Learn Why 2020 Is the Year of the SPAC
Yes, COVID has something to do with it
If you are someone who follows the stock market, you have probably heard of the term SPAC.
A simple search will give you results like:
As you can tell by these headlines, the SPAC obsession isn't being run by some no names trying to make a name for themselves. These are big-time business leaders. So why are we hearing about it so much now?
Background on SPACs
I will keep this section short because they are already a million articles describing what a SPAC is.
First, SPAC stands for Special Purpose Acquisition Company. The title of it does a great job explaining what it does.
A group of people who have a lot of money with industry and financial expertise will create a SPAC because they want to merge/buy a private company, and by doing so, take it public.
Investors can purchase shares of the SPACs and wait for them to announce their acquisition. Then this SPAC has two years to find a company it wants to acquire and then successfully merge. If not, it is liquidated.
Why are SPACs Becoming Popular?
It is not because they are a new thing. SPACs have been around since the 80s.
Right now, I think there are two main reasons that there have been so many SPACs created. There is a demand for growth companies and not a lot of supply. Interest rates are low and causing high stock valuations.
Hedge Fund Demand for Growth Companies
If you work in the financial industry, your performance is based on how your fund compares to indexes like the S&P 500, NASDAQ, and Dow Jones. Those indexes are mainly being moved by the well-known growth companies like Amazon, Facebook, Netflix, etc.
So if you are a fund manager, you can't beat these indexes by just buying these same companies. So they are trying to take the next big company public to have a chance to beat the indexes.
Low-Interest Rates are Causing High Stock Valuations
In response to COVID-19, governments worldwide injected stimulus into their economies, and the Federal Reserve in the US has brought the interest rate to near zero.
Even though our economy may be in a COVID-19 induced recession, our stock market is at near all-time highs. This growth is fueled because people need their money to grow or provide some income, especially retirees and people who rely on pensions. Most of those people/pension plans used to rely on US Government Bonds to provide consistent income. But since government bonds are essentially yielding zero there is only one more option in town.
So fund managers have looked to the stock market. This has caused many companies to experience a valuation boost—especially the growth companies, because of the reason listed above.
So if you are a startup and have been waiting to go public, this is a great time because you will get great valuations, which will help you raise more money to finance your companies' growth.
What does this mean for you?
SPACs and the companies they are trying to merge with are highly speculative. That means there is a lot of risk, but potentially a lot of reward, so you must understand that before buying shares in any SPAC.
Just because a company has strong brand recognition does not mean it has strong business fundamentals. For example, a popular startup that went public is Uber. In 2019, they lost almost $8.5 Billion. Uber was a pretty established company with a product and revenue. Some of these companies that are being acquired by SPACs don't even have revenue.
I heard some great advice from someone if you ever hear a company is, "Going to be the next (fill in the blank company)." It probably will not live up to the original. In the next couple of weeks, you start hearing on Reddit forums that this company that a SPAC is looking at will be the next whatever greet that recommendation with a touch of skepticism.