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Why SPACs Can Be A Poor Investment Choice For Retail Investors

Special Purpose Acquisition Companies Can Lead To Losses, High Fees

If you are an investor whose broker recommended that you invest in a special purpose acquisition company (SPAC) and you have suffered losses on your investment, you should contact our investment fraud attorneys at Shepherd Smith Edwards and Kantas (SSEK Law Firm at investorlawyers.com). 

SPACs grew even more popular in 2020 in the wake of COVID-19. Although they can be profitable for those who start one, they’ve also proven to be risky and can result in losses for investors. Contact SSEK Law Firm today to request your free, no-obligation consultation.

What Are Special Purpose Acquisition Companies (SPACS)?

Special purpose acquisition companies are shell companies established by investors. These are typically institutional investors that are Wall Street professionals or public figures who raise funds via an initial public offering to acquire another company. The money raised is a SPAC’s only asset. 

Investors of a special purpose acquisition company usually won’t know upfront what company will be targeted for eventual acquisition. This is one reason they are often referred to as blank check companies.

SPAC shares at IPO are usually sold at $10/share, with the funds placed in an interest-bearing account. Upon acquisition of a company, investors are able to exchange their original shares for shares in the merged company or seek redemptions of their original investments, along with interest earned. 

In theory, this allows many retail investors the opportunity to invest in a Pre-IPO company before the price rises. Should a SPAC acquisition not occur – sponsors have two years to make a merger happen—the company is liquidated and investors are supposed to get their money back along with interest.

Multiple Fees Are Charged For Investing in SPACs, Including The “Promote”

What many investors don’t realize is that even if they do redeem their shares in the end, their capital will likely be lower. 

Special purpose acquisition companies usually charge a percentage fee and a flat fee. There is also another fee, which many investors don’t anticipate, understand, or realize is a fee, and is referred to as the “promote.” These are additional shares created when a SPAC merges with a private company. These shares are for the SPAC manager/sponsor. 

This fee causes a SPAC’s shares to be priced higher, as they are issued as if there was no “promote”. What this means for investors is that they end up getting fewer shares along with their capital. Add up all of the fees, including the “promote”, and investing in a SPAC can cost investors about 25% of their investment. 

It is also important to note that if a SPAC performs badly and its share prices plunge, the SPAC sponsor could still end up with millions of dollars even as the other investors sustain massive investment losses. Also, if the SPAC does well after the merger, the sponsor ends up making most of the proceeds. 

SPACs Don’t Have High Success Rate

Renaissance Capital, an IPO expert, noted in September 2020 that only 93 of the 313 SPAC IPOs set up since 2015 have resulted in mergers with companies going public (The rest have either failed or have yet to merge). 

Common shares from these have led to -9.6% average losses and -29.1% median returns. This is a stark contrast to the traditional IPO, where 47.1% is the average aftermarket return. Also, just 29 of the SPACs had experienced positive returns at the time. 

Also in September, Market Realist named a number of SPACs that have recently failed, including: 

  • 2020: TGI Fridays’ SPAC merger with Allegro Merger. The failure left the former $350M in debt.
  • 2019: CEC Entertainment’s SPAC merger with Leo Holdings. CEC Entertainment has since filed for bankruptcy protection. 
  • 2019: Akazoo with Modern Media Acquisition Corp. because of findings that the previous management of the AI music streaming company had significantly falsified its records and books.

SSEK Law Firm represents retail investors, high net worth individual investors, and institutional investors in fighting for their financial recovery. Brokers have a duty to only recommend investments that are suitable for each customer and apprise them of all risks involved. Call (800) 259-9010 and ask to speak with one of our experienced investment fraud attorneys.

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