SPAC (special purpose acquisition vehicle) was arguably one of the key buzzwords in 2020 when several companies raised billions of dollars to go public through such shell companies. For the whole of 2020, SPACs raised about $79 billion, and this momentum has accelerated into 2021 as such firms have already raised nearly $26 billion in share sales in January this year.  

The well-received infusion was also followed by bumper listings of the companies acquired by SPACs, or blank-check firms, with prominent names such as Virgin Galactic (SPCE), DraftKings (DKNG) and Nikola (NKLA), among others, more than doubling investors’ wealth in a span of a year. Here’s a look at a one-year chart of a few acquired firms. Virgin was one of the first names in the past year to have taken the SPAC route.

Returns chart of popular SPAC companies that merged with acquired targets

Other prominent SPAC stocks that went public after reverse mergers have risen considerably, handing investors hefty rewards. Companies such as QuantumScape (QS) and Desktop Metal (DM), among others, have gained as much as 350%.

Stellar returns chart of popular SPAC stocks 

Not just stocks, investors have cashed in on ETFs covering IPOs too. The Renaissance IPO ETF (IPO) — comprising 50 largest companies to have gone public over the past several years, has surged about 133% between January 2020 and February 2021 so far.

So, what is a SPAC?

SPACs are shell companies set up by investors and have no commercial operations. They are incorporated only to raise money via IPOs that later go on to fund the acquisition of an existing company.

Who creates a SPAC?

The creators of a SPAC, or sponsors, are institutional investors, marquee names from the field of finance, private-equity or hedge funds, or even famous people such as the CEO of Virgin Group Richard Branson, former NBA star Shaquille O’Neal, ex-House Speaker Paul Ryan or the hedge fund billionaire William Ackman.

What happens to the money raised from the IPO?

After raising funds, the money is parked in an interest-bearing escrow account until its founders find a private company willing to go public. The sponsors also have a deadline of two years from the IPO date to strike a deal, failing which the SPAC will be liquidated and the money will be returned to its investors.  

What are the next steps after an acquisition is complete?

At this point, the acquired company is merged with the SPAC, giving the latter’s investors a choice to either swap shares of the merged company or redeem the SPAC shares to get back the original investment along with the interest accrued in the trust. Typically, SPAC sponsors get a stake of about 20% in the final merged company.  The stakeholders also earn hefty gains on the listing of the merged companies, given the euphoria created around such firms.

Why do SPACs click?

–     SPACs require complete transparency as they are supposed to file an S-4 while announcing an acquisition. This contains the same disclosures and risk statements as that of an S-1 that an IPO must file, as per this CNBC report.  

–    The association of big names from the financial sector adds credibility to the SPAC for investors to rely on.

–     If investors are unhappy with the acquisition target, they can sell their shares before the deal is finalised.

What are the risks?

–     Some market participants believe the current euphoria may be a part of a bubble that overvalues nascent companies.

–     Investors also stand a risk of parking their funds blindly in entities without having an idea about the acquisition target or its financials. On occasion, target companies also stare at a risk of having the deal rejected by SPAC shareholders.

–     Some investors are also worried about the long-term returns. Advisory firm Renaissance Capital analysed that average returns from SPAC mergers between 2015 and 2020 was short of average post-market return for investors from an IPO.  

Summing up
The SPAC flood shows no signs of abating, with about 287 blank-check firms still scouting for targets in sectors of technology and electric vehicles, among others. It only adds fuel to the frenzy currently seen in the markets. However, experts caution investors to research well and understand the risks of investing,  and not get swayed by the momentum.