Role of an Exchange: SPACs Offer Unique Opportunities, But Proceed at Your Own Risk
For retail investors seeking private-equity type growth and returns in their portfolio, SPACs or Special Purpose Acquisition Companies offer an opportunity to participate in the listing of a private company at the initial public offering (IPO) price. While SPACs provide some downside protection, individual investors should be aware of the risks.
In a traditional IPO, shares are often fully subscribed by hedge funds, large institutional investors, or private family firms before they begin trading, and individual investors do not often get to participate at the IPO price. As a result, retail investors get locked out of the opportunity to benefit from any “pop” if opening day trading brings big gains over the IPO price. A SPAC, however, offers retail investors a chance to get in at the IPO price and benefit from the growth—assuming a merger is achieved at a favorable price and the new company is appealing to investors and performs well.
Considering all of the risks
That said, there are also a number of potential risks inherent in SPAC offerings that don’t apply to traditional IPOs, including these four:
1. Conflicting interests
A founder’s shares, which as often referred to as the “promote,” can be worth hundreds of millions of dollars and is paid out regardless of the quality of the acquisition deal. Yet at the same time, sponsors are also negotiating the acquisition price of the company and negotiating with potential investors in any secondary offerings (more on those later). Large founders’ share grants can also be a barrier to striking a deal to acquire a private company because they may be viewed by the private company as dilutive to the equity post-merger.
2. Failure to land a deal
Given the current boom in SPAC issuances, there are a record number of SPACs looking for acquisition partners. If a deal fails to materialize, investors who purchased SPAC units in the IPO are protected from losing their investment when the SPAC is liquidated to return money to investors. However, any investors who paid a premium for units or shares after the IPO will only receive the IPO issue price (typically $10 per share). Warrants expire worthless when a SPAC liquidates. Even if monetary losses are negligible, there is an opportunity cost of parking money with a SPAC for several years only to have it liquidated.
3. Bad acquisitions
Investors can redeem units (for the IPO issuance price) if they don’t like the deal. However, investors who take a chance on the merger may stand to lose a lot more than sponsors if the resulting company doesn’t perform well or if the market thinks it was overpriced.
In fact, only about 30% of SPACs issued from 2015 to 2020 had positive returns. Warrants offer the greatest upside potential for SPAC investors, but they could expire worthless if the stock price of the post-merger company fails to reach the strike price before the warrant expiration date.
4. Secondary PIPE offerings
If sponsors identify a potential acquisition that costs more than they raised in the SPAC IPO, they may need to augment the capital pool with a private secondary offering known as a PIPE (short for private investment in public equity). Sponsors may also line up a PIPE investment to assure that there is enough capital to complete the proposed transaction given the uncertainty of redemptions. PIPEs can enhance the liquidity of SPAC shares when the acquisition is announced because they are viewed as a tangible demonstration of support for the acquisition.
However, PIPEs are potentially dilutive to the equity of the post-merger company. PIPEs are fairly common with SPAC deals—almost 40% of the equity capital of SPAC deals that closed throughout 2019 and the first three quarters of 2020 was sourced through PIPE offerings. Typically, PIPE investors cannot sell their shares immediately because those shares have to be registered with the SEC. In some cases, there is also a further lock-up on the PIPE investors limiting their ability to sell shares for a period of time.
SPACs present a unique opportunity for the retail market but understanding the risks and rewards of these blank-check companies is critical as we strive to advance inclusive growth and prosperity. With all of these factors to consider before investing in a SPAC, seeking the advice of a professional advisor is suggested.
Information is provided for educational purposes only. The content does not attempt to examine all the facts and circumstances which may be relevant to any particular company, industry, strategy or security mentioned herein and nothing contained herein should be construed as legal or investment advice. Nasdaq does not recommend or endorse any securities offering; you are urged to read the company’s SEC filings, undertake your own due diligence and carefully evaluate any companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The Role of an Exchange
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