What Are the Risks Involved In a SPAC Investment? (& How to Mitigate Them)

If you're tuned in to the US stock market, you've likely heard of SPACs (special purpose acquisition companies). This financial vehicle is a way to take companies public through the back door. A SPAC investment does carry some risk if done incorrectly.

What is a SPAC, really?

A SPAC, or blank-check company, is a business that's born solely to take another company public.

A SPAC files with the SEC to go public under its own ticker. From the moment it goes public, it has two years to find a privately held target and finalize a merger. From there, the private company becomes public and the ticker symbol changes to reflect the new face of the firm.

You can invest in a SPAC pre- or post-merger

Retail investors can access SPAC stock before or after the merger is finalized. By getting in early with the blank-check firm's ticker, you may be able to access an undervalued market price. However, waiting until the merger finalizes and the ticker changes reduces the risk of you losing capital on a failed merger.

Risks to know about before investing in a SPAC

SPACs can fail to merge, even after announcing a target. Be sure that the blank-check company and its target have an official DA (definitive agreement) before investing to mitigate risk.

Additionally, make sure the deal has passed SEC regulation before jumping in.

Many SPACs are backed by celebrities (including Jay-Z's The Parent Co. and the Richard Branson-backed 23andMe), but don't let that fool you. The SEC wrote in a press release, "Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss."

Examples of SPACs in the US

In June 2020, a Dubai blank-check firm called Frontier Investments (NASDAQ:FICVU) raised $250 million in a SPAC public offering to take its own asset management company FIM Partners public.

Unlike the Middle East, which has only seen a handful of SPACs in its stock market history, the US has experienced an influx of SPAC-style IPOs.

SPACs were once considered a back-alley deal for companies that couldn't handle going through a traditional IPO, but they've grown to be extremely popular for legitimate companies. In fact, they're so popular that analysts are harping on the "SPAC bubble" that may or may not burst. A whopping 250 SPACs went public in the US in 2020 alone.

ArcLight Clean Transition Corp. is a blank-check firm that recently merged with electric transit company Proterra Inc. (NASDAQ:PTRA).

TS Innovation Acquisitions Corp. is a blank-check firm that recently merged with building operating system company Latch, Inc. (NASDAQ:LTCH).

Pershing Square Tontine Holdings (NYSE:PSTH) is a blank-check firm that failed to merge with its target Universal Music Group. The SEC claims Bill Ackman, the SPAC's founder, tried to use the SPAC vehicle incorrectly. Investors who bought PSTH stock pre-merger lost millions.

Ultimately, there are risks and opportunities associated with a SPAC investment. Cover your bases and get familiar with the merger target's financials before buying in.