Although this is not something new, in recent years, partnering up with special purpose acquisition companies and investing in SPACs has become a very popular alternative to the traditional initial public offering (IPO) for growing companies.
After raising capital, SPAC is a shell company that, after raising capital, is listed on a stock exchange and then buys up an unlisted company that’s quickly listed.
As a result, the unlisted company doesn’t have to go through the same process as other companies, an initial public offering (IPO) or a direct listing.
A clear advantage of the procedure is that it goes very fast. However, if you’re eager to learn more about how to invest in SPACs, you should be cognizant and aware of the risks you may face.
Below, we look at the main set of risks that SPACs carry, which unwitting investors should know about to avoid losing money.
Inadequate Management Due Diligence
In a typical traditional IPO, thorough due diligence is typically performed on the company that’s going public. This requires time, and when it comes to SPACs, the founders or sponsors usually have a two-year deadline to find an acquisition.
This step is often disregarded, and investors can easily find themselves with executives or new board members whose backgrounds and expertise in the specific market segment wouldn’t pass in a traditional IPO, and when the time arrives, founders of such blank check companies might be in a hurry to buy firms unsuitable for public markets.
For this reason, it’s crucial, at a granular level, for both the investing in SPACs management and the operating company management to agree on important issues like target markets and key operating metrics.
Deal Collapse
Even though investing in SPACs, an operating company can enter into exclusive negotiation talks. It’s less than certain that the acquisition will be finalized. Many deals never reach the final stage, even after months of due diligence as well as countless realized meetings and calls.
These deal collapses were often driven by a variety of factors, including changes of mind by either the buyer or the seller, various external environmental factors, including the tumultuous financing market, and the ongoing global Covid-19 pandemic.
Being Public And Its Responsibilities
Oftentimes, you hear that despite certain challenges going public is easy, while being public is the difficult part. Many private companies are unprepared to become public registrants and don’t own the sustainable processes and controls needed for the severities of public company financial reporting through investing in SPACs.
The current team should be able to present timely and correct quarterly financial information, which also includes tax provisions, share-based compensation, international consolidation, and much more, with proper reviews and a Form 10-Q due to the SEC within forty-five days after the end of the quarter.
Conflicts Of Interest
The possibility for conflicts is high through investing in SPACs as sponsors, managers, and officers might not solely work on behalf of the SPAC but might have fiduciary responsibilities to other entities that compete for the SPAC’s business.
The original SPAC investors may profit from strategies that put them directly in conflict with acquisition targets.
The de-SPAC transaction, which is the process of purchasing a company, depends largely on advisers and sponsors who are encouraged to buy any company rather than buying a decent one.
Keeping in mind their intensely discounted interest in the SPAC common stock, a sponsor could benefit at the cost of a shareholder.
The Financial Industry Regulatory Authority (FINRA) cautions that underwriters, along with the other SPAC sponsors material, non-public information regarding potential SPAC investment targets and custom that knowledge.
Talent Attrition
All companies today face the risk of their key employees deciding to leave for another better opportunity. In the case of investing in SPACs acquired company, it is not rare for the cultural and regulatory environment to change swiftly once the company becomes a public registrant.
Many employees can see this as an excellent opportunity, but this carries a risk that certain employees, including crucial members of the management, may leave the company before or after the transaction.
Poor Controls
Since an acquired company doesn’t face close evaluation and is frequently in an earlier stage of development, the controls it undergoes may be unsatisfactory. Inexperienced finance and accounting staff may fail to establish and maintain effective disclosure processes and financing reporting controls.
Such omissions open the risk for erroneous financial reporting and fraudulent payments causing harm to investors.
Final Thoughts
Investing in SPACs represents an exciting opportunity that takes a business to a new level. However, SPAC investments are directly linked to acquisition-related risks. Carrying out company acquisitions is an extensive and complicated process that involves high costs.
Participants must first educate themselves and become well-aware of the risks involved, which can help create a successful investment.
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