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SPACs offer stark contrast to conventional public company IPO

But special purpose acquisition companies carry risk, experts caution

As high-net-worth investors look for higher-return assets, special purpose acquisition companies (SPACs) have moved into the spotlight.

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In the first half of 2021, SPAC acquisition volumes were at record levels globally. “The first half dwarfed the activity we saw throughout all of 2020,” says James Sweetman, a senior global alternative investment strategist for Wells Fargo Investment Institute in Charlotte, N.C.

SPACs offers investors a sharp contrast to conventional publicly traded companies – including the potential for both enhanced risk and return.

If an investor chooses to invest in an initial public offering, a private company issues new shares and, with the help of an underwriter, sells them on a public exchange, says Sweetman.

“In a traditional IPO, all existing shareholders must wait out the lockup period of up to six months before selling any of their shares and therefore investors would be subject to the market volatility often associated with that in the public market,” he explains.

The pre-IPO investment in a SPAC is different.

“You are raising money on pre-identifying the target. You’re basically investing either on the pedigree or the experience of whoever is sponsoring that SPAC. The people that invest in the pre-IPO SPAC have the option of whether or not they want to commit and invest in that SPAC-identified target. All the while, they’re collecting interest on that money,” says Sweetman.

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A SPAC starts as a speculative investment with little or no visibility as to what company or business ultimately ends up in it. When a company is acquired by the SPAC, shareholders can typically decide through a vote whether this is something they want to invest in, says Rod Larson, co-head of research and director of private markets at the BMO Family Office in Boston.

“An accelerated way for a private company to go public is to have a SPAC acquire it, versus the IPO path,” he adds.

Sweetman explains that investors who invest in a traditional private equity fund are making a commitment that gets drawn down as capital is invested into various companies.

You’re basically investing either on the pedigree or the experience of whoever is sponsoring that SPAC.

James Sweetman, Wells Fargo Investment Institute

With a SPAC, the pre-IPO investor is making a commitment to the SPAC general partner to find those investments, representing the so-called ‘blind pool’ or ‘blank cheque’ similar to traditional private equity investing, but focused on one company and not a diversified portfolio, he elaborates.

“For investors looking for private equity exposure, SPAC IPOs offer the potential of private equity exposure with enhanced liquidity but also the added risk of increased equity market sensitivity,” says Sweetman.

The pre-IPO SPAC offers several potential advantages, in exchange for the additional risk of investment uncertainty.

SPAC investors typically have up to two years to identify a target investment company. At the end of 24 months, if a company hasn’t been identified for acquisition, then the assets must be returned to the investors, Sweetman notes.

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There is also the potential for members of the sponsor group to elect to stay and lend their expertise to the company that is eventually acquired.

“Often times, that’s the benefit,” says Sweetman. “Once the deal is finalized, the SPAC sponsors may integrate themselves fully into the running of that company. I think part of the value-add that they lend to the company is they bring a lot of operating expertise to run that company on a go-forward basis.”

One reason for a surging interest in SPACs in the U.S. is a search for potentially higher returns than a conventional IPO would offer.

“We say it’s almost a democratization of private equity,” says Sweetman.

“Once the SPAC announced its target, a lot of retail investors were buying into these publicly traded single company vehicles. We saw, last year, a lot of interest in people trying to get access to concentrated positions. That was driving up the price, and there was a lot of active trading around the price in the public market,” he explains.