Investing with Purpose

What you need to know about SPACs—and why you should proceed with caution

By Judy Martel

SPACs (special purpose acquisition companies) might well be the exciting new investment kids on the block. A decade ago, these entities—formed for the sole purpose of raising capital to acquire existing private companies and take them public—were little-known outside the financialcommunity. But within the past year, they’ve emerged from the shadows, driven in part by some notable initial public offerings (IPOs) such as spaceflightcompany Virgin Galactic and online sports betting company DraftKings. Investors seeking a big payoff from buying into a company before it goes public can purchase shares of SPACs through a brokerage account. They are typically more accessible to the average investor than a more traditional IPO managed by investment bankers, and they can also circumvent some of the red tape, giving them more agility in the marketplace. But the relative speed and ease with which they can operate is the very reason potential investors should use caution when investing in SPACs, according to Deanne Butchey, a teaching professor in the department of financeat Florida International University and a former investment banker at Credit Suisse. “Investors often want to jump on the bandwagon immediately and don’t dig deep enough in their due diligence,” Butchey says. “They are relying on the expertise of the originator of the SPAC.” SPACs are sometimes referred to as “blank check companies” because investors put money in without knowing what company will eventually be acquired. Typically, if the SPAC doesn’t purchase a company within two years, the money is returned to the investors. The originators, called sponsors, are highly regarded experts in a particular fieldand often have a target company in mind when forming the SPAC, but investors are still putting their faith in the sponsor’s ability to do the proper research, Butchey explains. For an example of one SPAC investment that didn’t turn out as planned, Butchey points to the electric-vehicle company Nikola. “The original SPAC originators didn’t dig deep enough,” she says, and when the media reported that Nikola allegedly exaggerated claims about vehicle performance and production from the beginning, short sellers came calling and helped drive the stock valuation down, potentially leaving SPAC investors with a loss.

“With any equity investment, whether in an individual company stock or a SPAC, shareholders should be looking at making money over the long term and holding it for at least 10 years while continuing to follow the company and do due diligence,” Butchey notes. An immediate payoff from a SPAC IPO can be huge, and the hope is that the investment will continue to grow. But there’s always a possibility prices will flutuate wildly, particularly because it’s not unusual for SPACs to often invest in start-up companies, which are considered riskier than blue-chip company stocks. If shareholders panic, they could sell at the wrong time and take a loss. What’s more, cashing in on an immediate price increase will have tax implications that Butchey says are often overlooked; taxpayers will owe short-term capital gains tax on any shares sold within a year. Butchey encourages investors to view SPAC investing with the proper risk perspective because she believes it is appropriate only for the sophisticated individual willing to take a gamble. “Investors are hoping these SPAC originators will findthe next big company, and I’ve seen people lose money basically at the flip of a coin”