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What Is a SPAC?

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If you’re into investing, you’ve probably noticed that “SPACs” are getting a lot of publicity. The latest widely mentioned buzzword in finance, the SPAC is seemingly taking over the world. To some extent, this increase in publicity represents a real-world trend. According to Fool contributor Christopher Liew, SPACs raised $79 million in the U.S. last year compared to $13.6 billion in 2019 — a 480% gain!

Liew’s article goes on to note that the growth in SPACs has been less pronounced in Canada, with issues actually declining year over year. Still, the SPAC is a major trend in the world of finance, and one that Canadian investors would benefit from knowing about. In this article, I’ll explain what a SPAC is and explore whether SPACs have any value to retail investors. We can start by looking at the definition.

SPACs defined

SPAC is short for “Special Purpose Acquisition Vehicle.” It’s a company formed solely to acquire another company. CNBC defines “SPAC” as “a shell company set up by investors for the express purpose of acquiring another company through an IPO.”

SPACs are often called “blank check companies,” because investors buy them for the promise of a future acquisition. The SPAC itself has no revenue or earnings. It may have some cash flows from financing, but that’s about it. The company itself is a shell, designed to acquire or merge with another company.

So, why invest in these vehicles?

Well, they sometimes allow you to gain access to investments early. You can buy a SPAC before it completes its acquisition of a valuable company. If it succeeds in making such an acquisition, then its shares are likely to increase in value. This is probably the closest you can ever get as a retail investor to buying an IPO before it’s on the exchange.

Second, there is the potential with SPACs to get the money you invested back. Often, these vehicles have terms that say they have to re-pay their investors if they can’t make an acquisition within a certain timeframe — often two years. Prior to acquisition, a SPAC doesn’t do much except for hold cash. So, it’s reasonable enough for an investor to assume they’ll get at least some of their money back. That’s something you won’t get with a normal IPO stock.

You’re probably better off investing in normal stocks

While SPACs might sound new and exciting, the truth is that they’ve been around for decades. Their increased attention comes from their rising popularity, not the fact that they’re actually new. SPACs have a track record — and according to IG International, they’re underperforming stocks long term.

In light of this, you might want to consider stocks like Lightspeed POS (TSX:LSPD)(NYSE:LSPD) instead of SPACs. A recent IPO stock like LSPD has all of the desirable qualities of a SPAC — high potential returns and loads of room to grow — but none of the inherent uncertainty. With a SPAC, you really don’t know what you’re buying. Some of them turn out well; others don’t. With LSPD stock, you know exactly what asset you’re buying. It’s a publicly traded company with verifiable financial statements, a long-term track record of solid growth, and a track record of consistently outperforming the market. Over the years, we’ve seen stocks like Shopify and Constellation Software rise by thousands of percentage points. In a best-case scenario, Lightspeed could deliver similar results. These are the same kinds of results that SPAC investors seek, but the inherent uncertainty is much lower.

SPACs are super risky, but these stocks are tested and proven:

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Constellation Software, Shopify, and Shopify. The Motley Fool owns shares of Lightspeed POS Inc.

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