Have you always thought that in order to invest in a company, you should find out about its financial health, its activity, the amount of dividends it pays and so on? After all, nothing seems more risky than investing in a mystery company. And yet this trend is becoming more widespread and stirring up the financial markets through so-called SPACs.
SPAC stands for Special Purpose Acquisition Companies. Behind this name lies a new way of selling a business on the stock market by reversing the classic order of how companies go public. While the traditional method requires a long, exhausting and costly process to make an initial public offering (IPO), everything changes with SPACs.
This is how it works: investors set up a shell company, list it on the stock exchange to raise additional capital from, among others, private investors, with the aim of buying an unlisted firm. The target must be found within a predetermined period of time, which may not exceed two years. In the meantime, the funds raised are held in cash. Once the acquisition is completed, the SPAC is dissolved and merged with the acquired company. The new entity is now on the stock exchange, like any other listed company.
The latest example is the so-called Asian Uber, Grab, which recently announced a partnership agreement with the investment fund Altimeter Growth, which will value the company at nearly $40 billion in preparation for an IPO in the coming months. A record amount, which echoes the boom in the number of SPACs on Wall Street in recent times.
Since the beginning of 2021, more than 300 SPACs have already been created, raising nearly USD 100 billion in funds. This is already more than in the whole of 2020, when nearly 250 SPACs were created for nearly USD 80 billion of funds raised from investors! And yet 2020 was already a record year by far, with the number of SPACs created increasing almost four times between 2019 and 2020.
But how can you explain this explosion in the number of SPACs over the last two years? One reason is the very loose monetary policy of central banks in Europe and the United States, with interest rates close to zero. With the stimulus packages that followed the global coronavirus epidemic, cheap money started flowing. Today, both professional and retail investors are increasingly moving away from government bonds, which pay little and are likely to be overtaken by inflation. At the same time, the shares of major technology companies have skyrocketed over the past year and the prospects for gains are no longer as attractive as they were then. Everyone’s dream now is to find the hidden gem and invest in the Facebook and Amazon of tomorrow, right from the moment of their creation.
So yes, it all sounds very appealing at first, but what are the risks associated with SPACs? Faster and more flexible than an IPO, this scheme is not without risk. SPAC promoters have to complete an acquisition within a predetermined time frame. In the rush, they may be tempted to be less careful about the quality of the target. When you’re doing a normal IPO process, by comparison, you have a huge document requirement which is a strong safeguard.
There is another aspect that might worry some individual investors. When investing in a SPAC, you’re really buying a promise with all the uncertainties that this may entail. You don’t even know what private company your invested SPAC will merge with. Although investors are usually consulted at the time of the acquisition of the target company, it is difficult to have a clear picture at the time of the IPO of the SPAC.
To reassure investors, SPACs must therefore respect certain operating rules. At the time of the IPO, investors are informed of the main criteria of the target acquisition, such as the sector of activity, the size of the operation, or the desired profitability ratios.
Ultimately, the main question that people considering investing in an SPAC may ask themselves is whether they really want to sign a blank cheque to ultimately become a shareholder in a company they do not yet know. Think of it this way: SPACs are kind of like the blind dating of the financial markets. How willing are you to go on that date?
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