C. to find value in the market for private companies.
Operationally, the shares are valued at $10 per share, placed in a trust, and earn interest before a company purchase is made. The sponsors of the S.P.A.C. then look to find a private company to purchase and must gain approval from the S.P.A.C. investors. If approved, S.P.A.C. investors receive shares in the newly merged company, or they may receive their original investment plus interest back if not aggregable to the purchase.
S.P.A.C. sponsors have a deadline to complete a suitable deal, usually within two years. Otherwise, it is liquidated, and investors receive their principal back and interest. The incentive for the S.P.A.C. to put that money to work is heavy, and sometimes can be rushed if deadlines are looming. What is in it for the S.P.A.C. sponsor? Typically, S.P.A.C. sponsors receive “Founder Shares” which may entitle them to 20% of the common shares in the new company brought to market in the I.P.O.
S.P.A.C.s have grown tremendously with investors over the last year for a variety of reasons. One reason is from the investing public desire for higher returns. Investors become confident in accepting greater risk with speculative investments given the strong market we have experienced since the Covid sell-off of early 2020. Each bull market introduces a set of speculative instruments that catch an investor’s fancy. This time is no different.
On the other side, private companies see value in merging into a S.P.A.C. which may avoid the costly and time-consuming process of a traditional I.P.O. Simply put, it is an alternative to the bureaucratic I.P.O. process.
Having explained the S.P.A.C. vehicle and operations, what are the comparisons to Spam? The food product Spam (forgive me Spam fans) is a big unknown. When investing in a S.P.A.C., you do not know what you are buying. It is a great unknown. Investor parlance often refers to S.P.A.C.s as “blank check companies” in reference to the unknown company to be purchased. In many situations, investors in S.P.A.C.s may not even know the sector or the geographic region they are seeking purchase in. It is in fact, a leap of faith. Much like determining what is in Spam!
Given the risks presented to investors, Fragasso Financial Advisors steers away from these types of investments and securities. Special Purpose Acquisition Company would do well for all if the name was changed to “Speculative Purpose Acquisition Company”. Giving up 20% for the opportunity in a new company also seems pricey. Spam is supposed to be reasonable, not a delicacy.
Fragasso Financial Advisors adheres to the textbook principles of asset allocation, diversification, and risk management. Risk management is critical to managing your investments and as a fiduciary, Fragasso takes great efforts to managing this part of the investment equation, regardless of the environment or speculative vehicles that catch investor attention.
Source: 1. https://www.cnbc.com/2021/01/30/what-is-a-spac.html
Read more from Fragasso’s President, Daniel Dingus!