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What Are SPACs And Should You Invest In Them?

· Investing

What Are SPACs And Should You Invest In Them?

Description – A lot of investors are heavily interested in investing in SPAC stock to get rich quickly. However, it's not for everyone, as this specific market ultimately plays into the favor of veteran insiders, sophisticated investors, and investment banks.

Numerous investors are ravenously looking for new ways to get rich quickly, whether through acquiring a special-purpose company or by investing in SPAC stock. However, it is not for everyone as the only stockholders earning money through SPACs today are sophisticated investors and investment banks. It is not for people who are saving for the future or living in retirement. 

Before we dig deeper into this phenomenon, we need to understand what a SPAC is. As we all know, navigating through the stock market isn’t as easy as winning big on Jewels World. But, don’t worry; in this article, we will go through the definition of SPAC and whether it is safe to invest in SPAC stock or not.

What Are SPACs?

SPACs, an abbreviation for Special Purpose Acquisition Companies, are publicly-listed, non-operating companies. Its purpose is to recognize and buy private companies; later, the acquired target is allowed to have publicly listed stock. SPACs are also referred to as blank check companies. 

Whenever a SPAC or any other publicly traded company buys a private company, it is known as a reverse merger. This is because a traditional merger is referred to as the stock approach, where a public company turns private. 

Based on SPAC Insider reports, a capital of $83 billion was generated by 247 newly formed SPACs through initial public offerings in 2020. 

More SPACs were formed in 2019 and 2020 alone, as compared to the last 18 years. Additionally, each SPAC generates enough capital through IPOs (Initial Public Offerings) to buy out huge private companies. The average SPAC stock and IPO jumped from $230 million in 2019 to $336 million in 2020.

Why Are SPACs On The Rise?

Private companies find that being acquired by SPACs is less troublesome and more flexible than going public through an initial public offering on their own. The interest of the stock market in new public offerings depends on the investor’s penchant for taking risks and economic conditions in general. Since a SPAC stock is already public, a reverse merger enables a private company to go public when the IPO window is closed. 

Private companies also find SPAC acquisitions attractive because, in a reverse merger, the founders and other significant stockholders can sell a higher share of their ownership. It is much better than what they would be able to sell with an IPO. Private company founders can also avoid the required lock-up periods for IPOs after selling newly public shares.

Is It Safe To Invest In SPAC Stock?

It all depends on who you are talking to and how savvy you are regarding stock market trends and knowledge. If you happen to be a private company owner, a banker, or even work at Wall Street, then yes, investing in SPAC stock during this time will be profitable. However, if you happen to be a regular Joe looking to invest in it for retirement benefits, you should read up on it thoroughly.

It is not for everyone. You might earn a better profit by betting at an online casino and winning a 10 euro bonus. However, if you are still interested, you should go through the below-mentioned reasons for why you should avoid SPACs.

1. SPACs Turn Prudent Stock Allocation Into A Hassle 

Investors don’t know much about what underlying SPAC investments may be made. This makes it difficult to understand the process of structuring the rest of the portfolio to accommodate the investments that create a SPAC. Also, until the investments are made, the underlying investment is in cash. So, maintenance and rebalancing of stock allocation require a lot of work as the SPAC makes its acquisitions.

2. No Transparency  

SPACs don’t consist of publicly traded companies. Therefore, investors of publicly traded companies don't get to enjoy much disclosure and transparency. For instance, SPACs cleverly avoid regulatory oversight to their advantage and encourage the most unethical investing types.  

3. Costly And Risky Underperformers 

Many insiders and experts say that SPACs are just one step away from IPOs. This means that SPACs are riskier than IPOs. Studies have proven that the average IPO outperforms the wider stock market, but the average investor doesn’t receive the same returns in IPOs. According to experts, the average is steered by a small group of superior performers. For the rest, the average IPO return is lower than the wider market.

In some cases, it has also been demonstrated that SPACs, as a public entity, which accounted for about $80 billion from 237 IPOs, underperform post-merger. If they redeem their shares, an IPO SPAC investor usually earns about 11-½%. This includes what they might earn with rights and warrants. 

But, if a typical SPAC stock investor cannot redeem their shares, they will suffer about a 33% loss. On the other hand, the sponsor receives a bulky 20% stake for committing no capital.

Another issue that diminishes the potential returns is that a SPAC has to find and acquire a company cheaply. This is a risky task, and some SPACs have failed to do so. Plus, researchers found that it costs more for a SPAC to go public than an IPO.

4. You Won’t Get Any Access To New SPACs And IPOs 

Likely, the average investor won't be getting access to any great new SPAC or IPO deals. Instead, most of the brand new deals and SPAC stock are reserved for a brokerage firm’s best clients. They are usually unavailable to investors with lower portfolio balances. Potential investors must keep in mind that when they are provided access to a SPAC or an IPO, they should not purchase any easily accessible SPAC or IPO. 

5. Recency Bias 

Many experts have suggested that investors, regarding SPACs in the current climate, are struggling with behavioral finance adherents known as a "recency bias." To put it simply, investors tend to overvalue the most recent results and brush off the results they witnessed further back in the future. The biggest problem is that investors’ and clients’ recency bias is becoming shorter every year when it comes to longevity. 

This means that investors tend to take financial risks, even though they see the past nine months' bull market. However, they completely forget about the hassle of the sharp market correction made earlier in the year. Insiders suggest that SPAC stock investors should develop a stronger long-term memory. Going for high-risk ventures in bull markets can prove to be detrimental to one’s finances.

Final Thoughts

At this point, it should come as no surprise to you that investing in SPACs isn’t a great idea unless you are familiar with how the stock market works. Even seasoned experts and insiders have advised the average investor to steer clear of SPACs. If you are still interested in investing in it, be aware of the associated risks. We hope that this article helps you gain a better understanding of this topic. If you have any further queries regarding this topic or article, feel free to leave a comment down below.

Author's bio

The writer of this article is well-known to people who are interested in cryptocurrency. Thomas Glare is also an investor, and all the tips he has shared here are the ones he has tested and ensured they bring profits. He has written many other informative articles that can be found online. 

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