The Rise of SPACs

I am extremely risk averse when it comes to managing money for my clients. This might sound strange given that most of my clients have at least half of their retirement savings invested in stocks and others have at least some. Risk is necessary for growth (financial and personal) and I’m not shy about risks that I have some control over. It’s the unknown unknowns that bother me most and are why I have always avoided more speculative and illiquid types of investments.

Risk is a tool that can work wonders if used correctly but can also lead to disaster. Of all the different types of risk I think about, the one I try to avoid like the plague on behalf of clients is what I refer to as “blow up” risk. Call me old-fashioned, but I simply have an aversion to putting client money into anything that risks catastrophic failure, even if the potential return is huge.

This idea was drilled into me during an early-career training session led by a seasoned veteran who offered this simple advice to the newbie advisors in attendance: don’t blow anybody up. Some in the room laughed and others thought the concept too simple. For some the sage advice went through one ear and right out the other. But it stuck with me and I’ve been reflecting on the advice quite a bit during the last year or so with the rise of Special Purpose Acquisition Companies (SPACs).

You may never have heard of SPACs, or maybe only recently because they’ve been in the financial news lately. Also known as “blank check” companies because that’s essentially what investors are handing over when they buy shares, the structure has been around for years but really took off as the pandemic began to rage last Spring.

Celebrities like Shaquille O’Neal and A-Rod are in on the game, as are other big names like former Congressmen and VP candidate Paul Ryan. If they’re doing it, why shouldn’t you? SPACs are being touted in some circles as the “poor man’s private equity”, or another force “democratizing” investing much like brokerage firm Robinhood and the GameStop short sellers were said to be doing. This kind of hyperbole coupled with star power seems to have all the hallmarks of a bubble.

I’ve been getting questions about SPACs lately, so I thought I’d put together some resources for you if you’re interested in learning more. I would suggest treating this as an academic exercise and not something to jump into with your hard-earned savings. The reasons will likely become apparent as you investigate these things. But the bottom line is that, just like with other investment fads over time, blow up risk is high. Early entrants make money, often through private deals, and by the time they offer it to you it’s because they need to sell it to you to take their profits.

Here are some notes about SPACs and a few links for further reading, ordered by level of detail.

SPACs are formed with a relatively small amount of money and then sold to investors in an Initial Public Offering (IPO) so the fund can accumulate cash. Essentially, investors buy shares of a fund that has no value, just cash and a goal to merge with a private company so it can grow. Investors trust SPAC management to find a good company to merge with. It could ultimately be a good deal, but you won’t know much about it until it’s happened. There have been successes and notable failures.

Investors can buy the SPAC as an IPO, or afterward on a stock exchange before it announces a merger, or on an exchange after the merger announcement. These are the three stages of a SPAC and the latter stage might be most appropriate for a long-term investor, if at all.

SPACs have two years to merge with a company and, if they don’t, must allow early investors to sell their shares back to the fund. Apparently, lots of the early folks do this.

The SPAC allows a private company to “go public” faster than the typical IPO process and with less scrutiny. This gets a growing private company quick access to capital, but the process isn’t transparent to the end investor (you).

SPACs exploit a regulatory loophole that allows them to aggressively promote the fund on social media, podcasts, etc, in ways that wouldn’t be possible with a traditional IPO. Many suggest that this sucks a lot of unwitting retail investors into deals that help make initial investors rich but leaves the newbies with high costs and, often, losses.

Ultimately, once the SPAC merges with a private company, the new merged company begins trading in place of the SPAC. The new company is more transparent because it’s now public. This allows ordinary investors to see what the SPAC actually accomplished. If investors don’t like the new company they can sell in the open market, hopefully for a profit. Most of the original investors are already out at this point, profits in hand.

If you’d like to learn more consider checking out these links. It’s a reminder of how creative people can be when trying to make money off the backs of others.

Link 1 – A story yesterday from the WSJ about SPACs and their recent parabolic growth rate. There’s a soft paywall, so you may not be able to access the article. If so, let me know and I can email it to you through my subscription.

https://www.wsj.com/articles/spacs-are-the-stock-markets-hottest-trend-heres-how-they-work-11617010202?mod=hp_lead_pos6

Link 2 – A bulletin from the SEC for retail investors to learn more about the structure and risks of SPACs.

https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin

Link 3 – An excellent but long paper covering all you ever wanted to know about SPACs. The authors also discuss some ways that the SPAC structure could be used to actually democratize part of the investing landscape.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3720919

Have questions? Ask me. I can help.

  • Created on .

Contact

  • Phone:
    (707) 800-6050
  • E-Mail:
    This email address is being protected from spambots. You need JavaScript enabled to view it.
  • Let's Begin:

Ridgeview Financial Planning is a California registered investment advisor. Disclaimer | Privacy Policy | ADV
Copyright © 2018 Ridgeview Financial Planning | Powered by AdvisorFlex