How To Invest In SPAC? Should You Invest In SPAC?
Are you looking to diversify your investments beyond the usual stock markets, equities, bonds, and commodities? Do you want to know how to invest in SPACs? In this article, we will discuss the advantages and risks of this unique investment class.
Since a SPAC differs significantly from typical asset classes, it’s essential to understand its pros and cons to decide if it fits your investment objectives. Like all investments, SPACs carry their own risks, which we will explore in detail to help you determine whether this asset class is right for you.
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## What Is a SPAC?
A Special Purpose Acquisition Company (SPAC) is a shell company that isn’t operational but is publicly listed. Its primary goal is to identify and acquire private companies, enabling the acquired company to become publicly listed on the stock market.
SPACs have no operations, products, services, or revenue. Their main objective is to find an optimal target company to acquire. For instance, they might target a high-growth, innovative company with significant growth potential but minimal revenue.
After acquisition, the SPAC merges with the target company, effectively resulting in a reverse merger. In this process, the privately-held company becomes publicly listed. The SPAC, also known as a “blank check company,” handles all the regulatory work and preparations of an Initial Public Offering (IPO) on behalf of the private company.
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## How Do SPACs Work?
Investors who start SPACs often have expertise in a particular industry and may already have one or two target companies in mind. However, to avoid undue publicity and to protect competitive advantages, these companies are usually not disclosed upfront, which is why SPACs are called blank check companies.
While anyone can invest in a SPAC, institutional investors commonly get the first opportunity before public investors can participate.
A typical SPAC IPO structure includes Class A common stock and warrants. Warrants grant investors the right to purchase additional shares at a predetermined price in the future, often providing an attractive incentive.
SPAC common shares typically trade at around $10 per share during the IPO, though this price is not based on the value of the underlying business. IPO prices often come with a roughly 15% discount on the warrant exercise price, allowing investors potential upside.
Warrants are usually exercisable a few weeks after the IPO closes and trade separately from SPAC shares.
Most SPACs have a timeline of about two years to identify and merge with a target company. If a SPAC sponsor can’t complete a deal within this timeframe, the funds held in escrow are returned to shareholders, and the SPAC dissolves.
Once a target is announced, the SPAC sponsor performs due diligence and negotiates the acquisition details.
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## How Is a SPAC Different from a Traditional IPO?
One of the biggest differences is speed. A SPAC IPO process can take as little as eight weeks from inception to listing, much faster than a traditional IPO.
This speed comes because much of the financial reporting, disclosures, and due diligence typical of a standard IPO are deferred and happen later during the SPAC’s merger with its target company. This process is called the “de-SPAC” transition.
During the de-SPAC process, the target company must provide audited financial statements and other required disclosures, essentially undergoing a similar scrutiny as a traditional IPO.
If a SPAC fails to complete a merger within its 18-24 month deadline, it is forced to dissolve, and the remaining funds are returned to shareholders proportionally.
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## Pros of Investing in SPACs
**Opportunity to Invest in Private Companies**
SPACs allow retail investors to participate in privately held companies with promising growth potential that are usually inaccessible until they go public.
**Partner with Industry Professionals**
Public investors gain exposure to venture capitalists and investment professionals who perform in-depth research and due diligence on target companies. This partnership can unlock additional value and help grow investors’ portfolios.
**Great Potential for Growth**
SPACs offer an alternative route to invest in emerging, high-growth companies without going through the extensive process of a traditional IPO, which can be time-consuming and uncertain.
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## Risks of Investing in SPACs
**Limited Information**
Unlike traditional IPOs, SPACs require much less upfront disclosure and due diligence. Early investors often rely heavily on the reputation of SPAC sponsors rather than detailed company information, creating additional uncertainty.
**Incentives and Fees**
SPAC sponsors typically receive 20% equity in the SPAC, which can dilute shareholder value. Additionally, fees generally amount to about 5.5% charged to public investors. These costs mean SPACs can be more expensive overall compared to traditional IPOs.
**Price Fluctuations**
SPAC shares usually start at $10 per share during IPO but can fluctuate significantly in the secondary market, often even before a target is identified. This price volatility can pose risks for investors.
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## How to Invest in SPACs?
Investing in SPACs is somewhat similar to investing in Exchange-Traded Funds (ETFs). When considering a SPAC or a SPAC-based ETF, evaluate the portfolio composition, sectors represented, number of SPACs included, and associated costs like expense ratios.
You can invest in individual SPAC securities to focus on specific opportunities or choose a diversified SPAC ETF to spread risk.
Since the proceeds from a SPAC IPO are held in bonds until a merger completes, shareholders often have options to exit via liquidation (if no target is found) or by selling shares on the secondary market.
Another strategy is to buy SPAC shares immediately after IPO and sell them shortly after the merger announcement to capitalize on price movements.
To begin investing, open an online brokerage account on platforms like Robinhood, eToro, or others offering SPAC stocks.
Decide the number of shares based on the trading price and your investment goals.
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## Should You Invest in SPACs?
As with any investment, SPACs carry risks alongside their potential rewards. Performing thorough due diligence, understanding the underlying business, and aligning the investment with your risk appetite are crucial steps to maximize success.
Remember, investment success depends on managing risk, not avoiding it altogether.
Diversifying your portfolio by exploring alternative investment vehicles like SPACs can be beneficial if these align with your financial goals.
However, if SPACs do not fit within your investment objectives or risk tolerance, it is prudent to consider other investment products that may be better suited to support your journey toward financial independence.
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### Additional Resources
For further reading on other investment products and strategies to help build your wealth, check out these articles:
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Investing in sound and efficient financial products is key to a successful investment strategy. Take your time, research thoroughly, and make informed decisions to achieve your financial goals.
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