What is a SPAC?

Since the end of 2020, a number of European exchanges have recorded listings of SPACs. SPAC stands for special purpose acquisition company. A SPAC is a shell company established in the legal form of a stock corporation without an operating business and without operating or non-current assets. It raises capital, for example, through an initial public offering or a private placement, followed by listing, in order to invest this capital in a business combination with an as yet unlisted target company and in this way indirectly turn the target into a listed company. The business combination is intended to increase value for the SPAC shareholders. Since the target company of a SPAC is not yet specified at the time of the IPO or listing, SPACs are commonly referred to as blank check companies as in the US.

Examples of people who form a SPAC (sponsors) include managers with activities on the capital market, investment bankers or financing experts. The sponsors are usually represented on the SPAC's management board or supervisory board.

SPACs have a number of characteristics that distinguish them from operating companies that have existed for some time and are planning to list, or have already listed, on a stock exchange. The features that are typically adopted sometimes originate from US provisions and/or they implement requirements imposed by the exchange operators for admitting the SPACs to the regulated market. From a retail investor's perspective, this relates in particular to the following features, although it should be noted that the details may differ, depending on the SPAC in question:

• IPO proceeds paid into a trust account
  The capital raised from the investors by issuing shares (IPO proceeds) is normally paid into a trust account and may usually only be used for the purposes detailed in the prospectus of the SPAC in question.
• Investors involved in decision on initial business combination
  As a rule, provisions must be in place that require investors to decide with a certain majority (usually at least 50 percent) on the use of the trust funds and thus on the business combination proposed by the management board.
• Right to redeem shares
  Investors can normally redeem SPAC shares at the issue price if they do not agree to the business combination. For investors who have acquired the shares through a stock exchange and possibly paid a higher price, the repayment to which they are entitled is normally limited to the issue price.
• Time limit on the SPAC
  If no suitable target company can be identified and no business combination can be consummated within the time period specified in the articles of association of the SPAC, the contract terms specify in most cases that the SPAC has to be liquidated.

What are the opportunities and risks of investing in SPACs?

For retail investors, SPACs may offer investment options that are normally only available to financially strong risk capital providers. Any resulting opportunities (in particular the possibility that SPACs select targets that generate large profits and record high increases in value) are, however, set against considerable risks. In addition to the risks typically associated with any investment, risks of investing in a SPAC arise from the fact that they are investments in the unknown with the low risk diversification typical of single asset investments. For retail investors, opportunities and risks of a loss of capital are difficult to assess at the time of making the investment decision.

The prospects of positive performance of the SPAC depend on the expertise, commitment, networking and negotiating skills of its sponsors and the other management board members. In their search for a target that is suitable for listing but not yet listed, they have to compete with many other players.

The management board and supervisory board members of a SPAC often work not only for the SPAC but also exercise functions in companies with a similar business purpose as the SPAC, or they hold equity interests in such companies. This means that there is a risk of a conflict of interests.

Retail investors face a partial or possibly even full loss of capital, in particular in the following scenarios:

• Liquidation of the SPAC because the time limit has expired (see above)
  In this case, the contract terms normally stipulate that the trust assets must be distributed to the investors on a pro rata basis. The liquidation proceeds may be lower than the issue price of the shares.
• SPAC combined with an unsuitable target company
  The management board may possibly select an unsuitable target. This may be attributable to an error of judgement or inadequate due diligence, for example due to time constraints because the time limit is about to expire. Another thing to remember is that the sponsors normally receive remuneration only if an initial business combination is consummated. If the SPAC is liquidated, they come away "empty-handed". If the sponsors opt for an unsuitable target, this may have negative consequences for the share price after the initial business combination.
• Initial business combination on unfavourable terms
  Possible target companies are highly sought-after (see above). Even if the target company is suitable in principle, there is no guarantee that the business combination will be completed on terms favourable to the SPAC shareholders. It must also be considered that the SPAC's start-up and operating costs (for example, the issue of shares and warrants to the sponsors at favourable terms, consultant and auditor fees, due diligence costs) are also included in the cost of the business combination.

What should retail investors watch out for?

An investment in a SPAC should be approached with caution.

You should first generally familiarise yourself with this form of investment and the target markets. Does your risk appetite extend as far as wanting to write a "blank cheque" to the management board of the SPAC for your investment? Are you confident that you, as an investor, are capable of critically assessing its proposal for a business combination, including its impact on your investment, to ascertain whether you should approve it or exercise your redemption right?

The business model of the SPAC in question, including the remuneration agreements for the sponsors, consultants and other players, as well as other costs, are presented in detail in the listing documents, such as the securities prospectus. You should read and review all documents carefully. In addition, you should do your own research and seek professional advice if necessary.

The following applies to any investment: if you do not understand the characteristics of the product exactly, you should not invest.