Q. Some new “SPACs” have IPO’d lately, including Silver Eagle – and some people call them the “poor man’s private equity” – how do they work?
A. Special Purpose Acquisition Companies raise money in an IPO and then go out looking for a company to purchase. So in the best case a super experienced management team will do a SPAC, use the money to buy a company in their area of expertise, and the benefits of adding their management skills to the target company creates value for the public SPAC shareholders.

Q. But they don’t identify the company to be bought before the IPO?
A. No, very weirdly, they’re not allowed to. So for investors in the SPAC , its worse than buying a pig in a poke, since there actually is no pig at all in there on day one.

Q. These have been very popular at various times, accounting for almost 25% of IPO activity before the crisis… why?
A. Management teams love them because they earn a 20% carry on the deal, just like in true PE. The IPO bankers do well. But because of some very unusual features of SPACs, hedge funds actually like to invest in them…

Q. But.. why in the world would a hedge fund invest in a SPAC?
A. The SPAC has 2 years to find and close its acquisition. But shareholders get to vote on whether to approve the deal, or simply have the SPAC return the cash and close down. Hedge funds invest enough to control that decision, and thus can therefore get a free option– park their cash in a SPAC, but refuse to OK the acquisition deal if the don’t think the stock will pop.

Q. And if they do like the deal?
A. Then, they’ll vote to approve it, but sell their shares for a profit, usually keeping some options that they’ve picked up in the deal for upside. So for hedge funds that invest enough to control the acquisition decision, its heads I win, tails you lose.