What you need to know about SPACs

SPACs are all the rage in 2020, but investors should proceed with caution

Over the past year or so, I’ve had a lot of people ask me about SPACs vs. IPOs. So with this post let me try to clear up some of the confusion.

SPACs are a type of company, and IPOs are offerings (sales) of shares in companies.

Basically, a traditional initial public offering (IPO) is a type of public offering in which shares of a private company are made available on the public markets & sold to retail (individual) investors for the first time. An IPO is underwritten by one or more investment banks (e.g. Goldman Sachs, J.P. Morgan Chase), and may involve the listing of stocks on one or more stock exchanges such as the NASDAQ or NYSE. Through this process, a privately held company will be officially transformed into a public company, allowing its shares to be traded in liquid secondary markets.

As for SPACs, a SPAC is a “shell company” created specifically to raise money in a IPO from investors, then use that money to merge with or acquire another company. Hence the acronym: Special Purpose Acquisition Company … it’s a company formed for the special purpose of acquiring another company! Also known as "blank check companies," SPACs have been around for awhile but have gained prominence recently with the success of several SPAC IPOs such as Virgin Galactic ($SPCE) and DraftKings ($DKNG).

As compared to traditional IPOs, the process of filing a SPAC IPOs can be significantly quicker. Due to its lack of fundamental operations, the required statements filed during a SPAC IPO are significantly shorter and can be prepared in a matter of weeks (compared to months for a traditional IPO). There are no historical financial results to be disclosed or assets to be described, and business risk factors are minimal.

However, this convenience comes at a trade-off for investors, as the ultimate success or failure of a SPAC thus depends on the execution of its M&A strategy. Therefore, if a SPAC fails to find or come to agreement with an acquisition or merger partner, the company may totally fail as a legal and financial entity without ever operating as an actual business. When evaluating new investment opportunities, the SPAC vs. IPO distinction while notable should nevertheless take a back seat to essential considerations such as market positioning & financial metrics.