SPACs-ever heard of them?

By now you have certainly heard of Bitcoin and quite possibly even Coinbase, but another investing phenomenon over the past three years has been the emergence of SPACs.

SPACs are special purpose acquisition companies that raise capital through public offerings and then use that cash to merge with startups looking to go public through an acquisition.

SPACs are essentially blank check companies, meaning they are blind pools of capital that the operators can invest as they see fit. As an investor, you have no idea who the target companies might be, so you will need to trust that these operators are going to invest your cash at a fair price and in a growing company. The good news is that if these operators cannot find anything worthwhile to buy within two years, you get your money back.

According to Kiplinger’s, SPAC IPO issuance broke all records in the first quarter of 2021, with 298 SPACs raising nearly $88 billion. The tally was more than double the 132 SPAC IPOs conducted in the fourth quarter of 2020, which raised $39 billion. In comparison, 248 SPACs went public in 2020, raising $83 billion in the process.

Some of the better-known companies to be acquired or are in talks to be acquired by SPACs include: WeWork, Draft Kings, Virgin Galactic and Nikola Motor Corp. WeWork is particularly noteworthy because the traditional IPO the company planned in 2019 was shelved due to the leadership failings of its co-founder and CEO Adam Neuman and the massive pre-IPO overvaluation of the company.

The other interesting thing about SPACs is that several high-profile athletes have gotten into the game by attaching their names to some of these deals. Shaquille O’Neal, Steph Curry, Serena Williams, Alex Rodriguez and Colin Kaepernick are among those jumping into the SPAC field.

Investing in a SPAC it is like buying any other IPO. You put in an order through your broker and hope you get shares, or you can wait until the SPAC is trading and buy it on the open market at your brokerage firm. There are even SPAC exchange-traded funds, allowing you to buy an ETF that holds many individual SPACs for diversification and exposure to a myriad of companies.

However, there are a few problems with SPACs. First, like most things, when there are too many of them, investors are going to have do some research to determine how to distinguish those that are worth their money. In March alone, there were 109 new SPAC deals.

Second, a lot of these newly minted SPACs are chasing the same companies to buy. Operators are flush with this IPO cash and eager to spend, which means the companies they are looking to buy will be bid up in price. Bargains are getting harder to find.

Third, the SEC, Securities Exchange Commission, has just released an accounting change with regards to SPAC warrants. A warrant gives the holder the right to buy a share of stock at a specified price and time. Now the SEC has determined that SPAC warrants are going to be classified as liabilities or debt instead of equity instruments. This change is incredibly important because any future SPACs, as well existing SPACs, are going to have to change their reporting documents to account for the way warrants are now classified. This accounting change has led SPACs to fall in value by 20% to 50% in 2021. This change will make these warrants more complicated, and less liquid going forward.

If you are still interested in buying a SPAC, now may be a good time to do it, since most are now trading at such a deep discount to their initial public offering price. However, do your homework. Make sure the SPAC operating owner has a proven track record and that they are investing in companies that are growing and have a bright future. Finally, make sure you are in it for the long haul because it will take some time to get this SPAC cash invested. If you do not want to own an individual SPAC, buying an ETF or exchange-traded fund that invests in hundreds of SPACs might be a safer way to go.

 Fred Taylor co-founded Northstar Investment Advisors, LLC in 1995. The firm specializes in managing personalized investment portfolios for individuals, families, and retirees with a focus on income generation. He is a member of the Colorado Forum and also served as an economic advisor to Colorado Governor Bill Ritter from 2008 to 2010.