Too embarrassed to ask: what is a SPAC?

A financial instrument called a “special purpose acquisition company”, or SPAC for short, is growing increasingly popular in the US stockmarkets. But what exactly is a SPAC?

A lot of smart people currently think that the US stockmarket is in a bubble. One indicator that many point to is the growing popularity of a financial instrument called a SPAC. But what is a SPAC, and why is it significant?   

SPAC stands for “special purpose acquisition company”. These companies are listed on the stockmarket. However, there’s one big difference between a SPAC and a normal company – the SPAC doesn’t actually have any business operations of its own. Instead, its sole purpose in joining the stockmarket is to raise money to buy an existing private company or companies.

For this reason, SPACs are also known as “blank cheque companies” in the US. In the UK, they’d more commonly be described as “cash shells”.  Once it has listed, the SPAC has two years to find a deal to spend the money on. If it doesn’t then it has to return the cash to shareholders.  

Why would anyone want to invest in a SPAC, or a cash shell? For private companies, the selling point of joining the stockmarket via a deal with a SPAC is that it saves on the hassle and paperwork of enduring the traditional listing process. 

For investors – particularly small investors – buying into a SPAC provides an opportunity to invest in the types of deals and companies that they would otherwise struggle to gain access to.

The flipside, of course, is that investors don’t know what their money might be spent on. And the record is patchy. One recent academic analysis of deals done in the 18 months from January 2019 suggested that on average, SPACs lost 12% of their value within six months of a merger deal, even although the wider stockmarket rose sharply in that period.  

Moreover, while SPACs have been around for a long time, they have enjoyed record popularity in the last couple of years. This sudden enthusiasm for “lucky dip” investing suggests that investors are far more worried about missing out on potential gains than they are about incurring losses – usually a good sign that markets may be overheated. 

To learn more about bubbles and SPACs, subscribe to MoneyWeek magazine.

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