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SPACs are popular investments, but carry risks. Here’s what to know

3 min read
The stock market began to surge about a year ago, as government stimulus money and other assistance poured in. Over that time, an interesting investing subplot has emerged — the rise of “SPACs” as a way to get new companies, especially glitzy technology startups, to market faster.

Special purchase acquisition companies have been around for decades, but their recent ascent has been spectacular, even raising eyebrows in two recent investor alerts from the Securities and Exchange Commission.

The list includes last year’s biggest SPAC, Pershing Square Tontine, and both new Arizona-based electric vehicle manufacturers — Lucid Motors and Nikola Corp. Even Rapper Jay-Z and Colin Kaepernick, the pro-football quarterback turned social activist, have gotten involved in SPACs, focusing on a cannabis business and a social-activist consumer company, respectively.

The traditional way that private companies raise money in the stock market is through an initial public offering or IPO. SPACs offer a faster and potentially more controllable means of doing that, which partly explains their heady rise.

In 2020, 248 SPACs raised $83.3 billion, according to SPAC Insider, up from $3.9 billion in 20 deals just five years earlier, in 2015. From October through December of last year, SPACS surpassed traditional IPOs on a quarterly basis for the first time in both measures, and the pace is running even faster so far in 2021.

The SPAC surge “certainly has the look and feel of a … bubble,” wrote Dave Sekera, chief U.S. market strategist at Morningstar in a recent report. “The last time SPACs proliferated was in 2007, just before the market imploded.”

 

What, exactly, are SPACs?

SPACs are blank-check or shell companies, flush with cash, that search for attractive private corporations with which to merge.

The process starts when a SPAC raises money from investors in its own IPO. “Blank check” means the sponsoring firm doesn’t have any business operations of its own and few assets other than the cash raised in the IPO.

“If you invest in a SPAC at the IPO stage, you are relying on the management team that formed the SPAC,” said the SEC’s Office of Investor Education and Advocacy in a December alert to investors.

The management team might identify a specific industry to target, but it’s not obligated to go there. By contrast, more traditional IPOs happen when a company with operations and assets — and sometimes decades of history — raises money by selling shares directly in the stock market.

For target companies lured by SPACs, three main benefits cited by Sekera include a greater certainty of knowing how much money they will bring in, a process that’s often faster than for IPOs and the ability to disclose certain financial projections and other information that typically isn’t allowed with a traditional IPO.

Help from the sponsors is important, too. “They’re really relying on that management team and expertise,” said Adam Olsen, national quality leader at accounting and financial consultant Embark in Phoenix.

In some cases, SPAC officials share in management duties at the combined company....

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