Buying a SPAC investment vehicle might pay off for you—but it’s much more likely to end up costing you money. Here’s why.

I can’t imagine a situation where I’d buy or recommend a SPAC investment vehicle, U.S. or Canadian. Hidden conflicts of interest are the biggest risk you face as an investor, because they’re everywhere. A SPAC investment vehicle’s conflicts of interest are right out in the open rather than hidden, and that probably makes them more, rather than less, dangerous on average. I’m sure some SPACs will work out fine, but I don’t like the odds.

SPACs are a specialized kind of IPO (Initial Public Offering, or new stock issue). One key difference is that SPACs, also referred to as “blank-check companies,” raise money from investors without providing a detailed business plan. The SPAC goes through an IPO-like process, raising some money and getting listed on an exchange.

Its next goal is to find another business to buy, usually within two years. Then the two companies merge, giving the purchased company a relatively quick stock exchange listing and the liquidity that comes with it.

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The fact that SPACs give outsiders an easy way to invest in venture capital may be a sign of danger, rather than opportunity. As well, conflicts of interest are much bigger than the typical conflicts you face every day. That’s because SPACs have lots of motivation to find a company to buy.

For reaching that goal, the SPAC investment vehicle sponsor gets a low- or no-cost slice (up to 20%) of the merged company. As well, if the SPAC fails to find an acceptable takeover candidate within the allotted time (often two years), it folds and returns to investors any funds remaining after expenses. This obviously gives the SPAC sponsor a great incentive to buy something—anything—as opposed to folding the SPAC and returning the cash.

Understanding a SPAC investment vehicle and IPOs

We still generally stay out of IPOs, for one main reason. IPOs tend to take place when it’s a good time for the company or its insiders to sell. This may also be a good time for the public to buy.

Promoters portray SPACs as supercharged IPOs that start out with a sure-fire opportunity, chosen by an expert. Sponsors of SPACs usually include well-known venture capital investors who have had at least a few big wins. Venture capital is now a glamorous business where success can be hugely profitable. But many investors fail to appreciate the odds against venture-capital success. That helps explain why they accept the costly terms of these deals, and the potential conflicts of interest.

In pre-Internet days, venture capital was less glamourous and less profitable. Firms made money in about one investment in 10. However, one success was often enough to offset losses on the other nine tries, and still leave a healthy return.

In the past couple of decades, the venture capital industry has produced or contributed to a series of world-changing success stories: Google, Amazon, YouTube, PayPal, eBay, Facebook, Uber, AirBnB and Netflix are just a few. Outsiders may get the idea that this is normal. Some assume venture capital celebrities routinely discover companies like these. However, a lot more money is flowing into venture capital investing these days. It comes from many new sources—pension funds, sovereign wealth funds, university endowments, rich individuals and

conventional mutual-fund operators. To top it off, technology advances much faster than ever.

The fact that SPACs give outsiders an easy way to invest in venture capital may be a sign of danger, rather than opportunity.

Avoiding IPOs does not necessarily mean you miss out on great opportunities

People in the business will tell you that if you avoid IPOs altogether, you’ll miss out on some great opportunities. Some IPOs do turn into “hot new issues,” and double or triple or more soon after they hit the market. However, IPO underwriters know early on if a new issue is likely to succeed. That’s because they get out and promote new IPOs ahead of time to their biggest and best clients—financial institutions, heavy-trading hedge funds and so on.

Members of this select group get to buy first, and the best opportunities sell out early. The average investor may get to buy a few shares, if any. I suspect that same pattern applies with SPACs.

SPACs have been around for decades, by the way. Alberta had a low-cost early version of SPACs in the 1980s. The program aimed to help finance the oil industry, which went through years of low oil prices in the decade. These SPAC ancestors were officially known as “Junior Capital Pools.” They were casually referred to as “nickel deals,” since that was a common per-share price. On the whole, they did more good for the brokerage and oil industries than for investors.

Some investors will make money in SPACs, of course. However, it’s best to stay out of markets where you have to out-bid overly eager amateurs.

Use our three-part Successful Investor approach to pick stocks for your portfolio

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Would you have more confidence investing in an IPO over a SPAC?