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How to Avoid Getting Burned by Wall Street’s Hottest Money Machine

At their peak, they looked like the A-list’s hottest new accessories. Alex Rodriguez got one. So did Colin Kaepernick and Shaquille O’Neal. Jay-Z was a fan, as was Serena Williams.

Special-purpose acquisition companies — better known as SPACs, or blank-check companies — made a splash during the Covid-era retail-trading surge. They are companies built with a single goal in mind: They raise money on the public markets by selling investors on a vision, and then buy a public company that fulfills that vision. SPACs let just about anyone with a wild idea, be it flying taxis or even space travel, and a bit of money raise hundreds of millions of dollars.

For retail traders, SPACs are an opportunity to get in early on startups, often in buzzy sectors like electric vehicles and online gaming. For the rich, they’re an easy way to make even more money and further their fame. And for the private companies acquired by SPACs, the process is an easier route — less paperwork and scrutiny, essentially — to going public than a traditional IPO.

About 250 SPACs  held initial public offerings last year, attracting more than $80 billion. This year, more than 700 of these once-obscure investment vehicles have sold about $174 billion worth of shares.

With all the enthusiasm comes increased scrutiny. The U.S. Securities and Exchange Commission is looking into concerns that SPACs aren’t properly disclosing risks. Investors have lost money on once-hot companies that went public through SPACs, such as ATI Physical Therapy Inc. and Nikola Inc. In an indication of how SPAC shares have suffered this year, the SPAK ETF — which invests in U.S.-listed SPACs and companies derived from SPACs — has fallen more than 35% in price since its peak in February.

 

 

So how do investors dip into the world of SPACs and avoid getting burned? Here’s how to get started, and what red flags to look out for:

How a SPAC Is Born

A SPAC begins its life when a group of people team up, sometimes brought together by expertise in a certain industry or interest in an acquisition target. At this stage, a celebrity might get involved, bringing in additional capital and name recognition. The initial set-up costs are typically between $550,000 and $900,000, according to SPAC Consultants, an industry group.

Then, the SPAC will go through an IPO to sell shares and warrants in units that usually cost $10 each. After this, the management team behind the SPAC can use the money to buy what they consider a promising private firm.

“What you’re investing in really is that future deal,” said Sylvia Jablonski, chief investment officer for Defiance ETFs, the firm behind the SPAK ETF.

The SPAC typically has two years to complete a deal. If it doesn’t, the cash is returned to investors. It’s a faster turnaround than many other kinds of investments.

Once the merger is complete, the SPAC and the acquired company become a single public entity. This is how companies such as DraftKings Inc., Virgin Galactic Holdings Inc. and Lordstown Motors Corp. made their debuts.

 

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