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Investing strategies

SPACs: Risks to keep in mind

Learn about SPACs (special purpose acquisition companies) and the risks connected to investing in them.
6 minute read
September 16, 2021
Investing strategies
Managing portfolios
Financial terms
Understanding investment types

While SPACs (special purpose acquisition companies) aren’t new, they’ve increasingly been used as a mechanism for private companies to become publicly traded companies. In this article we’ll answer some of the most frequently asked questions we’ve received about SPACs. You’ll learn about:

  • What a SPAC is.
  • What you should consider before investing in a SPAC.
  • What Vanguard thinks about SPACs.

What’s a SPAC?

A SPAC is a common alternative to the traditional initial public offering (IPO) technique. SPACs are shell companies that have no business operations.

You may be wondering why someone would create a company without real business operations. The sole purpose of a SPAC is to raise money to support the future acquisition of a target company. After a SPAC goes through an IPO, it puts the money it raised into an interest-bearing trust account. This account will remain untouched until the SPAC management team finds a private company to take public.

SPACs are also known as “blank check companies” because investors don’t know what the targeted acquisition will be. At Vanguard, clients may begin purchasing SPACs after the initial IPO, when the SPAC units begin trading on the secondary market.

How long does it take a SPAC to find a target company?

A SPAC typically takes up to 2 years to find a target company.

If the SPAC management team is unsuccessful in completing a merger with a private company, the trust account is liquidated and SPAC investors receive money from the trust account in proportion to their original investment. SPACs usually trade around $10 per unit.

Are there risks associated with SPACs?

There are many risks related to investing in a SPAC. These include:

  • Not knowing the SPAC’s investment strategy during the initial IPO.
  • Having to rely on the SPAC’s management team to find a suitable target company.
  • Being in the dark about the intended target company.
  • Recent regulatory scrutiny by the SEC.
  • Dilution of SPAC share value due to compensation of the SPAC management team.

Companies that go the traditional IPO route are subject to regulatory and investor scrutiny of their audited financial statements. Because of their structure, SPACs don’t go through the traditional IPO process, and their success depends on the skill of the management team.

Investing in SPACs carries unique risks, so it’s important to evaluate whether a SPAC investment is a suitable choice for you. Before adding a SPAC to your investment portfolio, carefully read the SPAC’s prospectus and consider the company’s objectives and associated risks. The SEC has an investor education bulletin that discusses the risks associated with this investment.

How do SPACs trade?

In a SPAC IPO, the company will typically issue tradable units instead of common shares:

1 SPAC unit = 1 share of SPAC common stock + 1 warrant (or a fraction of a warrant)

After a SPAC merger event is approved, SPAC units will automatically convert into common stock shares and warrants of the acquired company. It may take up to 2 days after the merger event to see your new share and warrants online.

Tell me more about warrants

Warrants give shareholders the right to purchase a certain number of shares of the company at a set price, known as the exercise or strike price, up until a specific date, known as the expiration date.

When a warrant redemption is issued, the holder may have a limited time to exercise their warrants before the SPAC company redeems all outstanding warrants for $0.01. Further information on a SPAC’s warrant redemption process can be found in its prospectus.

What are SPAC redemption rights?

Before the merger event, SPAC shareholders are given the opportunity to redeem their shares from the SPAC’s trust account at the IPO price, which is usually $10 plus accrued interest. This process is separate from the merger vote.

If you’re a SPAC shareholder and you wish to request a redemption, you must call our Asset Servicing Team at least 2 business days before the redemption deadline. The deadline for redemptions is stated in the SPAC proxy prospectus.

What does Vanguard think?

We believe it’s better to avoid chasing investment trends and focus on things within your control. Follow our 4 principles for investing success:

  • Create clear, appropriate investment goals.
  • Develop a suitable asset allocation using broadly diversified funds.
  • Minimize cost.
  • Maintain perspective and long-term discipline.

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