SPACs Are The Hot Investment Trend For 2020, Should You Participate? – Forbes

One pronounced trend for 2020 is the growth of funds flowing to Special Purpose Acquisition Companies (SPACs), sometimes called blank-check companies. SPACs have raised over $20 billion so far this year.

This is a banner year for SPACs, setting records for the number of deals and amount raised. Prominent figures have launched SPACs. such as Paul Ryan former speaker of the House of Representatives and Gary Cohn former director of the National Economic Council. Last month, hedge-fund manager Bill Ackman raised a $4 billion SPAC, the largest ever. The resulting deals are getting attention too, Draft Kings used a SPAC structure to go public in April as did Virgin Galactic

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in late 2019. Both have seen positive returns since.

How SPACs Work

The alternative name blank-check company is a useful summary of how SPACs work. Deal-makers raise money based on their credentials and expertise. They then specify plans for the area they want to invest in, such as U.S. fintech companies, for example.

Once the SPAC is funded, they have a war chest established and hunt for an attractive acquisition target. Despite the term blank check, investors in SPACs do have some protections. Once the deal is announced, if investors don’t like it they can typically redeem their shares, and if a deal doesn’t occur within a specified time frame, investors can get the remaining cash out. Also, investors typically hold both shares and warrants in the SPAC. The warrants enable the investor to increase their holding at a fixed price should the deal ultimately perform well.

For companies, SPACs can offer a quicker and less complex route to market than a full IPO process.

Risks

SPACs are, in one sense, just a means of enabling companies to trade publicly. Similar to an IPO process, the crucial element is the quality of the company being acquired. However, unfortunately the historic data on SPACs is not encouraging.

First off, SPACs can fail to find a suitable acquisition candidate. Yes, investors typically get their money back when this happens, but that can mean a return equivalent to Treasury bills for a period of years, rather than being invested in the market. That can be a big opportunity cost. With an IPO you can be confident your money will be put to work, with a SPAC you can’t be so sure.

Secondly, historically SPACs have not performed all that well. Historically SPACs are found to have lost about 3% a year compared to the market according to research from Jog and Sun. Though this is historical data, and more recent SPACs could fare better.

That said, when compared to a SPAC, the average performance of IPOs is not too hot either, since IPOs tend to underperform the market in their first year according to history. This does not bode well for today’s crop of SPACs. The same research found that SPAC managers do incredibly well from the transactions given they typically receive shares at discount prices, while investors may lose money, SPAC managers can accumulate substantial wealth via the SPAC process even if shareholders see gains depending on the terms of the deal.

Blank-check companies can trace their origins back to the blind pools of the South Sea Bubble of the eighteenth century. That’s not a great omen. SPACs can certainly benefit their managers, but the benefits to investors are less clear and this may be another sign of a relatively frothy stock market environment. As with IPOs, the success or failure of any SPAC, will depend on the specifics of the company being acquired. As with IPOs, deal-makers can reap large short-term rewards, but investors bare much of the long-term risk.

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