Every so often, some new trend or craze tends to hit the capital markets and threatens to completely change ways of doing things. Perhaps you’ve heard of the term ‘SPAC’. Or maybe you are hearing it for the first time.

Whatever the case, here’s an overview of why SPACs are trending and why celebrity investors like former NBA player Shaquille O’Neal and rapper Jay Z are jumping on the bandwagon.

What is a SPAC?

‘SPAC’ is an acronym for ‘special purpose acquisition company’.

Also known as blank cheque companies, SPACs do not have a business of their own. What they have is a stash of cash that they use to buy or merge with another company and then take it public.

Investors invest in a SPAC under the agreement that it will find a target for a merger within a specific time, usually two years. If a target merger is not found within the set time period, the entity is wound up and the money is returned to investors.

How does it start?

It starts with a sponsor (typically a well-known business person or executive) launching a SPAC and completing the normal filings associated with taking a company public. Because the company doesn’t have an operational business, the filing process is fast and easy.

The SPAC then raises capital through an initial public offering IPO and begins trading on the stock market. It then starts searching for a target company to acquire. Once it has identified one, it negotiates the acquisition terms.

Shareholders then vote and agree to buy the company. Those who are unhappy with the merger can choose to redeem their shares and get back their money.

After this, the SPAC buys the company using the money from its IPO (and additional funding from new investors).

The company then starts trading on the stock market under its new identity.

What is their appeal?

According to experts, one main reason for the increased popularity of SPACs is a buildup of frustration among entrepreneurs looking for alternatives to the traditional IPO. This frustration stems from the large amount of work and time the IPO process requires.

While an IPO can take years from start to finish, a SPAC merger typically takes three to four months.

A lot of IPOs also tend to leave a lot of money on the table due to underpricing. With a SPAC, a company is able to negotiate an exact purchase price purely based on business valuation. This ensures that no money is left on the table.

It’s not surprising that SPACs are becoming trendy. High-profile businesses that have been funded through SPACs in recent times include Sir Richard Branson’s Virgin Galactic and DraftKings.

What’s the status of SPACs in the UK?

Right now, special purpose acquisition companies largely remain a US phenomenon. They are yet to catch on in the UK mostly because UK-listed SPACs are perceived to be risky for investors.

Unlike in the US, where shareholders are free to redeem their shares if they are unhappy with the target acquisition, UK SPACs do not have an opt-out. Once a UK SPAC has made an acquisition, its shares are suspended until an FCA-approved deal prospectus is published.

Basically, this locks up investors’ capital limiting the ability of those who disapprove of the merger to get out.

However, Chancellor Rishi Sunak is said to be considering a relaxation of listing rules in the UK to encourage more flotation of SPACs. So, things could change down the road.

How can I invest in a SPAC in the UK?

UK investors can invest in special purpose acquisition companies through a share dealing account or a stocks and shares ISA. Depending on your goals, you can choose to invest in individual SPAC shares or in SPAC funds including ETFs.

But keep in mind that with SPACs yet to make a solid mark in the UK market, the available options might be limited.

Should I invest?

Ultimately, the decision is yours.

Remember that when investing in a SPAC, you’re essentially banking on the expertise and reputation of the sponsor of the SPAC and the management team. Before you take the plunge, make sure you’ve done your homework.

The post What is a Spac? appeared first on The Motley Fool UK.

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