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Role of an Exchange: Five Key Questions to Consider About SPACs

Evaluating SPACs is different than evaluating traditional IPOs, so you should consider five key questions that can help narrow down SPACs that fit your investment profile.

SPACs - or Special Purpose Acquisition Companies - have gotten a bad rap in the past, mainly due to deals where sponsor interests were not aligned with shareholder interests. Early SPACS were often structured in a manner that ensured sponsors and founding investors received generous payouts whether they made a good deal or not—and if the merger wasn’t favorably viewed by the market or didn’t perform well, shareholders were left holding the bag when the stock price plummeted.

In recent years, a new breed of SPAC sponsors is working to reduce that imbalance by structuring offerings in a manner that better aligns the interests of all investors. There is a wide range of SPAC offering structures out there. Whether seeking a long-term investment or speculating on mergers that will potentially bring early profits, it takes research to find the right SPAC to fit your investment profile.

Evaluating SPACs is different than evaluating traditional IPOs because there are no operational or financial records to review. Instead, SPACs are differentiated by their management teams, acquisition strategies, and offering structures.

A SPAC’s prospectus is a good place to begin your research, and most SPACs have company websites as well. There are five key questions that can help narrow down SPACs that fit your investment profile.

1. What are the qualifications of the SPAC sponsors?

Given that an investment in a SPAC is essentially placing your reliance on the sponsors, a SPAC prospectus will prominently feature the biographies of the sponsors, which the prospectus may refer to as the “management team.” Who are the sponsors of the SPAC, and why would you trust them with your money? Do they include best-in-class marquee investors who have completed successful SPAC deals or traditional IPOs before? Are there any former executives among them with niche industry expertise?

2. What is the stated investment target?

The prospectus will have a section discussing plans for the capital raised in the IPO. Does the management team have full discretion to make any kind of deal it chooses? If the stated investment target seems vague or wide-ranging, it could indicate a “we just want to do a deal, any deal” mindset. More frequently, sponsors have knowledge and experience in a particular industry and are pursuing a thoughtful acquisition strategy in that industry. If the sponsors are targeting an acquisition within a specific industry or sector, check their bios to ensure someone on the management team has relevant experience.

3. Are sponsor and shareholder interests aligned?

When reviewing the details of compensation for sponsors and founding investors, look for possible scenarios enabled by the deal structure where shareholders can do poorly while sponsors are handsomely rewarded.

For example, is the vote to proceed with an acquisition decoupled from the redemption of shares? If so, there’s less incentive for investors to stick with the company post-acquisition. They are free to vote in favor of a deal and at the same time cash out of their initial investment. What percentage of shares are allocated to compensate founders? Do founder shares have performance triggers? Ideally, founder shares are issued on a vesting schedule tied to stock price.

4. Do the sponsors and founding investors have skin in the game?

Are the SPAC sponsors or founding investors investing their own capital? Are founders awarded their founder shares for a nominal upfront fee, or do they need to invest a significant amount of capital to get them? Substantial capital investment by sponsors can be indicative of a long-term mindset. Sponsor and founder capital can also offset the need for a potentially dilutive secondary PIPE offering.

5. Who is underwriting the deal?

Examine any conflicts of interest in the relationship between the sponsors and the investment bank that is underwriting the deal.

This is not meant to be an exhaustive list of evaluation factors but a starting point. SPACs are complex, and it’s wise to seek the advice of a professional advisor before finalizing your decision. An investment professional can provide information and advice on the logistics of trading in SPAC units, common shares and warrants. Investors can also leverage investment websites devoted to tracking and researching SPAC companies, such as SPAC TRACK.                                                                                                                  

Information is provided for educational purposes only. The content does not attempt to examine all the facts and circumstances which may be relevant to any particular company, industry, strategy or security mentioned herein and nothing contained herein should be construed as legal or investment advice. Nasdaq does not recommend or endorse any securities offering; you are urged to read the company’s SEC filings, undertake your own due diligence and carefully evaluate any companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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