SPAC investing might sound like a pretty good deal. You buy shares and if the blank-check company manages to find a good acquisition target, they can pop nicely. If they can't find a target, the special-purpose acquisition company dissolves and investors get their money back. While this is true, it's not quite that simple. In this Fool Live video clip, recorded on March 8, Fool.com contributor Matt Frankel talks about some risk factors SPAC investors should keep in mind.
Matt Frankel: Joe says, "What is the risk of investing in a SPAC? How do you know what company it will merge with, and what are the risks involved if it doesn't since it's a publicly traded company, will they fall in price if there is a delay in merger with the intended company?" Just to break that down, a SPAC, it holds in escrow the money that it initially raises. So there's $10 a share roughly in an escrow account for that SPAC. I consider $10 to be a floor. If a SPAC doesn't find a company to merge with, shareholders get that $10 back. That's a margin of safety if you will. I mean, it's like putting your money in a savings account, so it's not going to earn a ton of money while it's sitting there, but you will get your money back if they can't find a company.
You don't have any idea what company it's going to merge with. That's one of the big risks that they decide on a merger target that you don't want to invest in. I've had a few like that; in which case, I sell my shares. The big risk of a SPAC is that they're generally very high-growth companies at very high valuations. Latch (TSIA +0.00%) and Matterport (GHVI +0.00%) are certainly not exceptions to that.
I mean, Latch is trading for something like 100 times sales right now. They're highly valued companies. They're not always well-received by the market after the SPAC merger goes through. Like I said, until it goes through, the SPAC shares are just representing that $10 that's sitting in an escrow account. After the merger, it's representing the company. Once the merger happens, there's a chance that the company will fall below $10 a share. IPOs go down all the time. I've mentioned this before, we forget it in 2020 and 2021, IPOs don't always shoot through the moon. Keep that in mind. That's the big risk.
Like you said, it's opportunity cost. You're keeping your money essentially in an escrow account instead of being in some productive asset until they can find a deal. SPACs don't find deals all the time too. At the end, you'll get your money back with whatever little bit of interest it might've earned.
