Is SPAC, The Next Bubble? Will it be the Trigger for next stock market crash?
Is SPAC, The Next Bubble? Will it be the Trigger for next stock market crash?
SPACs, or special purpose acquisition companies, raised around 300 billion dollars in 2021 so far. These are “blank check” shell companies that have no operations or business plan other than to acquire a private company using the money raised through an IPO, thereby enabling the private company to go public quickly.
Let me simplify SPAC –If any company needs to go public, they need to fulfil lot of conditions. To avoid this, private companies take SPAC route. It’s a back door for private firms to go public without bothering with the tedious IPO or direct listing process. They will first create a SPAC or shell company and use this company to raise money by going public through IPO and later, they will merge/acquire their original private company using the money they got from the IPO. This route is now used by lot of worthless companies to go public.
You may ask, why would people invest in such companies?
- SPACs must identify firms they can merge with within 24 months after they have raised their funds or they will be wound up and the IPO proceeds returned to investors along with the interest. So SPAC is being advertised as no-loss investing scheme.
- Also, SPAC is touted as an investment vehicle, which will allow investors early access to the unicorn companies that was previously reserved for institutional investors, and giving public market investors a right to sell in the open market at any time during the process or redeem at the IPO price plus interest.
- But whenever you hear fancy names and products like these in the stock market, you should understand that this is another complexity created to confuse you.
Remember Reverse Mergers?
- This was the route used by most of the useless Chinese companies to get listed in US Stock Market. In a standard reverse merger, a successful private company merges with a listed empty shell to go public without the paperwork and rigors of a traditional IPO. The shell is usually a remnant of a previously operational public firm or a public virgin shell formed to combine with a private company.
- SPACs are slightly different from reverse mergers. In SPACs, shell company is a company without any business or operations flushed with cash from the IPO and they will be hunting for private targets to acquire.
- But More than 500 SPACs need to find companies to merge this year or they risk being liquidated. But with only so many quality companies to go merge, they are in a race. This provides SPAC founders a strong incentive to close deals, even at the expense of shareholder value. To avoid returning money to investors, they will eventually end up merging with poor companies. This will reduce the value of shares hold by investors, which will trigger a downward spiral.
Final Note:
But the larger concern here is, just like what happened during dotcom bubble and housing bubble, will the bust of SPACs have the fire power to bring down the whole market with it? Can it be the trigger for a market crash? Well definitely a possible trigger, but only time will tell. But for now, stay away from fancy names like these.