SPACs have been making quite a splash in the last couple of years.
Trending headlines and the occasional celebrity endorsements of SPACs may have you wondering what they’re all about. Is it the latest skincare routine? Another space venture?
Not quite. While SPAC would be a good name for both, it actually stands for “special purpose acquisition company,” which can provide a way for private companies to go public outside of the traditional initial public offering (IPO) process.
Companies going public – whether through a traditional IPO or SPAC – often come with great fanfare. And whenever there’s buzz around a particular public offering, retail investors, like you, may be curious to know whether they could get in on the action and invest early in a company that’s potentially about to take off.
So let’s review the basics of IPOs and SPACs and go over some key things you’ll want to know before jumping in.
Before we get into definitions, let’s take a step back and talk about what it means to “go public.” (If you’re already familiar with this, feel free to skip ahead!)
When a private company decides to go public, it basically means that it wants to become a publicly-traded and owned business. Companies may go public for a variety of reasons, but it’s usually because they want to raise money (or capital) and expand their business.
Once a company is public, it gets listed on the stock exchange, where you could then buy and sell shares of its stocks. When popular companies announce plans to go public, it’s often a big deal, and it can come with a lot of press, prestige and paperwork.
So how does a company do all of this? Yep, you guessed it – via a traditional IPO or SPAC, which are two common ways to take a company public.
Good to know: Direct listing is another way companies can go public. With this route, businesses sell shares directly to investors in an opening auction without going through the IPO process. But we’ll save this topic for another day.
You’re probably familiar with this term. IPO stands for initial public offering and is the traditional way of taking a company public.
Going the traditional IPO route can take a lot of time, money and effort. While we won’t be able to go through all the steps and details of the IPO process in this article, here’s the capsule version:
To go public in this way, a private company will typically work with an investment bank (hello Goldman Sachs) who will help with the underwriting process. For instance, the bank will review the company’s assets and crunch a lot of numbers to come up with data like a valuation, share price, IPO date and more.
The bank will also host events – called roadshows – where they pitch the company and IPO to institutional investors to drum up enthusiasm and interest in the business.
As the underwriter, the investment bank will also help the company register with the Securities and Exchange Commission (SEC). Sounds simple, right? But there’s actually a lot of paperwork to file and regulatory requirements to check off to get things in order (see the SEC’s “Going Public” portal here).
Once everything is squared away, the company is listed on an exchange and investors (like you) can buy and sell shares of its stock.
A SPAC or special purpose acquisition company also goes through an IPO process, but it does things a little differently. Compared to a traditional IPO, SPACs can provide a faster and less expensive way of taking a company public.
Here’s a high-level overview of how it works.
Although “company” is in the name, a SPAC may not match your impression of one. A SPAC doesn’t have specific products or services to sell. This is why SPACs are sometimes referred to as “blank-check” companies because they don’t have traditional business operations when they’re first formed.
SPACs are created for the purpose of raising capital through an IPO and then finding a private company to acquire or merge with. In this way, you can think of a SPAC as more of an investment company.
Generally speaking, a SPAC has about two years to find a target company. If they don’t find one, the SPAC will dissolve and any remaining funds (from the amount that was raised) will have to be returned to its investors.
But if a match is found, the SPAC, which is already a public entity, will acquire or merge with the private company. By coming together with the SPAC, the private company effectively becomes a public company once the deal is done. As for the SPAC, it will have fulfilled its “special purpose.” In short, when a SPAC and a target company come together, they complete each other (go ahead, cue the violins).
Here’s the key thing to remember: A company has to be bought by a SPAC in order to become public, but the company itself doesn’t have any control over the SPAC formation process.
We know that was probably a lot of information to take in, so here’s a quick recap.
In both a traditional IPO and SPAC, the goal is to raise funds – the money is just being used for different reasons.
A company that decides to go the traditional IPO route already has a product or service (think: retail, food delivery, vacations, etc.) that it’s selling, along with a proven business model. The goal of going through the IPO process is to raise funds so that it can grow its existing business.
A SPAC also goes through the IPO process, but in this case, the aim is to raise capital to acquire or merge with another company.
While IPOs and SPACs could offer unique investment opportunities, here are three key things to keep in mind.
Participating directly means you get to buy shares at the initial offering price before they’re traded on the secondary market (translation: the national stock exchanges). Usually, only institutional investors or clients of the underwriters will get first dibs. We’re talking about mutual funds, pensions funds and high-net-worth individuals.
A company that’s going public may also set up a Directed Share Program, which allows certain eligible people, like friends, family and employees, to buy shares at the initial public offering price.
Other retail investors, on the other hand, typically have to wait until the stock becomes available in the public market before they can buy shares (at the trading price).
If you’re interested in participating in an IPO, check with your brokerage firm to see what options are available to you. Sometimes, a brokerage firm may allow certain qualified individuals to buy shares at the IPO price.
While SPACs may be more accessible to regular individual investors, they’re generally considered less transparent than traditional IPOs.
When evaluating a SPAC investment, you usually have to rely on the reputation of the SPAC sponsors (the person or firm that sets up the SPAC) – since there’s really no business operation history to evaluate.
In short, potential investors have to accept a greater degree of uncertainty with SPACs. This is why the SEC encourages you to review a SPAC’s IPO prospectus and filings carefully to understand the investment terms, the SPAC’s features and the background of its management team.
For instance, does the SPAC specify which business industry they will look to for its acquisition? While a SPAC may have a specific target industry in mind, they’re not obligated to follow through – they could end up acquiring a company from an entirely different industry. (And it may be an industry you’re not interested in.)
At this point, you may be wondering: Is one investment better than the other?
Headlines about upcoming IPOs and SPACs often come with a lot of fanfare, but it’s important not to get swept up by all the excitement (even though sometimes the fear of missing out can be strong).
First, as with all investments, there’s no guaranteed return.
Second, both IPO and SPAC investments can be speculative and risky. There can be a lot of uncertainty and volatility when it comes to their performance.
For instance, you may have to get comfortable with the possibility of big price swings. Some IPOs and SPACs can come with great expectations in the beginning – only to fall flat once the initial high wears off.
And remember: With SPACs, it’s possible that they never find a target company to acquire. Even though investors may get some of their original investment back, that’s money that could have been invested elsewhere.
Now, this isn’t meant to sound like a downer. But it’s a reminder to do some due diligence before diving in.
Because of their speculative nature, IPO and SPAC investments may not be right for everyone. If you’re interested, definitely check in with a financial advisor to see whether they make sense for your risk profile and overall financial goals.
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