Special purpose acquisition companies (“SPACs”), sometimes referred to as blank-check companies, have captured headlines and the attention of individual investors in recent months. A private company may use a SPAC to go public. By using a SPAC to go public, a company has more leeway to make optimistic predictions and forecasts than in a more regulated, traditional initial public offering. The limited regulation and freedom for a company to hype its prospects are not necessarily good for individual investors.
In an article titled, Investors Flock to SPACs, Where Risks Lurk and Track Records Are Poor, the Wall Street Journal reported that critics are concerned that the recent interest in SPACs “could end badly for smaller investors who don’t understand the risks.” The Wall Street Journal explained SPACs that went public since 2017 on average significantly underperformed companies that went public using a traditional IPO.
The Securities and Exchange Commission issued guidance in December 2020 about SPACs. The guidance says that the “economic interests” of those behind a SPAC “often differ from the economic interests of public shareholders.” Critically, as the SEC explained, “[u]nlike the traditional IPO process where a private operating company sells its securities in a manner in which the company and its offered securities are valued through market-based price discovery, these individuals are solely responsible for deciding how to value the private operating company and how much the SPAC will pay for it.” In other words, the people behind the SPAC, who often engineer lucrative schemes for themselves to profit, decide the terms of the deal and the price.
Among other important questions, an Individual investor considering a SPAC should understand: i) why using a SPAC is preferable to an initial public offering; ii) how and when the investor can sell and whether there will be liquidity; iii) what support and auditing is there for projected financial performance; and iv) how the sponsors, promoters, and others behind the SPAC will profit?