Special purpose acquisition companies (SPACs, for short) exploded in popularity during 2020. A SPAC is a company with nothing more than a chunk of money and a management team dedicated to finding a private business to merge with and take public.

Last year, total SPAC listings more than quadrupled from 2019, and gross proceeds raised were more than six times higher year over year. So far in 2021, SPAC issuances and proceeds are accelerating and are on pace to comfortably pass 2020's records.

With this movement in full swing, there are some considerations investors should make before investing in any SPAC. Here are the two most important.

1. Valuation is tricky 

After a SPAC selects a company to take public, it will release investor materials covering the various aspects of the business such as valuation. These valuation calculations are somewhat informative but can also be tricky to gauge. Why?

A fork in the road with signs pointing in both directions

Image source: Getty Images.

Initial market caps and enterprise values are usually derived based on the SPAC IPO's price of $10. But when looking around the SPAC landscape, tickers such as Longview Acquisition (bringing the ultrasound disruptor Butterfly public) and many, many more trade at a share price well over $10.

Knowing this, the enterprise values and market caps offered are often underestimated due to share price appreciation taking place after the merger announcement. To properly assess the valuation, investors must use the ticker's current share price, not the initial $10 per share benchmark.

Beyond share price fluctuations, shares outstanding can also be difficult to quantify. SPACs will offer rough share counts in investor materials, but also sometimes exclude a portion of ownership from the measurement. Things like warrants and options to be exercised in the future are sometimes not considered in a SPAC's total valuation.

The future exchanging of these options and warrants for common shares would dilute current owners and expand the company's market cap. None of this is to say a SPAC can't be a good investment (I own four of them), but these factors must be weighed when valuing a company in the SPAC world.

2. Forecasts are uncertain

Along with valuations being somewhat tricky to calculate, long-term forecasts offered by management teams are tough to evaluate. SPACs often publish revenue and profitability targets for several years (I've seen up to five years ahead). These forecasts are valuable and should be considered. The uncertainty associated with these estimates, however, should also be considered.

Nobody can predict future financial results with certainty. Company executives are much better positioned than we are, but even then, estimates are always a best guess. Some long-term forecasts will be met, and some exceeded. But some will never be realized.

To gauge the quality of a SPAC's forecasts, studying things like leadership's track record as well as the size and growth rate of the industry that the business is in can be informative. Furthermore, studying its competitive landscape and how compelling the specific product offering actually is can also hint at how realistic an organization's ambitions are.

Only time will tell if revenue targets three or five years from now are accurate. Still, we can improve our odds of picking viable SPAC forecasts by putting in the work to identify a quality product, competitive environment, and leadership team -- just as with any investment.

To SPAC or not to SPAC

Having a firm handle on valuation, management's capability, and the quality of the business is vital. After that, investors can approach evaluating a SPAC similar to investing in any initial public offering.

I'm personally cautious of anyone painting SPACs with a broad brush, either positively or negatively. Each is its only unique animal, and should be treated as such. Invest accordingly.