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How do special-purpose acquisition companies (SPACs) work?

A special-purpose acquisition company (SPAC) is a shell corporation that is involved in the process of taking a company public on the stock market. Also referred to as a ‘blank check company’, it is formed and listed on a local stock exchange with the purpose of acquiring a private company and raising capital. It can then take the company public without going through the traditional initial public offering (IPO) process.

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What is a SPAC?

SPAC stands for a special-purpose acquisition company, which is also known as a blank check company. This type of company is created without any commercial operations in mind. It aims to raise capital through an IPO that can then be used to acquire an existing company, in what is called a reverse-merger.

This method of taking a company public has been used for a number of decades, but SPACs saw a dramatic rise in 2020 as companies hit by the Covid-19 crisis looked for alternative ways to raise capital. In 2020, 248 SPACs were listed, in comparison with only 209 traditional IPOs.

If you're interested in learning more about the rise of SPACs and how they can benefit individual companies and investors, listen to our podcast below.

What is the structure of a SPAC?

Pre-merger phase

  1. Target companies: Usually, the founders of a SPAC will have one or more companies that they are planning to target. However, during the process of raising capital, these targets will not be revealed. This means that the investors in the IPO do not know what company their money might be going towards.
  2. Funding: The founders of the SPAC usually provide the starting capital, and then institutional investors and underwriters are the main targets for raising capital before the public can trade SPAC shares. The capital raised during a SPAC IPO will be secured in a trust account. It can only be used to conduct an acquisition or return the funds back to the investors if the SPAC is liquidated.
  3. SPAC IPO: The shares are then made public on the stock market through a SPAC IPO, which usually cost around $10 per share plus interest. Traders can speculate on these shares through derivatives, such as spread bets and CFDs.
  4. Marketing: The SPAC usually issues a press release to announce the upcoming acquisition of the target company, which is a crucial part of the process. Third-party trader speculation around the potential target of a SPAC and its potential for future growth and success can help to promote the SPAC. In turn, this bumps up the demand and subsequently, its share price, upon flotation on a stock exchange.

Post-merger phase

  1. Voting: After the deal is announced, a redemption and vote phase takes place where shareholders can exchange their shares for net asset value, if they are not happy with the deal or shares are trading below that level.
  2. Lock-up period: This refers to the period after a SPAC IPO in which shareholders are restricted from selling shares. This can be up to 180 days from closing. Investors typically prefer shorter lock-up periods so that they can trade any volatile price action that results from the process, and cash out their positions earlier.
  3. Completion: There is usually a defined period (between 18-24 months) for a SPAC to complete an acquisition, or it may be liquidated. Any interest earned can be used as working capital.

SPAC examples

Some recent examples of major companies taken public on the stock market through a special-purpose acquisition company include Virgin Galactic and DraftKings.

Space flight company Virgin Galactic completed its reverse-merger in October 2019 with the SPAC named Social Capital Hedosophia. The company, founded by Richard Branson, received approximately $800m in funding from the original SPAC, and then earned $460m more through a secondary offering in August 2020.

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Fantasy sports contest and sports betting company DraftKings went public through a reverse-merger in April 2020. This deal saw a SPAC named Diamond Eagle Acquisition Corporation merging with DraftKings in a deal that was worth $3.3bn. Diamond Eagle provided about $700m worth of funding to the company as the starting capital.

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SPAC vs IPO

There are benefits and downsides to both SPACs and traditional IPOs. Some of the differences are explained below, and these may sway a company either way when deciding how to take their business public. The main differences between the two processes focus on the timeline and costs.

SPAC IPO
Usually takes less than 3-4 months to float the shares on an exchange. Most often takes more than 3-6 months to go public, sometimes around one year.
Investors can buy shares in private companies that they predict will have high growth potential for the future. Investors can buy shares in private companies that they predict will have high growth potential for the future.
Comes with a 2% underwriter fee and 3.5% fee at completion, which is cheaper than an IPO. A traditional IPO comes with a 7% underwriter fee.
Private companies present forward-looking guidance for revenue and profitability 5-10 years in the future. Companies can share previous fundamental reports and financials but are not easily able to make detailed projections for the future.
SPACs come with a time limit to get a deal done, which is usually a maximum of 24 months, meaning that the shares will be readily available. IPOs can be delayed by months or even years if there are issues, meaning that investors can be left waiting.

SPAC stock

SPACs are a great way to raise capital for innovative companies at a time when markets are under pressure. For example, large companies including Virgin Galactic have listed with a SPAC, which shows that SPACs are not just used for smaller or start-up businesses. It is possible to trade SPAC stocks, as well as their target companies that were merged. Below are some popular SPACs that are available to trade on our Next Generation platform via spread bets and CFDs:

  • Social Capital Hedosphia Holdings: this is a partnership between the investment firms of Social Capital and Hedosophia. The SPAC aims to unite technology-oriented entrepreneurs and investors around a shared vision of identifying and investing in innovative and agile technology companies.
  • Foley Trasimene Acquisition Corp: this is a blank check company that has an initial focus on financial technology or business process outsourcing. The company aims to lead the US gaming and gambling market through the acquisition of various payment solutions companies.
  • Capstar Special Purpose Acquisition Corp: this SPAC has more than 40 years of experience evaluating transactions, investing capital and growing operations on behalf of a variety of different companies, within the consumer, healthcare, technology, media and telecom sectors.

There are a few benefits to trading on SPAC stock with CMC Markets. We offer tight spreads, low commission fees and our margin rates start at 20% for shares, meaning you can trade with a leverage ratio of 5:1. There are also no foreign exchange fees to pay and spread betting is tax-free in the UK*.

SPAC ETFs

As SPACS become more popular in the world of investing, exchange-traded funds (ETFs) have been created to give investors more exposure to these types of companies. The aim of this type of fund is to invest in SPACs and SPAC-merged companies, and these can be either passive or actively managed.

Special-purpose acquisition companies often publicise innovative and tech-savvy companies in particular, as these pose long-term potential for growth. However, the risks of SPAC ETFs remain the same as SPAC shares; these companies are not guaranteed success for the future and can easily crash upon entering the stock market. Given that SPAC ETFs have not had as much time to develop, there are only a few floating across the market right now, although this may change in the months and years to come.

Special-purpose acquisition company: pros and cons

Benefits of a SPAC

  • SPACS often invest in highly innovative companies that they expect to grow and develop within their respective industry, which is appealing for investors. This presents many opportunities for speculative trading once the company’s shares are issued to the public.
  • SPAC stock can be highly volatile at times. Share prices may trade for a lower price than their IPO, so traders can use short selling strategies to profit from price falls.
  • As the raised funds are kept in a trusted account, there is less downside risk for investors. If the SPAC is liquidated, their funds will be returned, provided they are not used within the defined time period.
  • Investors have a say in which acquisition target is being pursued. The voting process means that they can opt-out of an opportunity and get a refund of their funds or they can vote in favour of a target acquisition. This contrasts with a traditional venture capital where you cannot influence how your funds are used.
  • A reverse-merger is often quicker and cheaper than a traditional IPO, as explained above. There is also less timing risk or an IPO window that must be met, which can sometimes have an adverse effect on an IPO’s success.

Drawbacks of a SPAC

  • Although volatility may be preferred by some investors, highly speculative shares can also offput a trader, as they do not guarantee success. For example, a start-up company that showed promising potential to a SPAC can end up crashing in the stock market and you may get caught up in the wrong side of the trade. This is why risk-management controls and tools are important for traders.
  • With both SPACs and IPOs, investing in start-ups and pre-revenue companies can come with risks. Once a vote to merge has happened, investors are no longer able to redeem shares at net asset value. If the share is unsuccessful, this could make their profits drop.
  • Valuation of SPAC stock often overtake the underlying fundamentals of the company. Some investors worry that the SPAC market will be short-lived and then drop.
  • If there are too many new SPAC listings, the market may not be able to handle the overflow. The process is becoming increasingly popular and may even overtake the IPO market at some point.
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Trade on SPAC stock with CMC Markets

With us, you can open an account to start spread betting or trading CFDs on SPAC stock that has recently gone public. Examples of shares on our platform that have gone down this route include Virgin Galactic, Nikola Corp, DraftKings and Coinbase.

Alternatively, consult our article on upcoming IPOs to see which shares have recently been made available to trade on using our Next Generation trading platform through the traditional initial public offering process. Public shares are listed on our platform on their opening day of trading.

FAQ

What does SPAC mean?

SPAC stands for special-purpose acquisition company, which is an alternative method to taking a company public on the stock market. A SPAC is a blank check company that raises capital for its own version of an initial public offering (IPO), acquiring their target company in the process.

What’s a SPAC stock?

Special-purpose acquisition companies are listed on a national stock exchange, which means that their shares can be traded like any other company. Read about how to trade stocks through spread bets and CFDs here.

Can you lose money in a SPAC?

It is possible to lose money in a SPAC investment if the target company does not perform well after becoming public on the stock market. Not all IPOs have the same amount of success, and some can end up in the opposite direction. By analysing company fundamentals, this will give you an insight into where its share price is headed, based on earnings reports and cash flows.

Are SPACS good investments?

SPACs can be seen as a good investment as they have lower costs and a narrower timeline than a traditional IPO. However, SPAC shares can end up trading below their IPO prices on the opening day. Therefore, you should consider all associated risks before investing in a SPAC.

What happens if a SPAC fails?

If a SPAC fails to complete a merger within the given time period, it is then liquidated and the IPO earnings are returned to its shareholders. This means that you do not lose any capital that you funded into the SPAC, minimising your capital risk.

Who are SPAC sponsors?

SPAC sponsors can fall into a number of groups, including private investors, equity funds and experienced business executives. SPAC sponsors typically receive around 20% of common equity in the SPAC for an investment of 3-4% of the IPO funding.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.