Welcome back to “Ask an Advisor,” the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.
This week’s question is on special purpose acquisition companies, or SPACs.
These short-lived shell companies, also called “blank check companies,” exist solely for the purpose of acquiring another business. Through an initial public offering, the SPAC sells shares of itself to raise enough money to buy the target company.
If it succeeds, the acquired company goes public. If it fails, after two years the SPAC dissolves and investors get their money back. In theory, this is a faster and easier way to take the target company public than a traditional IPO.
In the first years of the COVID pandemic, investment in SPACs skyrocketed. In 2019, there were only 59 SPAC IPOs, according to the website SPAC Insider. Then, in 2020, there were 248, and in 2021 there were a record-breaking 613, raising a total of $265 million. Celebrities got in on the action, from Shaquille O’Neal to Martha Stewart to Donald Trump.
Soon afterward, the SPAC boom began to bust. A number of high-profile acquisitions failed to pan out — O’Neal’s SPAC, for example, eventually called off its merger with the hyperloop company it was trying to acquire — and SPACs started to lose their luster. In 2022, the number of SPAC IPOs sank to 86.
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So are SPACs a bad investment? Or are a few bad apples ruining the whole category’s reputation? A tech entrepreneur in New York is intrigued by the shell companies but wants to know the red flags to look out for before he invests. Here’s what he wrote:
Dear advisors,
Some of the most exciting story stocks over the last few years were, for me, SPACs. Obviously, these shell companies have generally not done well since the end of the 2020-2021 boom, but is that because IPOs and story stocks in general haven’t done well? Or are SPACs, by definition, cursed with selection bias (i.e., only companies with things to hide go public via SPAC)?
As an investor, I’m wondering what to look for when deciding whether to invest in a SPAC. Are there any good reasons why a fundamentally sound company would launch that way? What signs can I look for that a SPAC is a safe investment? Or should I avoid them all together?
Sincerely,
SPACing Out in SoHo
And here’s what financial advisors wrote back: