Investing involves risk. This truism is often used as a warning, but often does not dissuade individuals from their “shiny object” ventures… because with high-risk comes high-reward. It’s fun to brag to friends about the investment that went up 80% when historically, the average annualized return for equity investments is less than 10% (Chen, 2020). The past 10-12 years of market action – often upward – has caused many investors to believe that money is always made in equity investments if you just wait it out. Two such phenomena that continue to play investor hijinks are Special Purpose Acquisition Companies, or SPACs, and the IPO markets. Over the past few years, the market for SPACs has risen from $1 billion in 2014 to more than $71 billion in funds raised in 2020 (Harvard Law School Journal, 2018; Size of SPAC, n.d., respectively). And the initial public offering (also called an IPO) market continues to amaze as wildly unprofitable companies are rewarded with billions of investor dollars at launch.
SPACs are formed by like-minded investors to fund IPOs in a certain segment and are sometimes called “blank check companies.” While they do not have any commercial operations, this wisp of an idea is launched on a market exchange as an IPO with the purpose of investing in a future company. The magic is in the details. Typically, an IPO is offered when a company is ready to raise capital to fund business operations. But – and certainly this is cynical – by operating a SPAC, investment managers can approach millions of anxious investors without the messy details of actually operating a business. Of course, the IPO market routinely rewards companies losing billions; see DoorDash. Worse, this food delivery service is not the only public company of its kind.
At the current stock price, we must assume they capture over 100% of the available market. One competitor was at least frank with investors. Bloomberg reported that GrubHub’s quarterly report honestly served up a helpful fact: “food delivery is only a means to an end, unlikely to ever be profitable on its own” (Sen, 2019). Yes, it’s a stunning admission. But investors smile and happily hand over money in hopes that markets continue to rise indefinitely. And in all this, it’s the investment banker and SPAC originators that get the payday.
Want a recent example? Take Nikola. Does it matter that the would-be electric vehicle maker has no product, no IP and no foreseeable future selling electric vehicles? (Bushy, et al, 2020). Nope! Founder Trevor Milton has current holdings of over $1.7 billion and recently cashed out around $60 million of stock for real estate (Nagaragin, 2020). Investors lucky enough to be along for the ride after the SPAC launched in June saw a meteoric rise to almost $94 per share back down to around $16 today. (NKLA, 2020).
Is this an argument against raising capital? Absolutely not! This is an observation of structural weakness within markets which are exploited; investors are harmed by this. The SEC in their infinite wisdom, (may-they-be-forever-exalted) has declared that risky investments are reserved for the rich. We give them titles like “accredited” or “qualified” investor (U.S. Government, n.d.), but in this case, it’s a title that comes with a warning label: caveat emptor, meaning let the buyer beware. The SEC assigns these titles to individuals with a net worth greater than $1 million because in its oracle-like judgment, the SEC has decided that rich people can afford to lose money if they get greedy. Never mind that that $1 million theoretical nest egg needed for retirement in most 21st century communities is now mythical in several ways. However, the “little guy” must be protected, and so he is shielded from the ruinous grasp of big bad private equity firms or evil venture capitalists. News flash: SPACs are run by the same guys. But here’s the thing. These special investment vehicles- SPACs – are not reserved just for the greedy rich. They are traded on a regular stock exchange where anyone can purchase. So unsuspecting investors will be lured in with flash and a wink with hopes of a big score. But I’m sure it will all work out OK.
References:
S&P 500 Historical Annual Returns. (n.d.). Retrieved December 8, 2020, from https://www.macrotrends.net/2526/sp-500-historical-annual-returns
Lenahan, B., Boxwala, M., Layne, R., Bokosha, T., & Swartz, Z. (2018, July 6). Special Purpose Acquisition Companies: An Introduction. The Harvard Law School Forum on Corporate Governance. https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/
Size of SPAC IPOs in the U.S. 2009-2020. (n.d.). Statista. Retrieved December 12, 2020, from https://www.statista.com/statistics/1178273/size-spac-ipo-usa/
Sen, Conor. Food Delivery Looks Like Another Gig-Economy
Dead End. (2019, October 31). Bloomberg.Com.
Nikola Corp. (n.d.).
Nikola Corp: Investors: Stock. Retrieved January 04, 2021,
from https://nikolamotor.com/investors/stock?active=chart
Nikola founder bought truck designs from third party | Financial Times. (n.d.). Retrieved December 12, 2020, from https://www.ft.com/content/9bd5e3f3-4d09-458c-b390-bc94b1f4a024
Nagarajan, Shalini. (n.d.). Nikola founder Trevor Milton
plans to remain the automaker’s largest shareholder despite being free to sell
stock, report says. Markets.Businessinsider.Com. Retrieved December 12, 2020,
Accredited Investors | Investor.gov. (n.d.). Retrieved
December 12, 2020, from
https://www.investor.gov/introduction-investing/investing-basics/glossary/accredited-investors?