Tuesday, January 26, 2021
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Special Purpose Acquisition Companies and Investor Risk

Special Purpose Acquisition Companies (or SPACs) have been around for quite some time. Investors have tended to be wary of or straight up averse to them. Recently, however, a string of success stories have been changing minds. Many investors are starting to come around to the idea that SPACs offer good return potential and are sound investments.

Some suggest that SPACs may have officially replaced the IPO as a new way for companies to go public. With that in mind, here are a few reasons why Special Purpose Acquisition Companies are no longer such a risk for investors.

What is a Special Purpose Acquisition Company?

A special purpose acquisition company is essentially a shell company with no commercial operations. It is created to function similar to an IPO. An SPAC raises capital with the express intent of using the funds to acquire an existing company. Alternatively, the target company can also merge with the SPAC and become a listed company instead of carrying out its own initial price offering.

SPACs have been around for a while. They are usually publicly traded and investors include large institutions, PE funds and the general public.

SPACs Tend to Invest Conservative at the Beginning

One reason SPACs are increasingly attractive, even to risk-averse investors, is that they tend to invest their capital conservatively. They typically wait until they find a suitable deal. If the SPAC ends up purchasing a company that you don’t believe in, you can simply cash out. This usually happens at around the same price as the IPO, which could offer downside protection.

There have been several high-profile SPACs over the last year. These have prompted the conversation around this investment do a 180 turn. Current and upcoming SPACs are already receiving a lot of positive press coverage and will continue to draw investors during the rest of 2020 and into 2021.

More SPACs Means More Accurate Valuations for Companies

Because of the resurgence of popularity for SPACs (over 175 in 2020), there is now more competition for deals, which means that the company in which a SPAC is interested can drive a harder bargain, selling itself for more. This is good for both the company and for non-institutional investors.

The large funds and institutional investors usually underwrite IPOs. As a result, they have access to profit from the huge differentials between the IPO and the company’s true valuation. Unfortunately, this means that smaller investors miss out. SPACs, because they constitute a valuation that is much closer to a company’s true value, provide more realistic investing opportunities for different classes of investors–although beginners should always understand investing well-prior to getting involved with something like a SPAC.

A Managed Trade-Off

One of the most appealing things about SPACs is that they provide good hedging against potential downside. The value proposition of a SPAC is an ownership stake in a solid company with good long-term potential. In the worst-case scenario, it is a stake in a company that doesn’t meet your expectations and which you cash out of with a capped downside.

Keep in mind that not all SPACs promise to give you your money back in every circumstance. Make sure you read the prospectus carefully before investing. Historically, the trend has been for the SPAC to return your capital should a suitable acquisition fail to present itself. This is something that is ironed out in the paperwork.

Conclusion

Special Purpose Acquisition Companies are just hitting many investors’ radar because of the high-profile successes over the last year. SPACs have been favored by both companies and investors because of the potential for more fair business valuations, and because of the risk management offered by the opportunity to recover your principle, as well as the more conservative selection process that goes into choosing a SPAC candidate.

The SPAC market has exploded in 2020, with some analysts suggesting and predicting a bubble. So, investors and businesses should always do their due diligence and market research before proceeding with a SPAC investment. However, as the above information demonstrates, SPACs no longer represent the risks to investors they once did. Keep the above considerations in mind when evaluating SPAC opportunities and make smart choices with your money.

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