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“When you compare it to an IPO, the pitch is actually very simple. It is a better way to go public.” — Chinh Chu, Blackstone Group
Is there anything Softbank, Shaquille O’Neal, Bill Ackman and Paul Ryan have in common? Nothing at all one would assume, aside of this one thing: All of them have a SPAC in place. ‘Special Purpose Acquisition Companies’ have been the hottest trend of 2020 — which is fairly strange, as SPACs have been around for decades.
In the 1990s ‘blank check corporations’ had a shady bad boy reputation, as they were famous for scamming investors. That is why a federal law was passed to take them down. Even though, the blank-check model was reinvented in 2003 with crucial safeguards for investors, SPACs still remained unpopular — until now.
According to SPAC Insider, 2020 has seen 4.2x more SPACs (248 in total) with 6.1x higher total gross proceeds (USD 83bn) and a 1.5x larger average IPO size (USD 335m), compared to 2019. For the first time ever, 2020 has seen more SPACs in terms of total gross proceeds than traditional IPOs — as investing in SPACs is probably the closest risk-free opportunity imaginable for investors.
As if this would not be impressive enough, the first two weeks of 2021 have already been bigger than all of 2019, in terms of total SPAC IPOs and gross proceeds. Furthermore, SPACs which announced an acquisition target company in 2019 / 2020 have a current median ROI of 65.8% and a median ARR (Annualized Rate of Return) of 54.7% — which is out of this world, compared to the private market equivalent.
So what exactly is a SPAC and what are PIPEs for?
“SPACs are another way for companies to get late-stage growth capital.” — David Erickson, former co-head of global equity capital markets at Barclays
A SPAC is a ‘blank check shell corporation’ designed to take companies public, without going through the traditional IPO process — which is somehow outdated, I guess. In other words, with a SPAC the IPO is already done.
Usually, a SPAC is formed by an experienced sponsor or management team with round about 20% nominal invested capital. The residual interest is held by public shareholders through so called ‘units’, offered in an IPO of the SPAC’s shares. These units are splitted into common stocks and warrants (the possibility of buying more at a particular price, once they are exercisable).
SPACs do have an investment thesis, which usually focuses on an industry, geography or the experience of the management team. After the IPO, the proceeds are placed into a trust account, from that point on a SPAC typically has 18 to 24 month to identify and complete a merger with a target company (as well called de-SPACing). In case a merger can not be executed in time, the SPAC liquidates and all IPO proceeds are returned to the investors.
The magic happens, once a target company is identified and the SPAC shareholders approve the merger. Usually a SPAC requires additional funding (prior to the merger), which can be done through either debt, or a so called PIPE (Private Investment in Public Equity), a very useful and important tool. A PIPE is a lot like raising a VC funding round, it validates the valuation of the target company.
“There are people in Silicon Valley who do not understand SPACs and think that they should not do a PIPE. That is insane, frankly.” — George Arison, Shift CEO
The PIPE process takes place after a LOI is signed, but before the merger is publicly announced (a PIPE deal is more efficient than secondary offerings, due to fewer regulatory issues with the SEC). In a perfect world a PIPE should be highly oversubscribed, as it is helpful for the de-SPACing process. Most SPAC investors aim to sell their shares after the merger, as they only look for a short-term arbitrage opportunity.
SPAC or IPO, what is the better deal?
“SPAC fees are about a quarter of the money raised, three or four times as much as you’d pay in an IPO.” — Matt Levine, Columnist at Bloomberg
I will compare the most relevant aspects, in order to get to an answer, or at least an opinion.
As already mentioned, SPACs will have 18 to 24 month to find a target company and execute the merger, otherwise the SPAC investors can redeem their investment. IPOs are rather driven by market circumstances and organizational readiness. The process can last from a month to a year, or even longer.
SPAC roadshows are not existent, the target company is found and the SPAC shareholders’ vote demonstrates the marketability of the merger. On the other hand IPO roadshow underwriters market the share, they test the waters in pre-trading roadshows to generate interest from investors.
SPAC have more legal reporting obligations, but fewer financial obligations within the registration process. IPO legal obligations seem easier, though financial reporting obligations can be overwhelming.
There are no heavy underwriting or roadshow cost to market a listed SPAC, though there are high expenses for the target company (20% nominal buy-in by the sponsor). IPO underwriting and roadshow fees are more of a burden, though they are absorbed by offering proceeds.
SPAC valuation is determined by the SPAC sponsor and the target company, it can as well be backed by a PIPE deal. An IPO valuation highly depends on roadshow success, market demand and of course good timing.
So what is better after all?
Well, it depends. There are plenty of pros and cons for a SPAC and for a traditional IPO. In my opinion, SPACs are a fast, but expensive way to go public (aside of the fact that the SPAC has to find the target company and not the other way around, as there are more SPACs than attractive targets). SPACs are particularly attractive for less mature tech unicorns — so in conclusion, I think SPACs are simply a new item on the menu, next to traditional IPOs and direct listings, still they have to prove that there is a market need for them.
IPOs have been and will always be around, even if they take longer and seem more complex in multiple ways. The whole SPAC boom could end from one day to another, due to investors getting cold feet in a bear market, due to poor performance, or because the market is flooded with too many SPACs and not enough attractive targets. Regulatory action and challenges for the SEC might as well play a relevant role in the future of SPACs, as well as their expensive structures.
Either way 2021 will be an exciting year for Wall Street IPOs, SPACs and some target companies.
Any thoughts or questions? Reach out! Want read more?
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KPI <kē pərˈfôrməns ˈindiˌkātər> Hunter
I am a passionate and hands-on venture capitalist (+8y), serial entrepreneur (+7y), mentor and active angel investor. After 8years of flying over 1.000.000 miles, spending 1.200 hours on airplanes, looking at +1.000 start-up pitches on all continents, I decided to gather some of my thoughts based on this extremely rewarding professional journey. Reach out and get connected!