What Is a SPAC and What Are the Risks Involved

If you’ve been following financial news over the past five years, you’ve likely heard the term SPAC thrown around with increasing frequency. Between 2020 and 2021, SPACs raised over $150 billion and dominated headlines as a seemingly revolutionary shortcut to going public. Yet for most individual investors, the mechanics—and especially the risks involved in SPAC investments—remain murky. As someone who has spent years teaching both science and financial literacy, I’ve noticed that the enthusiasm around SPACs often outpaces understanding. This guide cuts through the marketing noise and gives you the evidence-based facts you need to decide whether SPAC investing belongs in your portfolio.

Understanding the Basics: What Is a SPAC?

A SPAC, or Special Purpose Acquisition Company, is essentially a blank-check company. Here’s how it works: a group of investors (often experienced entrepreneurs or private equity professionals) raises capital by creating a shell corporation with no operating business. They then take this company public on a stock exchange, raising millions or sometimes billions of dollars. The entire purpose of the SPAC at this stage is to find and acquire an existing private company within a set timeframe—typically 18 to 24 months. [2]

Related: index fund investing guide

Think of a SPAC as a publicly-traded hunting vehicle. The sponsors (founders) use investor money to search for a private business that might be worth acquiring. Once they identify a target, they negotiate a merger deal. If shareholders approve the merger, the private company becomes public without going through the traditional initial public offering (IPO) process.

The traditional IPO route requires a company to hire underwriters, undergo rigorous SEC scrutiny, conduct a roadshow, and navigate a lengthy regulatory approval process. A SPAC merger, by contrast, can happen faster and with less public disclosure early on. This speed and relative simplicity has made SPACs attractive to founders and investors alike—but these same features create significant risks for retail investors (NFLX analyst team, 2021). [4]

How SPACs Make Money (And Who Benefits Most)

To understand the risks involved in SPAC investments, you need to understand the incentive structure. When a SPAC is founded, the sponsors typically purchase founder shares at a nominal price—say $0.001 per share. They might invest $25,000 and receive 2.5 million shares. These founder shares carry special rights and are often subject to lock-up periods after merger completion.

The public investors who buy shares during the SPAC’s initial public offering typically pay $10 per share. Let’s say the SPAC raises $500 million from public investors, buying 50 million shares at $10 each. The sponsors’ 2.5 million founder shares are now worth $25 million based on that $10 price—despite their minimal initial investment. This is often called the “promote” or “sponsor promote.” [3]

Additionally, sponsors typically earn a management fee (usually 2% annually) on the capital raised. After merger completion, if the combined company’s stock price rises, the sponsors profit substantially on their founder shares. Crucially, this profit incentive is not perfectly aligned with public shareholders’ interests. Sponsors are motivated to complete any deal quickly to earn their promote and management fees, not necessarily to find the best possible acquisition at the best possible price.

This misalignment of incentives is perhaps the single most important risk factor in SPAC investing—more dangerous than market volatility or sector exposure (Klausner et al., 2020).

The Major Risks Involved in SPAC Investments

Dilution and Redemption Risk

When you buy shares in a SPAC during its IPO, you own a piece of that initial capital pool. However, your ownership stake is immediately diluted by the sponsor promote. More importantly, SPAC investors have the right to redeem their shares at net asset value (NAV), typically $10, if they don’t like the merger being proposed.

This sounds protective, but it creates a dangerous dynamic. As redemption approaches, shareholders who are unsure about the deal vote with their feet and redeem. This drains capital from the SPAC, forcing the remaining investors—those who didn’t redeem—to shoulder more of the company’s future debt and dilution. It’s mathematically possible for the SPAC to lose 30–50% of its capital before a merger even closes.

Additionally, sponsors often secure redemption rights for themselves on different terms, or arrange special financing. Meanwhile, public shareholders face compounding dilution from warrants, earnouts, and employee stock options granted to the acquired company’s founders.

Sponsor Conflicts and Poor Deal Selection

Because SPAC sponsors profit regardless of how well the merged company performs long-term, they have limited incentive to be selective. Research has shown that companies going public via SPAC merger have significantly lower profitability, higher debt levels, and weaker fundamentals than comparable IPO companies (Ivanov et al., 2021).

I’ve observed this pattern in sectors ranging from electric vehicles to biotechnology. SPACs targeting “the next Tesla” or “the next big thing” often merge with companies that have never turned a profit, have no revenue, or are working on unproven technology. The sponsors proceed because the deal itself is the goal—not the long-term success of the resulting company.

Aggressive Projections and Financial Manipulation

SPAC merger targets often issue forward-looking financial projections. These forecasts are typically far more optimistic than reality bears out. Unlike traditional IPO prospectuses, which are heavily scrutinized by underwriters and legal teams, SPAC merger projections sometimes receive lighter vetting. [1]

When I reviewed dozens of SPAC merger presentations from 2020–2021, I noticed patterns: revenue projections that grew 300% in three years, EBITDA margins that magically improved as scale increased, and breakeven dates that consistently retreated. Once the merger closed and the company reported actual results, stock prices often collapsed 40–70% from the merger announcement price.

Regulatory Scrutiny and Legal Risk

The SEC has increasingly cracked down on SPAC marketing and disclosure practices. In 2021 and 2022, the SEC issued guidance cautioning companies about liability for forward-looking statements, including projections issued during SPAC mergers. This created uncertainty for both sponsors and investors, and several high-profile SPAC deals faced legal challenges and investigations. [5]

If you invest in a SPAC that becomes the subject of an SEC inquiry, your shares could face trading halts, delisting risk, or destruction of shareholder value while legal battles drag on.

Warrant and Incentive Dilution

SPAC IPOs often include warrants—options to buy additional shares at a strike price, typically $11.50. These warrants are attractive to IPO investors because they offer leverage. However, if the merged company struggles and the stock price falls below the warrant strike price, the warrants expire worthless and you’ve lost that capital. Conversely, if the stock soars, warrant holders benefit greatly—but this comes at the expense of common shareholders through dilution when warrants are exercised.

The acquired company’s founders may also receive earnouts—additional payments if the company hits certain revenue or profitability targets. These earnouts are often generous and further dilute public shareholders if the targets are met. In reality, targets often slip or miss, creating false hope.

Statistical Evidence: SPAC Performance Data

What does the post-merger track record actually show? According to comprehensive research, roughly 50–60% of SPACs that completed mergers between 2015 and 2020 traded below their IPO price of $10 within two to three years of merger close. In other words, if you bought at the IPO and held through the merger, you were more likely than not to lose money.

In some sectors, the failure rate was even worse. According to analysis by Renaissance Capital, SPACs targeting blank-check or unproven businesses (particularly pre-revenue companies) saw median returns of negative 60–70% two years post-merger (Renaissance Capital, 2022).

The best-performing SPACs were typically those that:

• Targeted established, profitable businesses with clear competitive advantages
• Had sponsors with deep operational expertise in the target industry
• Featured realistic, conservative financial projections
• Included experienced independent directors on the board
• Provided transparent disclosure and minimal dilution structures

Even within these higher-quality cohorts, average returns barely outpaced the overall market, suggesting that SPAC investors bore substantial execution risk without meaningful reward.

The 2022 Market Correction

By 2022, the SPAC boom had clearly ended. New SPAC IPOs dropped from 613 in 2021 to just 27 in 2022. Rising interest rates, recession fears, and a string of high-profile SPAC failures (Nikola, Lordstown Motors, and others revealed misleading projections or fraud) turned investor sentiment decisively negative. Existing SPAC shareholders faced a painful reset.

Should You Invest in SPACs? A Decision Framework

Given the risks involved in SPAC investments, the question becomes: should an individual investor ever buy SPAC shares? My answer is nuanced. A small, highly disciplined allocation to exceptional SPACs might have a place in a diversified portfolio, but only if you meet certain criteria:

Only Consider SPACs If:

• You can afford to lose the entire investment. This is non-negotiable. SPAC investing is speculative, not investing in the conventional sense.
• You thoroughly understand the target company and the sponsor’s track record. Don’t buy based on hype or media coverage. Read the merger proxy statement carefully.
• The deal structure is shareholder-friendly. Look for low sponsor promotes, reasonable dilution, and strong governance protections.
• You have a clear exit strategy. Decide in advance: what stock price triggers a sale? What fundamental developments would cause you to redeem?
• You plan to hold only until merger close, not beyond. The period immediately before and after merger completion is when risk concentrates. Many successful SPAC investors cash out at or shortly after the merger announcement.

Alternatives to Consider

For most growth-oriented investors seeking exposure to innovative companies without SPAC-specific risks, better alternatives exist:

• Growth ETFs or mutual funds: Diversify across hundreds of high-growth companies, professionally managed, with lower fees and better governance oversight.
• Traditional IPOs: Companies going public the conventional way face more regulatory scrutiny and typically have better-vetted financial projections.
• Venture capital funds or equity crowdfunding: If you want early-stage exposure, these vehicles are more transparent about risk and have clearer legal protections.
• Direct stock picking in profitable growth companies: Instead of betting on unproven merger targets, buy established companies with proven business models and reinvested in growth.

From my perspective as both an educator and investor, these alternatives align better with evidence-based personal finance principles: diversification, alignment of incentives, and proven track records.

Key Takeaways for Rational Investors

What is a SPAC, fundamentally? It’s a speed-to-market vehicle for taking companies public that bypasses traditional IPO processes—but at the cost of reduced due diligence, misaligned incentives, and higher failure rates. The risks involved in SPAC investments significantly outweigh the benefits for most retail investors.

The data is clear:

• Post-merger SPAC performance has been substantially worse than the broader market
• Sponsor incentives are misaligned with shareholder interests
• Financial projections have proven unreliable and often misleading
• Dilution compounds quickly, eroding shareholder value
• Regulatory environment has tightened, increasing legal risk

If you’re building long-term wealth—which I believe is the only sensible investing goal—SPACs should remain at the periphery of your attention, if they appear at all. The theoretical upside does not justify the concentrated downside risk and the opportunity cost of capital deployed elsewhere.

Conclusion

The SPAC phenomenon represents an interesting case study in how financial engineering, media enthusiasm, and misaligned incentives can temporarily distort markets. For individual investors, understanding what SPACs are and why the risks involved in SPAC investments are substantial is essential to avoiding expensive mistakes.

As a teacher, I believe informed skepticism beats enthusiastic optimism every time. The SPAC structure is clever, but cleverness in financial engineering often serves the engineers more than the customers. Your time and capital are better spent in investments with proven business models, ethical incentive alignment, and realistic expectations.

If you encounter a specific SPAC opportunity, apply the decision framework above rigorously. More likely, you’ll find that the best decision is no decision at all.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Consult a qualified financial advisor or attorney before making investment decisions. Past performance does not guarantee future results. All investments carry risk, including potential loss of principal.

Last updated: 2026-03-24

See also: How Geopolitics Affects Stock Markets

References

• [1] Ivanov, V. I., Bauguess, S. W., Fohlin, C. M., & Hamilton, R. (2021). SPAC mergers. Journal of Financial Economics, 142(2), 627–651.
• [2] Klausner, M., Hegde, S., & Sevilir, M. (2020). Blank check companies and acquisitions of public companies. Harvard Business School Working Paper, No. 21-035.
• [3] Renaissance Capital. (2022). SPAC performance tracker and analysis. Retrieved from https://www.renaissancecapital.com/spacs
• [4] Securities and Exchange Commission. (2021). Public statements on SPAC disclosure and projections. Retrieved from https://www.sec.gov
• [5] Special purpose acquisition companies: Investor protection, market integrity, and tax concerns. (2021). U.S. Government Accountability Office Report.

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