SPACs Explained

A SPAC — Special Purpose Acquisition Company — is a "blank check" company that raises money through an IPO with the sole purpose of acquiring another company. Instead of a company going through the traditional IPO process, it merges with a SPAC and becomes publicly traded that way. SPACs exploded in popularity during 2020-2021, raising over $250 billion. Celebrities, athletes, and former politicians launched SPACs. They were everywhere. And for most investors who bought in, they were a disaster.

How SPACs Work

Step 1: The SPAC IPO. A sponsor — typically a well-known financier, executive, or celebrity — creates a shell company with no operations. The SPAC sells shares (usually at $10) in an IPO. The money raised sits in a trust account, earning interest, while the sponsor searches for a company to acquire.

Step 2: Finding a target. The sponsor has roughly 18-24 months to find and announce a merger with a private company. The target company gets to become publicly traded without going through a traditional IPO.

Step 3: The merger vote. SPAC shareholders vote on the proposed merger. They can approve the deal and keep their shares, or they can redeem their shares for the original $10 plus interest. This redemption right is the key investor protection.

Step 4: The merged company. If approved, the SPAC merges with the target, and the combined company trades under a new ticker symbol.

Why SPACs Became Popular

For private companies: SPACs offered a faster, more certain path to public markets. A traditional IPO takes months and is subject to market conditions. A SPAC merger can be completed in weeks, with a negotiated price.

For sponsors: The economics were incredibly lucrative. Sponsors typically received 20% of the SPAC's shares for free (the "promote"). This meant that even if the merged company lost value, the sponsor still profited enormously.

For investors: SPACs offered the allure of investing in the "next big thing" — electric vehicles, space tourism, flying cars, cannabis — before the company was available through a regular stock offering.

Why Most SPAC Investors Lost Money

The track record has been dismal. A 2023 study found that the average SPAC that completed a merger underperformed the broader market by more than 50% within two years of the deal. Many SPACs fell 70-90% from their peaks.

Sponsor incentives are misaligned. The sponsor gets 20% of the shares for essentially free. This massive dilution comes directly from regular shareholders' value. The sponsor is incentivized to complete any deal — even a bad one — because they get paid regardless.

Projections replace track records. Traditional IPOs are restricted from publishing forward-looking financial projections. SPACs are not. This means SPAC targets routinely presented wildly optimistic revenue and profit forecasts to attract investors. When reality fell short — as it almost always did — share prices collapsed.

Hype over substance. Many SPAC targets were pre-revenue or early-stage companies that wouldn't have qualified for a traditional IPO. Electric vehicle companies with no production. Space companies with no launches. The SPAC structure let companies access public markets before they were ready.

The redemption window. Sophisticated investors (hedge funds and institutions) would buy SPAC shares at $10, redeem at $10.30 (getting their money back plus interest) before the merger, and sometimes short the stock post-merger. This meant the institutional money was often out before the stock declined, while retail investors held the bag.

The Numbers

Of the roughly 700 SPACs that completed mergers between 2020 and 2022, the average post-merger return was approximately -40% within one year. Prominent failures include:

• Nikola (NKLA): Electric truck SPAC. Peaked above $80. Fell below $1. Founder charged with fraud.
• Lordstown Motors: Electric vehicle SPAC. Went bankrupt.
• Virgin Galactic (SPCE): Space tourism. Fell from $60+ to under $2.
• Clover Health (CLOV): Healthcare SPAC. Fell from $28 to under $1.

Some SPACs did work — DraftKings and Lucid Group had periods of strong performance — but they were exceptions, not the rule.

Lessons for Investors

Sponsor incentives matter. When the people bringing you a deal get paid regardless of the outcome, their interests are not aligned with yours. This applies beyond SPACs — in any investment, always ask: "How does the person selling this to me make money?"

Projections are not reality. Forward-looking financial projections are, at best, educated guesses. At worst, they're marketing materials. Judge companies by what they've done, not what they promise to do.

Hot markets produce bad deals. When SPACs were raising billions per month, there weren't enough quality companies to acquire. The pressure to complete deals led to mergers with companies that had no business being public.

Celebrity endorsements are red flags. When athletes and actors are launching investment vehicles, it's a sign of a market top, not a signal of quality.