The SPAC boom is here to stay
There were 112 SPAC IPOs this year till now, making 2020 the record year for SPACs.
Silicon Valley is just full of unicorns (valuation up north of $1 billion) waiting to go public. These companies have stayed private for far too long than the usual start-ups. Remember, Uber was the most valued private company in the world ($75 billion) before it went public! These companies have raised tons of money (from a few millions to billion dollars) in venture capital.
And in the world of free money, just look at the Fed printing trillions of dollars & pumping record high liquidity in public markets, every investor in Silicon Valley can raise a fund!
The current SPAC boom can be attributed to ace investor Chamath Palihapitiya, “King of SPACs”, who raised $600 million in 2017 through SPAC — Social Capital Hedosophia Holdings and bought 49% stake in British spaceflight company Virgin Galactic by taking it public. He followed it with SPACs which brought companies like Opendoor and Clover Health public and currently in process to raise funds for another three SPACs. Even the former Republican Speaker of House Paul Ryan has a SPAC now and also Billy Beane (remember Brad Pitt’s character in Moneyball)!
If we look at the numbers, investors raised $12.4 bn in 2018 by SPAC IPO, $15.5 bn in 2019, and mind-boggling $25 bn just through August’2020, making it the busiest year for SPACs.
What are SPACs?
SPACs are “Special Purpose Acquisition Company”, also known as Blank-Check Company. So what does it mean? In layman’s terms, SPACs are “Mountain of cash that exists for a merger”. Let's take a person, called a Sponsor who leads the SPAC, raises a pool of money from investors. These investors believe that the Sponsor can find a company worthy of investment and bring that company public through a backdoor. Investors trust the Sponsor to find that one perfect investment opportunity. But how does that work?
Once the Sponsor has raised capital/funds from investors, SPAC is created & IPOed and now it trades as a public company with No Operating History. The Sponsor gets 24 months to find that perfect investment opportunity otherwise at the end of this time period, funds go back to respective investors. If the Sponsor is successful in finding it then the SPAC merges with that private company and now the newly merged entity trades on public markets with a new ticker.
Why not traditional IPO?
Recently, a number of companies who had opted for traditional IPO route to go public found themselves in a bit of trouble due to extensive scrutiny of markets. Remember WeWork IPO fiasco! In case of traditional IPO, investors need to be interested in that company to invest their capital. There is always a level of uncertainty about the valuation till the offering. The private company has to lead negotiations with multiple investors, mostly institutional investors.
And in COVID times, pandemic has increased volatility in markets which again raises uncertainty! Many companies who raised tens of millions to billion dollars through Venture Capital and were waiting to go public found themselves in uncertainties of volatile public markets in COVID times and their IPO plans got derailed or slowed by pandemic. What other way they have to go public! And there comes a SPAC Acquisition IPO route which removes complexities of traditional IPO process, takes private companies public faster, and avoids vagaries of markets.
Traditional IPO vs. SPAC Acquisition
The main reason Wall Street considered SPAC as a shady backwater financing or backdoor way of going public is the stock returns outpace the SPAC returns. If we check the relative performance of stock market with respect to SPAC then S&P500 returns have been 203% to SPAC’s 10%. But then why would a company choose a SPAC acquisition IPO route over a traditional IPO? And why are investors still lining up to form SPACs?
From a company’s perspective — In SPAC acquisition, IPO is already done. The SPAC is trading on public market and now promoters of private company has to engage in negotiations with only one party — SPAC that might acquire that company. The traditional IPOs are affected by the Vagaries of Markets but not SPACs.
From a SPAC sponsor & investors’s perspective — Sponsor does get an unprecedented power in deciding who will be the investors in SPAC. Sponsor can choose investors specific to the sectors who have entrepreneurial experience in sector in which SPAC is looking for acquisition. This makes SPAC appealing to promoters of private company as they not only get capital but also leadership from SPAC investors through merger.
SPACs aren’t without Risks!
The investors who are investing their capital in SPAC, apart from Sponsor, sometimes don’t care about the longetivity of the company in terms of performance, comepetance, etc. What they really want is quick return on investment. So, it becomes crucial for Sponsor to on-board only those investors who are there for a long game and have a considerate risk appetite.
SPAC are also expensive than IPO for a private company going public. Generally, investment banks handling traditional IPO charge 1-7% of total capital raised through IPO as their fees. On the other hand, underwriters of SPAC IPO charge 5.5% of total capital raised through IPO as their fees. But it doesn't just stop there! SPAC takes another 25% of total capital raised and Sponsor gets home with 20% of stock/shares outstanding. Isn’t it a sweet deal for Sponsor!
Let’s consider the Sponsor is unsuccessful in finding that one perfect investment opportunity until last month, knowing the risk of returning capital to respective investors at the end of time period. If that happens, Sponsor will not be able or won’t be trusted to raise capital from investors in the future for another SPAC. So Sponsor can lure investors to take part in SPAC Acquisition IPO with even a mediocre, flawed or financially weak company just to avoid embarrassment of returning capital. This is a huge risk for investors who’re trusting Sponsor with their capital. There is also a less due diligence in SPAC.
Disclaimer: All views expressed here are mine and does not represent that of my employer’s. All views maynot be completely accurate and if found any discrepencies, please feel free to comment.
