Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

IF you are wondering what is a SPAC, how does a SPAC work and whether a SPAC is a good investment read on. Here’s a guide to (and warning about) Special Purpose Acquisition Companies (SPACs), following changed rules in the UK that promise to bring one of Wall Street’s hottest investment trend over here.

What is a SPAC?

A SPAC is a non-operating publicly listed company that is set up with the sole purpose of acquiring a privately-owned company and so enabling its target to gain a public listing. Until that happens, the SPAC’s only assets are its cash and its stock market listing. Even if its sponsors have their eyes on a specific target, this is not disclosed (to simplify and speed up the process of listing the SPAC).

This is why SPACs are sometimes called ‘blank cheque companies’ or ‘cash shells’.

Are SPACs a new concept?

Not really. The idea has been around for at least 30 years. At the time of the bubble, a number of similar vehicles were set up to invest in technology and internet businesses. Go even further back and the idea looks remarkably similar to one of the most famous investment manias in the 18th century when, following the apparent success of the South Sea Company, a number of speculative companies were formed, one of which proposed: ‘a company for carrying on an undertaking of great advantage, but nobody to know what it is.’

Why do SPACs exist?

SPACs are a flexible and less burdensome route to a stock market listing for a private company than a traditional initial public offering (IPO). Private company bosses like them because they can allow them to sell more shares than they could in a normal flotation and avoid the onerous lock-up periods that are generally required in an IPO.

How do SPACs work?

A SPAC raises money via an initial public offering. Typically, the cash raised will come from its sponsors (or founders) as well as outside investors. The sponsors will receive a higher stake in the SPAC relative to the amount they invest. Both types of investors will usually purchase both ordinary shares and warrants, which allow them to buy further shares at a favourable price once the identity of the target company is known.

Once listed, the SPAC sets out to find a suitable target. There is usually a time limit for this search of two years. If no target is found, or none approved by the SPAC’s shareholders, the vehicle is unwound, and the money returned to investors. During the search, the money is safely invested in government bonds. The value of the shares and warrants should trade at close to their launch price but can fluctuate if shareholders believe that management has identified an attractive acquisition target.

Once a target is found, shareholders are furnished with financial details of the target and they vote on the acquisition. If approved, further funds may be raised (if the target costs more than the initial money raised). Once the takeover is approved, the SPAC will usually change its name to the target’s. Effectively the private company has ‘reversed’ into the cash shell and gained its public listing.

Are there SPACs in the UK?

SPACs are a relatively new concept in the UK. But in America they have been a hot topic for a couple of years. So far in 2021 there have been more SPAC issues than traditional IPOs. Their popularity has caused concern in the UK that our relatively burdensome listing rules are making the London market less attractive - not just compared to the US but to European financial centres like Paris and Amsterdam too.

A review was commissioned by the Chancellor in the spring, in which Lord Hill (a former EU financial services commissioner) recommended a number of changes to make SPACs easier to launch here.

In April, the financial watchdog, the FCA launched a consultation on these amendments and last month the regulator issued a new policy statement which came into force this week (10 August). The most important change is an end to the presumption that a SPAC’s shares should be suspended when it announces the identity of its acquisition or where there is a leak of the proposed deal. Getting rid of this requirement is a major step towards making London a more competitive destination for SPACs and has the potential to rapidly increase the number of these listings in the UK.

Should I care - how do SPACs perform as investments?

There is a long history of financial innovations making more sense for the clever financiers who invent them than for the ordinary investors who put up the money. The popularity of similar cash shells during the bubble makes the link between new investment ideas and market tops.

Recent research has questioned whether the costs of SPACs might actually be significantly higher than for a traditional IPO. It has been estimated that a typical SPAC priced at $10 a share at launch may only hold $6.67 in cash by the time it acquires its target.

The performance of SPACs, in the period following the acquisition, has also been surprisingly poor. One explanation for this is the incentive for SPAC sponsors to do a deal rather than hand money back to investors, due to the size of their stake, even if the investment logic of the transaction is not really compelling.

Should I invest in SPACs?

There is nothing inherently special about a SPAC. Whether it turns out to be a good investment will be determined by the quality of the business it acquires, the price it pays for the target company and the price that you pay for the shares.

SPACs can often deliver a windfall to sponsors because they are able to purchase a significant shareholding (up to 20%) for a nominal sum. SPAC investing has tended to be less profitable for individual investors who come to the party later.

Investing before the identification of a target may work out well if it enables an investor to get in before a story becomes well known. This is why SPACs are sometimes called the ‘poor man’s private equity’.

But, as ever, if something looks too good to be true in investment, it usually is.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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