There were more special purpose acquisition companies, or SPACs, created in 2020 than in the previous 10 years combined. More companies are choosing to go public via a merger with one of these "blank-check" companies than ever before.
However, SPAC investing isn't well understood by many people. In this Fool Live video clip from Dec. 22, 2020, Fool.com contributors Dan Caplinger and Matt Frankel, CFP, discuss how these companies work and what investors should know.
Matthew Frankel: The traditional IPO process is not accessible to a lot of people listening, myself included. I get shut out of IPOs all the time. I use TD Ameritrade and they don't sponsor a lot of them. It's a way for everyday investors to get into IPOs. Like any kind of investing, there's a right way and a wrong way to do it, and there's a lot to know before you get started. I feel that's really important. Real quick, for those listeners who don't know, who have just maybe heard SPACs in news headlines and stuff like that, give everybody just like a 30-second rundown of what a SPAC is.
Dan Caplinger: Sure. The acronym S-P-A-C stands for Special Purpose Acquisition Corporation. Basically, the way it's set up, it's like a shell company. You'll get a group of investment managers, they will go out to the general public, they will say, "Hey, we want to raise some money. We want to buy a privately held company. We don't know exactly which privately held company we want to buy upfront, we just know generally what we're looking for. If you will give us some money, we will do the legwork, we will negotiate a deal with a good acquisition candidate, then we'll come back to you as shareholders once we've got that deal in place and say, 'Hey, do you think this is a good deal?'" Shareholders vote. If they vote to approve it, then the merger goes through. Basically what happens is, the way that the SPAC is formed, they go through the IPO process. They list their shares on the New York Stock Exchange, on the NASDAQ. When they buy the privately held company, they set up the merger in such a way that after the merger is complete, then suddenly it's the private company's business that's available to those SPAC investors. The shares that you own as a SPAC shareholder, they represent that privately held company after the merger.
Frankel: SPACs can be a little complicated to trade. When they go public, SPACs are generally first brought to the public market as something called units. Then, at some point later, I want to say it's 52 days, in most cases, something to that effect. They split into common shares and warrants. Each SPAC unit is a combination of one share, and a certain fraction of a warrant. Some cases it's half, some cases it's a quarter. One thing is, it's important to know the distinction of what you're investing in first of all. When you buy a SPAC that has recently gone public, your choice is pretty much the units, which we'll see in a couple of examples a little bit later. That's a combination of a share and a piece of a warrant. Once the SPACs traded for a while you can choose; should you just buy the common stock, should you buy the warrants, which are similar to options, or should you buy the units which are a combination.