invest Archives | Page 119 of 180

Aug

2023

What Are Options on Futures & How Do They Work?

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

Futures options can be a low-risk method to getting exposure to the futures market. Trading options on futures works like trading options on individual equities but rather than the underlying asset being a stock, it’s a futures contract.

In addition, there are other key differences for investors to bear in mind, including how futures are traded.

It is important to be aware of these differences, and familiarize yourself with key terms and understand how futures options work for buyers and sellers.

What Are Options on Futures?

Options on futures allow you to make bets on futures contracts with lower capital requirements than the futures themselves, which is in turn lower than the capital required to trade in the assets underlying the futures. Instead, puts and calls are used.

Recommended: How to Trade Options

Key Terms to Know About Futures Options

Experienced options traders might be familiar with many of the primary terms of options on futures. New traders should understand these basics. Let’s investigate some key terms.

Premium

Premium is the amount you pay for calls and puts when you buy these instruments. Options sellers collect the premium at the initiation of a trade. The amount of premium paid or collected is determined by a variety of factors including the size of the underlying futures contract.

The lower the premium, the less the market believes a futures contract will be in-the-money by expiration.

Contract Months

Unlike stocks, options contracts have expiration dates. When trading options on futures there are two expiration dates to keep in mind: the expiration date of the futures option and the expiration date of the futures contract.

Options on futures pricing usually expire near the end of the month before physical delivery of the futures contract takes place.

In general, the longer the time until expiration, the more expensive the options will be.

Strike Price

The strike price on futures options is the price at which you can buy or sell the underlying futures contract.

For example, when you buy a call option on a futures contract with a strike price of $10, you have the right, but not the obligation, to buy the underlying futures contract at $10 on or before expiration for an American-style option.

Many futures options contracts are European-style, however, which means they can only be exercised on the expiration date and not before.

Most options are not exercised, rather they are closed in the market before expiration.

How Do Futures Options Work?

Futures options work very much like options on equity securities, but there are differences.

Let’s outline some of the specifics so you understand the mechanics of trading options on futures contracts.

Calls and Puts: Rights for Buyers

The buyer of a call option on a futures contract has the right to buy the underlying futures contract at a predetermined price and time. The buyer of a put option on a futures contract has the right to sell the underlying futures contract at a predetermined price and time.

Recommended: 10 Options Trading Strategies

Calls and Puts: Obligations for Sellers

The seller, or writer, of a call option on a futures contract is obligated to sell the underlying futures contract at a predetermined price and time. The seller of a put option on a futures contract has the obligation to buy the underlying futures contract at a predetermined price and time.

Be aware that most options on futures are cash-settled. That means the price difference is paid or received — there is no physical delivery of the futures contracts or assets with cash-settled options.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Pros and Cons of Options on Futures

Options and futures have benefits and drawbacks. Let’s clarify some of those.

Pros

A primary advantage of options on futures is that you can trade with high leverage. This means you put down a small amount of capital to access a large notional value of an asset. Small swings in price can lead to large moves in your account’s equity.

Another upshot is the options market on futures is open more hours than the stock market. You can trade overnight in many markets.

When you purchase options, the most you can lose is the premium you pay. When you sell options, you know what your max gain is: the premium received. For this reason, options on futures can be used to tailor an investment strategy based on your risk and reward objectives.

Cons

There are downsides to consider. For example, when you trade with high leverage, you expose yourself to a large loss potential.

You must also be aware of differences in options specifics in futures trading. For example, a $1 move on a futures index option could have a much greater impact on your account’s equity versus a $1 move on an equity option.

Finally, futures contracts are more complex than equity options. Each futures contract has unique specifications. It can be tough to understand all the futures contracts available to trade.

American-Style vs European-Style

American-Style	European-Style
The holder can exercise before expiration	The holder cannot exercise before expiration
Most options on equities are American-style	Futures contracts often have European-style options
Quarterly options on S&P 500 futures contracts, Eurodollar options, and Treasury options	Most CME Group options on futures are European style

There is a third less common option, the Bermudan option. Bermudan options lie somewhere between American and European options — hence the name. The biggest difference is Bermudan options can be exercised on specified dates prior to expiration. These dates are laid out in the options contract.

Option Value vs Underlying Futures Value

The price impact on a futures option works just as options on stocks. Calls benefit from higher prices on the underlying asset while puts rise when the underlying price drops, all else equal.

Futures Price Change	Call Price Change	Put Price Change
Increase	Increase	Decrease
Decrease	Decrease	Increase

In-the-Money vs At-the-Money vs Out-of-the-Money

It is important to understand the moneyness of options when trading. Moneyness is simply the difference between an option’s strike price and the underlying asset’s price. Knowing the moneyness of an option can help you decide whether to exercise.

In-the-money options have intrinsic value and are priced more expensively than out-of-the-money options. Out-of-the-money options are often cheaper and can be accessed with a smaller amount of capital.

In-the-Money	At-the-Money	Out-of-the-Money
For calls, when the underlying asset’s price is above the strike	For calls, when the underlying asset’s price at the strike	For calls, when the underlying asset’s price is below the strike
For puts, when the underlying asset’s price is below the strike	For puts, when the underlying asset’s price is at the strike	For puts, when the underlying asset’s price is above the strike

Examples of Futures Options

You can find examples of futures options on many types of futures contracts. Stock market indexes and commodities are two markets that have options available to trade. Interest rate and foreign exchange markets also have futures markets with options. You can construct options strategies in these markets including defined-risk plays such as a collar in options.

The Takeaway

Options on futures allow investors to make bets on futures contracts with lower capital requirements than the futures themselves, which is also lower than the capital they’d need to trade the underlying asset. Instead, puts and calls are used.

So in that case, an option on a futures contract gives the holder the right, but not the obligation, to buy or sell a futures contract at a predetermined price usually on a pre-specified expiration date. Trading options and futures is a low risk way to access the futures market.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

With SoFi, user-friendly options trading is finally here.

FAQ

Can you trade options on futures?

Yes, you will need to open an account with a broker that offers this type of trading. There might be high capital requirements to meet in order to open an option on a futures trading account.

How do you buy futures?

Futures contracts can be bought through a futures trading brokerage company or directly at an exchange. Most retail traders go through a brokerage company. Not all brokerage firms offer these products, however.

What is the difference between futures and options?

Futures obligate the buyer to purchase an asset and a seller to deliver that asset unless the option buyer’s position is closed by the expiration date.

Options give the buyer the right, but not the obligation, to buy or sell an asset at a specified price during the life of a contract, while potentially creating an obligation for the seller (of the option) to buy or sell the underlying asset if the buyer exercises that option.

Photo credit: iStock/Drs Producoes

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Aug

2023

Do IPOs Offer Dividends?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Some companies may have the financial means to make regular dividend payments before being listed on a public exchange, i.e. prior to their initial public offering, or IPO. A company may choose to offer this type of pre-IPO dividend in order to garner interest in the IPO if it anticipates a high valuation.

Dividends represent a percentage of a company’s profits that it pays out to shareholders. Dividends most commonly come from established companies, but it’s possible to collect an IPO dividend from up-and-coming companies as well.

Do IPOs Offer Dividends?

Most companies that are going public are doing so to raise capital and don’t necessarily have money to spare that they can pay out as special dividends or stock dividends.

However, some companies involved in the IPO process can pay dividends on a regular basis before and/or after going public, or they may pay a special one-time dividend. In either case, the dividends could serve as a useful incentive to attract and retain investors.

In general dividend-paying stocks and IPOs pay different roles in an investors’ portfolio. The former represents a steady source of income, while the latter holds the potential for capital appreciation through strategies such as the Dogs of the Dow, a strategy in which investors purchase the Dow Jones Industrial Average stocks with the highest dividend yield.

A simple way to know whether a pre-IPO company plans to offer a dividend is to review their registration documents. Companies must amend their S-1 registration form with the SEC if they plan to offer any type of dividend payment to investors. You can find S-1 forms through the SEC’s EDGAR database online.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

REIT IPOs and Dividends

Typically, companies do not offer dividends as part of the IPO process. If you do find an IPO company that’s offering a dividend payment, it’s more likely to be a real estate investment trust (REIT) versus a more traditional company structure.

REITs are companies that own income-producing real estate investments and must pay out 90% of their taxable income to shareholders as dividends. Just like other companies, REITs can choose to go public in order to raise capital from investors.

REIT IPOs work a little differently than other IPOs in that there are additional filing requirements they have to meet under SEC rules, but otherwise the overall process is largely the same.

IPOs Explained

IPO stands for Initial Public Offering, and the event represents the first time a company makes its shares available for trade on a public exchange. This is often referred to as “going public”.

Companies launch IPOs, a process regulated to raise capital from investors. The Securities and Exchange Commission regulates the IPO process to ensure that the company has performed its due diligence, completed all of the appropriate paperwork, and established an accurate valuation of the IPO.

Investing in IPOs can offer an opportunity to diversify a portfolio while potentially getting in on the ground floor of a company poised for significant growth. It can, however, be risky as there are no guarantees whether an IPO stock will be a success — and even a successful IPO doesn’t necessarily predict how well a company will do over time.

For this reason, it can be difficult for individual investors to buy IPO stock when it’s first issued. In most cases, individuals can trade IPO shares on the secondary market through their brokerage.

IPO stocks are considered high-risk investments, and while some companies may present an opportunity for growth, there are no guarantees. Like investing in any other type of stock, it’s essential for investors to do their due diligence.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Dividends Explained

A dividend is a share of a company’s profits that’s paid out to shareholders, usually in cash. The company determines how frequently to make these payments to investors. For example companies may pay dividends on a monthly, quarterly, biannual or annual basis, or it can pay them on a one-time basis.

The amount an investor receives in dividends correlates to the amount of stock they own. Preferred stock shareholders receive first priority for dividend payouts, ahead of common stock shareholders. However, preferred stock shareholders do not have voting rights while common stock shareholders do.

Companies that offer dividends can decide whether to increase or decrease dividend payouts over time, depending on profitability. Companies that consistently increase dividend payouts over a period of 25 consecutive years or more are called Dividend Aristocrats. Companies that do so over a period of 50 consecutive years or more are called Dividend Kings.

Types of Dividends

Dividends can take different forms, depending on when and why a company pays them out to investors. When discussing IPOs and dividends, you’re typically talking about special dividends and stock dividends. Companies may use both to encourage investors to buy that their IPO is an investment opportunity, though they aren’t exactly the same in terms of what the investor is getting.

Special Dividends

Special dividends, also referred to as one-time dividends or extra dividends, are dividend payments made to investors outside the scope of regular dividend payments. A company that plans to go public may make a pre-IPO special dividend payment to its existing shareholders. The total value of the dividends paid may be equal to or less than the amount the company expects to be raised through the Initial Public Offering.

Dividends

Dividends are regular payments made in stock or via cash to shareholders out of a company’s profits. Cash dividends can increase the value of an investor’s holdings over time if the investor reinvests them in the stock. Again, the amount an investor receives in dividends depends on the company.

Dividends may go up when profits are up and drop when profits fall. But a high dividend payout alone is not a reason to consider investing in a company. It’s important to look at the company’s financials to determine whether that higher payout is sustainable over time.

Why Do Companies Give Dividends?

Companies offer dividends as a reward or incentive to attract new investors and retain existing ones. A company that offers a dividend regularly can attract income-focused investors. As long as the dividend payout sticks around, then the investors are likely to stick around as well. Of course, this assumes that a company is profitable and has the means to pay out dividends in the first place.

Dividends are less common among newer companies because they’re typically reinvesting any profits they realize into further growth. That doesn’t mean they won’t offer a dividend to investors later but for the near term, they may need every bit of profit to continue expanding.

The Takeaway

The purpose of most IPOs is to raise capital and generate buzz; paying shareholder dividends is more common with an initial public offering for a REIT than a traditional company IPO. In either case, the dividends could serve as an incentive to attract new investors.

The easiest way to know whether a pre-IPO company plans to offer a dividend is to review their registration documents by reading the S-1 registration form that’s been submitted to the SEC.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What is an IPO dividend?

An IPO dividend is a dividend payout associated with a company’s Initial Public Offering. IPO companies can make special dividend payouts on a one-time basis or offer regular stock dividend payments to investors.

How do shareholders make money in an IPO?

Shareholders can make money in an IPO if they’re able to sell shares at a higher price than their initial offering price. Shareholders can also collect IPO dividend payments to supplement their profits.

Are dividends taxed?

Yes. The IRS considers dividends a form of taxable income. The tax rate that applies can depend on whether you have qualified or nonqualified dividends. The IRS taxes nonqualified dividends at ordinary income tax rates while qualified dividends follow the long-term capital gains tax rate structure.

Photo credit: iStock/LaylaBird

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Aug

2023

International IPOs for International Investors

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Private companies often choose to go public in the country that offers the brightest prospects for a successful IPO. Sometimes, that means getting listed on a stock exchange in the company’s home country — but sometimes it makes more sense to list in a foreign market.

So, while many U.S. investors focus primarily on domestic companies, it’s also possible to invest in an international IPO.

Likewise, foreign companies can choose to launch their IPO on U.S. stock exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq. And in some cases, a company could choose to do both through a global IPO.

Investing in IPOs, international or domestic, may appeal to certain investors who want more geographic diversity within their portfolio, and understand the risks of doing so. Knowing how these IPOs work and where to find them is the first step.

What Are International IPOs?

An international IPO is an initial public offering from a private company that takes place outside of that company’s home country. For example, a company based in South Korea decides to go public but instead of listing on the Korea Exchange (KRX), it wants to list on an American exchange.

If the company successfully meets the regulatory requirements established by the Securities and Exchange Commission (SEC), it could move forward with an international IPO. International investors could then purchase shares of the company once it begins trading on the NYSE or Nasdaq.

In most cases, an investor must apply or qualify to buy IPO shares through their brokerage, as these stocks can be restricted in certain ways, limited in quantity, and come with a much higher risk level than other types of stocks.

There are a number of reasons and companies may choose an international IPO. Those include:

• More lenient regulatory requirements for securities on a foreign exchange than those of the home country.

• Better prospects for raising capital through an IPO on a foreign exchange.

• More credibility versus listing on its home country’s exchange.

The most important thing to keep in mind with foreign companies that list on U.S. stock exchanges is that they must complete the IPO process just like a domestic company would.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

Understanding IPOs

When discussing IPOs, “international” refers to public launches involving companies that are foreign to the market they plan to list in. But what is an IPO in general?

In simple terms, an IPO represents the first time that a private company allows investors to purchase shares on a public stock exchange.

Why do companies choose to go public? The answer can depend on the company and its overall business plan. In most cases, the answer is to raise capital so the company can continue to grow and expand. Companies don’t enter into the IPO process lightly, however, as it can be time-consuming and costly.

In the United States, the SEC regulates the IPO process. An IPO can take upwards of a year to complete, as the company moves through the various phases, including:

• Due diligence

• SEC review

• Road show

• Valuation

• Launch

International IPO Funds

With domestic companies, it’s possible to purchase IPO stock on the day the company goes public, using an online brokerage account. In the case of companies that offer pre-IPO placements, it may also be possible to purchase shares before they’re made available to the market at large. Effectively, you’re investing in a private placement.

When investing in international IPOs, you may choose to invest through IPO mutual funds or international exchange-traded funds (ETFs) instead. You might go this route if you want more diversification, or if you don’t have access to IPO shares.

When comparing international IPO ETFs or international mutual funds, it’s important to consider a few things, including:

• Underlying holdings (i.e. which sectors does the fund include, what countries does it offer exposure to)

• Expense ratios

• Management style (i.e. active versus passive)

With either type of fund, you’d also want to consider the track record and performance, particularly in the case of actively managed funds with a higher expense ratio. This can help you determine if a higher returns justify a higher expense ratio.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

International IPO ETFs

What is an exchange-traded fund (ETF)? An ETF is a type of pooled investment that combines features of both mutual funds and stocks. Essentially, it’s a mutual fund that trades on an exchange like a stock.

This feature makes ETFs different from mutual funds. However, like mutual funds, ETFs have an expense ratio that reflects the annual cost of owning the fund over the course of a year. ETFs can follow an active or passive management strategy, with some funds using an index-based approach.

For some investors, international ETFs that concentrate holdings on companies that go public in foreign markets could make sense since they provide diversified exposure to newly listed non-U.S. companies in a single investment vehicle.

International IPO Mutual Funds

Mutual funds are also pooled investments, meaning multiple investors contribute funds used to buy underlying securities. Each investor in the fund assumes a share of the fund’s earnings (or losses), based on the number of shares they own.

The key difference between mutual funds and exchange-traded funds is how they’re bought and sold. Rather than trading on an exchange like stocks, traders settle mutual fund transactions once a day.

Mutual funds that invest solely in international IPOs may be harder to come than international IPO ETFs. But there are mutual funds that focus on international holdings.

How to Find International IPOs to Invest In

You may be able to purchase international IPOs or international IPO funds through your brokerage account.

To find potential investments, you might use an online resource like the Nasdaq IPO calendar, which lists all upcoming IPO dates. This can help you identify potential investment opportunities for upcoming international IPOs or global IPOs. Investing websites that report on the latest market trends and news offer another way to gain information about foreign companies that are pursuing international IPOs.

Key Things to Consider When Investing in International IPOs

If you’re looking to international IPO funds for investment, consider the following:

• What the fund holds (both the companies and the geographies)

• The expense ratio, or costs associated with the fund

• The fund manager’s strategy (or the index it follows)

• If you’re investing in multiple international IPO funds, consider whether there’s any overlap in the holdings that might reduce your diversification

Evaluating international IPOs is similar to evaluating domestic IPOs. The company’s prospectus provides important information about the offering. Though keep in mind that a red herring prospectus may not disclose full details about the company’s financials or organizational structure.

It’s also important to consider risk factors unique to a foreign company that could affect its IPO outcome. A company located in a country that’s experiencing geopolitical turmoil or economic impact related to climate change, for instance, may have a higher risk profile than a company that isn’t facing those types of threats. So getting familiar with a company’s economics, politics and geography may be helpful before investing in an international IPO.

The Takeaway

IPOs allow investors to get in on the ground floor of an up-and-coming company. Whether you choose to invest in domestic IPOs or international IPOs, it’s important to understand, however, that they can also represent a riskier investment than an established public company.

International IPOs come with their own special set of concerns. While qualified U.S. investors may have access to IPO shares, it’s important to read the prospectus of international companies carefully, understand the product and the market you’re investing in, and vet the terms of any IPO international stock before you choose to buy it.

Invest with as little as $5 with a SoFi Active Investing account.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Aug

2023

What’s a SPAC?

By Beth Braverman | Growing Wealth, invest, Investing | Comments Off

Special purpose acquisition companies (SPACs) are shell companies that go public with the intent of buying a private business. Also known as “blank check companies,” SPACs can be an alternative to the traditional initial public offering (IPO) route.

SPAC IPOs have drawn criticism from those who believe they benefit SPAC insiders over retail investors, and that the businesses that they ultimately take public lack solid business fundamentals.

Here’s a rundown of what investors should know about SPACs before investing in one.

Understanding What SPACs Are

It’s important to know that SPACs go public before they have any actual business operations, and before they have a target company to buy.

SPACs typically have a two-year horizon to find a private company with which they can merge. If they do not find a deal, the SPAC dissolves and returns any proceeds to investors.

While SPACs are less common today, interest in SPACs peaked during 2020 and 2021 as many private companies, particularly ones that had reached “unicorn company” status, looked to debut in public markets. In 2021, there were more than 600 SPACs, up from nearly 250 in 2020.

In 2022, by contrast, there were only 86 SPACs, according to data from SPACInsider.

Some SPACs have a checkered track record, having historically underperformed the broader market, a trend that has continued in the recent boom. SPACs may also offer more favorable terms to bigger, institutional investors versus retail ones, making it crucial that the latter do their research.

The IPO process and trading IPO shares is a risky one for most investors. Understanding the route a company chooses when going public can help investors better assess whether the stock falls within their risk tolerance.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

How SPACs Work

Here’s a step-by-step guide to how a SPAC merger typically occurs:

1. A “sponsor” sets up a SPAC. Sponsors are typically industry experts or executives. They can pay $25,000 for a 20% stake — what’s known as the “promote” or “founder’s shares.”

2. The SPAC goes public, promising to buy one or more private companies with the proceeds from the IPO listing.

3. The newly public entity hunts for a private business to merge with.

4. When the SPAC finds a target, stockholders vote on the proposed merger. They have the option to vote against the deal.

5. If the SPAC needs more funding for the merger, stockholders who are institutional investors or private equity firms can provide the additional capital in what’s known as a “private investment in public equity” or PIPE.

6. The target company then merges with the SPAC in a “reverse merger” known as a deSPAC. The target company’s name and ticker symbol on the stock exchange, replacing the SPAC.

7. When SPACs go public, institutional investors have access to shares called “units.” Each “unit” includes a share priced at $10 and a warrant the holder can exercise when the shares reach $11.50.

So let’s say a SPAC’s shares rise to $15 each after the deal is announced, the institutional investor can exercise their warrants and net a profit from the difference between the $15 shares and $11.50 warrants that can be converted into shares.

Recommended: What Is the IPO Process?

History of SPACs

Investment banker David Nussbaum launched the first SPAC in 1993 and went on to cofound the SPAC-focused investment bank EarlyBird Capital. At the time, SPACs represented a new take on the “blank check companies” that had become embroiled in fraud and penny-stock schemes in the 1980s.

Over the next 25 years, SPACs remained a relatively obscure avenue for private companies to go public.

In 2009, only one company went public via a SPAC, and in the decade that followed, the numbers of SPACs per year ranged from just a handful to a high of 59 in 2019. The market saw an unprecedented boom in SPACs in 2020 and 2021, but with mixed results. Many SPACs that went public in 2021 have failed to find merger targets.

The number of SPAC deals since then has continued to dwindle, with traditional IPOs also decreasing.

Recommended: How to Buy IPO Stock

SPACs vs IPOs

The SPAC model emerged after years of dissatisfaction with the traditional IPO process. Some startups may believe that going the SPAC route will put them less at the mercy of the stock market’s mood when it comes to their valuation when listing. The SPAC negotiates the price for the private company behind closed doors, similar to deal making for a traditional merger.

This process may allow for more stability in determining the value of the stock, which is especially attractive when the stock market is volatile. In an IPO, the price is set the day before the listing and often relies on the judgment of investment bankers.

SPACs also may offer a speedier way for companies to enter public markets. A merger between a SPAC and target company can take a few months, while the conventional IPO model can take 12 to 18 months, and requires extensive investment in the documentation for regulators as well as the roadshow for investors.

The Securities and Exchange Commission (SEC) reviews merger terms between the SPAC and the target company, similar to how it reviews IPO prospectuses. However, because the SPAC is a merger, it’s more likely the deal can be marketed using forward-looking projections, which can be helpful for fast-growing companies that aren’t yet profitable.

For IPOs, regulatory rules require that only historical financial statements can be shared.

SPAC	IPO
Valuation negotiated behind closed doors like a traditional acquisition	Valuation determined the day before launch by underwriters
Process takes three to four months	Process takes 12 to 18 months
Merger terms reviewed by SEC	IPO prospectus reviewed by SEC

SPAC Pros & Cons

There are benefits and drawbacks to investing in SPACs. Here’s a look at some of them.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Pros of SPACs

There are several reasons that SPACs appeal to some investors and founders as a method of taking companies public.

Seasoned Sponsors

Some recent SPACs have had sponsors who are more prominent figures. In essence, betting on a SPAC is trusting an experienced executive to suss out an underappreciated business in private markets and bring them to public markets.

IPO Alternative

Startups have increasingly shunned the traditional IPO model, calling it expensive, time-consuming, and onerous. SPACs have become an alternative for some to go public in an often cheaper, faster way.

Navigating Stock Volatility

SPACs are one way that private companies can manage choppy trading in the stock market, since they can privately negotiate valuations and deal terms.

SPAC 2.0

SPACs were once considered the “backwater of the stock market” and associated with penny-stock schemes. However, some of the more recent ones have featured seasoned executives, investor protections such as time-restricted warrants, and sponsors with more skin in the game.

Retail Participation

Retail investors can potentially get in on a deal at $10 a share. In a traditional IPO, they have to wait until the shares hit the public market after getting priced. Buying a company before it goes public does provide an opportunity for a potentially higher profit if the company eventually succeeds, but SPACs and IPOs are high-risk endeavors that offer no guarantees.

Cons of SPACs

While there are some potential advantages of investing in a SPAC, there are also important risks to understand.

No Deal

With SPACs, there’s always the risk that the SPAC cannot find a company to acquire. While in such cases investors do get their money back, plus interest, they may have preferred to put their money elsewhere during that time period. And because so many SPACs went public in the last two years, there’s now much greater competition for companies to buy, increasing the risk that they’ll overpay for targets or be unable to find one.

Underperformance

Many of the SPACs that have recently gone public have failed to live up to their projections. Short sellers — investors in the market who bet that a stock’s price will fall — have already started targeting SPACs.

Sponsor Payout

Some observers believe that the 20% stake paid to sponsor has been deemed by some observers as too lucrative.

Risk of Dilution

The warrants given to institutional investors who buy into SPACs can potentially dilute others when the warrants are exercised.

Potential Retail Disadvantage

When institutional investors participate in PIPE deals, they’re typically told the potential acquisition company. While this is legal, it’s potentially one way SPACs can favor bigger investors versus smaller ones, who are often left in the dark.

More Regulation

SEC Chairman Gary Gensler proposed new rules that would increase the oversight and accountability for SPACs so that investors would receive the same protections as they would vis a vis IPOs.

SPAC Pros and Cons Summary

SPAC pros	SPAC cons
Seasoned sponsors lend legitimacy	SPAC could fail to acquire a company
Alternative route to IPO	Despac companies have underperformed
Ability to negotiate deal terms in private	Terms favor institutional over retail investors
Some investor protections	Risk of dilution through warrant execution
Some investor protections	Risk of dilution through warrant execution

The Takeaway

While often described as a simple reverse merger, SPACs can be more complex than they seem at first glance. A SPAC is a shell company that attracts investors, raises capital, and then finds a target company to acquire. Although SPACs went through a heyday of sorts in 2020 and 2021, their numbers have dwindled owing to regulatory concerns and some high-profile failures.

As with any investment, individuals can benefit from doing their due diligence on these types of shares, researching the sponsor’s incentives and understanding the terms for the warrants.

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FAQ

Are SPACs good investments?

You’ll need to evaluate each SPAC based on its specific characteristics. While many SPACs have underperformed the market, others have performed in line with expectations. Either way, SPACs and IPOs are considered high-risk investments.

How do SPACs work?

SPACs are shell companies, typically led by industry experts, that go public with the sole intention of acquiring a private company and listing it on an exchange. If investors in the SPAC approve the merger, the companies combine, taking the name and ticker symbol of the newly private company.

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Aug

2023

Guide to the Dual-Track Process for IPOs

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

A dual-track initial public offering (IPO) allows companies to explore both going public and a private sale simultaneously.

For the company’s early and initial investors — those who acquired equity during seed funding rounds, for instance — both an IPO and a private sale could present an opportunity to cash out on their investment. Or, to find an exit.

Often the dual-track process may allow investors to get a higher return on their capital, since they can choose to move forward with the method that provides a higher valuation.

Dual-Track IPO Process Explained

For many early-stage investors, be they private equity or venture capital firms, or individuals, the time to execute an exit strategy is often when a company goes public, as an IPO opens up an opportunity for early investors to make an exit.

In a dual-track process, a company works toward both an initial public offering and a private sale through an auction — or an M&A (mergers and acquisitions) process — at the same time. The dual-track process gives investors looking for an exit the potential to fetch a higher valuation for their investment, particularly when market conditions make an IPO less than ideal.

How the Dual-Track Works for IPOs

Investors have an endpoint in mind: An exit and liquidation of their stake in an investment (the company). It only makes sense, then, that they’d want to get the highest possible profit back from their investment, while being aware of the substantial risks involved in the IPO process. That’s the aim of the dual-path IPO.

As such, the process varies — and a lot depends on the goals of the investors. But by exploring both an IPO and a potential M&A deal, companies have options. The process isn’t all that structured, as each company’s circumstances will differ.

But in broad strokes, the process utilizes two teams: One staffed with underwriters to prepare for an IPO, and another with lawyers and advisors who are feeling out potential M&A partners.

While the IPO process proceeds slowly, the M&A team is meeting with investors. When the regulatory approval has been granted for an IPO — a company can look at its options and decide if it wants to go public, or otherwise find a buyer through an M&A deal.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

What Is the Purpose of the Dual-Track IPO Process?

The goal of the dual-track process is simple: To increase the value of a company before its investors execute their exit.

But the process also provides companies a certain level of flexibility to either go public, or pursue an M&A deal or a private placement. Having options can help investors ultimately reap more gains if one avenue provides a higher valuation.

Recommended: Why Do Companies Go Public?

Benefits of the Dual-Track Process

Though the dual-track process is more resource-intensive than a traditional IPO, there are some clear benefits to engaging in it, including:

• Flexibility: Utilizing the dual-track process gives companies the chance to either go public or execute a private deal, rather than being bound to one or the other. It gives companies additional options.

• Maximizes odds of a higher valuation: Additional options means that there can be multiple valuations on the table. For instance, a private deal may value a company more than if it were to IPO. For investors, getting an idea of a company’s ultimate value from more than one source can be illuminating, and they may learn of exit opportunities that they did not previously recognize.

• Mitigates risks of the market: The market isn’t always going to cooperate when a company plans to IPO. There are a lot of factors that can hurt an IPO, and by having another option (an M&A deal), the dual-track process can help reduce the risks of going public at the wrong time.

Using Dual-Track for an IPO Exit

For investors who want to exit their investment, the dual track IPO provides several options. If the firm IPOs, they can sell their investments (after the lockup period) to the public. If the company goes the M&A route, early investors can sell some or all of their stake in the company to the acquirers.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

Is Dual-Track Suitable for Every Company?

No. Given the resources required, not every company should pursue a dual-track IPO. Whether it makes sense for a specific company will depend on the company’s and the investors’ goals.

Some companies might want to go for the private sale route, for example, because they want to avoid the disclosure process in an IPO. On the other hand, some organizations will want to focus on an IPO because there aren’t any appealing potential buyers on the market.

M&A Exit Explained

An M&A exit is a private deal between the company and another company (or companies). Often the two companies have some sort of aligned interest or operate in the same market, and one acquiring the other serves to increase market share or create a more diversified, multi-dimensional company.

And naturally, there are some pros and cons to an M&A, just as there are for an IPO.

Pros of M&A Exit

The biggest benefit of an M&A exit is the prospect of a higher valuation. That can come for a few reasons: A buyer may have an immediate need for the service a company provides, and needs to onboard as soon as possible, for instance, or multiple potential buyers can bid up a company’s value.

Also, the prospect of less disclosure (as opposed to the IPO process) can also be very attractive for some companies — like those in tech.

Cons of M&A Exit

Conversely, there are some potential drawbacks to an M&A exit, particularly for entrepreneurs with an emotional attachment to their business. A buyer may “clean house,” so to speak, and replace employees or company leadership, for one. It may also drastically restructure the business itself.

The Takeaway

A dual-track IPO is a way for companies to explore multiple liquidity events to choose the one that makes the most sense for their organization and their investors. If those companies do choose to go public, retail investors will have an opportunity to purchase shares in them for the first time.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What is an M&A exit?

An M&A (mergers & acquisitions) exit is when one company purchases, or merges with, another company. For investors, a company being acquired by another offers the chance to liquidate their position, as they’re selling their equity to the purchaser.

Is an IPO part of M&A?

No. A company typically either executes an IPO or goes through an M&A deal — investors are looking to exit through one or the other. However, companies that plan on going public or that have gone public can still engage in M&A deals. And an M&A deal may still result in a company staying private, too.

What are M&A deals?

M&A deals can take several forms: Mergers, acquisitions, consolidations, outright purchases, etc. The essence of an M&A deal is that one company, or its assets, is absorbed by another. Two become one.

Photo credit: iStock/kate_sept2004

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE