SPAC Explosion In case you haven’t heard, SPACs are all the rage to take a company public (IPO) right now and because we listen to our savvy audience who have asked for more information about this space, we are here to inform and discuss what the recent SPAC explosion is all about. First, let’s discuss the four main ways to IPO a company, then lay out what SPACs are exactly. Four Methods to Take a Company to Public Markets
1. Traditional IPO: 98% companies go public in this manner. It is the full package, company hires bank to put on investor road show to drum up interest and set the price of new shares to be listed on stock exchange. Usually takes 9-12 mos. 2. Direct Listing: Faster option that minimizes investor review and allows shares in a private company begin trading on the stock market. No new shares are offered, and the entire process takes 1-3 months to. Spotify and Slack did this 2019. An important distinction between IPO vs. Direct Listing is that the latter has no underwriting process, so increases liquidity with no share Dilution, no lockout periods, and is less expensive. 3. Acquisition: by an existing company. InstaGram went public when Facebook acquired them in 2012, becoming part of the larger public company. 4. SPAC!!: Special Purpose Acquisition Company. Great idea to first create a cash shell, which is a public vehicle that allows a private company to bypass the risks of going public. It is a fast track IPO.
SPACs Defined
A special purpose acquisition company (SPAC), sometimes also called a blank-check company, is essentially a shell company with no operations that plans to go public with the intention of acquiring or merging with a company with the proceeds of the SPAC's initial public offering (IPO). A SPAC allows a company to go public without going through the traditional cumbersome and often expensive IPO route (which typically involves several investment banks and a comprehensive investor roadshow in order to market itself to a slew of institutional investors to issue NEW shares). A SPAC is also similar to a reverse merger except SPACs come with a clean public shell company and a certainty of financing in place which allows the management team to better search for a target acquisition. This is an important distinction because hedge funds and investment banks prefer SPACs over reverse mergers primarily because of these lower risk factors involved.
There are five key steps in the SPAC process:
1. A money manager sets up a new company.
2. This new company goes public, but with no operations and no actual revenues, this company is essentially a shell company or blank check company.
3. The money manager then raises capital for this company by selling shares to other investors who already trust his/her track record. They are in fact investing in the manager and not the business itself because again, there are no real operations as yet.
4. The money manager then has roughly two years to find a suitable company to acquire. He/she already has raised the necessary funds to do so.
5. Once an acquisition target is identified, the manager brings it to shareholders (i.e. investors) to vote on in order to approve the deal. If it’s approved, the acquisition proceeds. If not approved, investors (some or all) can exercise redemption rights to recoup their initial investment.
SPAC Explosion
Some of the biggest names that have previously successfully IPO’d this way are Draft Kings, Nikola Motors and Virgin Galactic (more on that later). This year, just through July alone, over $12 billion has been raised through SPAC IPOs in close to 40 deals. That compares to the full year of 2019 when only about $13 billion was raised. In the year of a global pandemic, SPAC IPOs are on track to double the amount of money raised from the previous year. So what’s driving this SPAC explosion? Well, capital is cheap. Just look at interest rates. What interest rates you ask? Exactly! Yes, we might be in a recession, but there is still a lot of money out there with limited areas offering true value to invest (stock market, anyone?). Private companies especially prefer liquidity and SPACs are liquidity providers. But as with anything, not all SPACs are created equal. Welcome to the world of investing.
SPACs – Pros and Cons
We’ve already covered that there are certain advantages to SPACs. It is a relatively easier, less expensive and faster way to access the public markets (literally weeks vs. months) and typically managed by a much smaller team (or one individual) who are committed for a longer term (years, not months). From an investor perspective, there is full transparency on the net asset value (NAV) so if you don’t agree with the NAV as an investor, you can exercise your redemption rights and exit with your initial investment intact. That means a much lower risk of your upfront investment.
One of the disadvantages is that there is an opportunity cost to the time value of money given your investment is parked for some time (again, years, not months). But given the amount of uncertainty right now with an upcoming election and global pandemic, this cost might be negligible. Another potential drawback is that because this is a faster way to list publicly without a comprehensive due diligence process required by a more traditional IPO process, there is also, by default, a lack of scrutiny. So for example if WeWork had taken the SPAC route, it could have become publicly traded very quickly and been disastrous for investors given the horrendous financial state it was (and still is) in. But because of all the intense investor scrutiny that is required per traditional IPO discovery and disclosure rules, WeWork’s financial and operational issues were revealed well in advance which is also why the IPO was eventually scrapped, saving investors from huge potential losses.
The most common method to take a company public (98% of all IPOs) is to hire an investment bank, and they handle everything from the marketing to investors to listing on a stock exchange. The hired bank presents the soon to be public company in an Investor Road Show, which helps to drum up interest and set the price of the new shares issued. This entire process takes 9-12 months. The Future of SPACs
No investment is ever a sure bet. The hope is that as SPACs become more popular, there will also be an influx of more experienced sponsors and investors in this space which will (again, hopefully) lead to better publicly listed companies via SPACs at the end of the day….and better investment returns in the long run for all. One of those experienced investors is Chamath Palihapitiya who has been very pro-SPACs and vocal about its growing popularity. Having seen investment interest grow in SPACs as an alternative way to invest in newly public companies as the number of IPOs have declined, Palihapitiya strayed from his VC roots and launched his first SPAC in 2017, Social Capital Hedosophia Holdings which acquired Virgin Galactic in 2019. This success led to two more recently IPO’d SPACs in 2020, Social Capital Hedosophia Holdings II (NYSE:IPOC) and Social Capital Hedosophia Holdings III (NYSE:IPOB) which essentially means he will be targeting a different-sized target for each and has already raised over $700 million for IPOC and $360 million for IPOB. For Palihapitiya, managing a SPAC is much easier because the structure is composed of a more passive group of investors vs. more active (and more short term focused) VC fund investors.
No one can predict how the SPAC space will evolve, but this is surely an interesting time to be on the hunt for SPAC acquisition targets and will certainly be eye-opening (if nothing else) to see how SPACs change the way companies and investors think about what it means to go public.