The Investment Scientist

Oxford: Should You Invest in SPACs?

Posted on: October 3, 2021

Last week I completed the Venture Capital class at Oxford, and I have at least two take-aways  I’d like to share with my readers. Today, let’s talk about SPACs since a few of you have asked me if we should invest in those, and before I had not felt qualified to answer the question.

What are SPACs?
The name SPAC is a shorthand for the Special Purpose Acquisition Vehicle. These are companies backed by famous investors/entrepreneurs (sponsors) that raise a sum of money via IPO then search for a private company to buy.

For venture-backed companies that want to go public, this is a great option since they don’t have to go through the IPO process – roadshows, book building, the whole nine yards. All they need to do is to sell to a SPAC. 

However, for investors who buy into a SPAC and its fame and promise, is it such a good deal? It is usually not. Normally what’s being promoted with SPACs is the access to famous sponsors without the management fee. What’s usually left out is that once a deal is done, the sponsors get 20%.  Also, there is normally a stipulation that sponsors must get a deal done within two years, or else the money will be returned to the investors. 

Think about the incentive that would provide. Let’s assume Rich Dad, Poor Dad’s author Kiyosaki sponsored a “rich dad” SPAC and raised a total of $1b. Let’s also assume that after a year or so, he has not found a good target and time is running out. If he does not acquire something by the deadline, he will need to return the money. So he just uses the $1b to buy a company that is worth only $500mm. In this instance, he gets 20% of the $500mm, which is $100mm. The owners of the acquired company that include the founders and the venture capitalists are also winners – selling a $500mm company for $1b. Who is the sole loser here? It’s the investors in the “rich dad” SPAC, losing a total of $600mm. 

Of course, Kiyosaki could find a good target and pay $1b to acquire a $1.5b company, so after his 20% take, the “rich dad” SPAC investors still end up ahead. But what are the odds of that? The lure for the sponsor is to get a deal done regardless, and the surest way to get a deal done is to overpay for something. 

I am sure about one thing.  I will stay away from SPACs, even one with Elon Musk as the sponsor. 

By the way, I use Kiyosaki as an example because he allowed his name to be used to promote questionable real estate investment schemes. The SPAC craze essentially is the same play – a gimmick to abuse ordinary people’s blind trust in famous established people. Since you guys read my newsletter, you are no ordinary people!

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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