Get the Facts About SPACs
SPACs (Special-Purpose Acquisition Companies) are changing the way companies go public
Of all the financial acronyms spinning around these days, SPACs are getting some of the most buzz. Standing for Special-Purpose Acquisition Company, a SPAC is a vehicle to take a company public.
However, unlike traditional methods where investors deploy capital in a known company, a SPAC first raises cash through an initial public offering (IPO), which is held in a trust, and then looks for a private company to take public with that cash. This is done by selling common stock (shares typically sold at $10 apiece) along with a warrant to give investors the opportunity to buy more stock later at a fixed price.
Oftentimes, SPACs are considered to be more similar to a private sale than a public offering. As a result, there may be more diligence and capital considerations. However, companies considering going public through a SPAC are not required to keep silent; they can drum up excitement through the media and other nontraditional outlets such as touting a celebrity investor.
What happens after the common stock is sold?
SPAC sponsors are under enormous pressure to find a deal after the common stock is sold. If the SPAC doesn’t find a company (usually after a deadline of two years), it expires, de-liquidates, and investors get their money back. This incentive often drives SPAC sponsors to offer high valuations to the acquired entity in order to “get a deal done.”
SPACs typically supplement their commitment with a PIPE (private investment in public equity) or additional capital raised after selecting a company to acquire. If the PIPE investors — who are usually large, sophisticated financial players favor the deal — (even if priced high), the deal will likely be approved by the SPAC investors. PIPEs also provide much of the working capital needed to fund the underlying private company that is being taken public.
Why a SPAC?
SPACs have recently become increasingly popular. In 2020, they drove the majority of IPO growth, with 248 companies going public via SPAC. But SPACs have actually existed since the early 1990s, where they were predominantly used as a way to help small companies go public. Today, SPAC interest continues to break records, with $87.9 billion raised in the first three months of 2021 alone.
Some of the many reasons SPACs entice companies, investors, and sponsors as a desirable exit strategy are as follows:
Private Company Benefits:
- Certainty: Unlike a traditional IPO, companies can negotiate the terms of their public offering, most importantly the valuation upfront, giving employees and shareholders more assurance. Also, many SPACs are well-capitalized via the PIPE, allowing the company to plan and pursue long-term missions.
- Speed: The SPAC merger can take 3-4 months — much shorter than the 6-9 months in a traditional IPO.
- Strategic partnership: Some SPACs are combined with an experienced team and/or board of directors to help guide the company.
- Redemption option: If the SPAC sponsor can’t find a target company in two years, or if investors are unhappy with the chosen acquisition, initial shareholders can redeem their shares and get their money back.
- Warrants: Some SPACs allow their initial investors to vote against a planned merger and redeem shares, but retain their warrants. This optionality has a lot of value should an approved SPAC perform well in the after-market.
- Additional profit opportunities: Institutional investors can purchase additional shares after the acquisition once they invest in the initial SPAC.
- Easy access to capital: The SPAC IPO process is relatively simple, as the shell company faces fewer complications compared to traditional IPOs. Moreover, raising a SPAC is usually much easier than raising a new VC fund.
- Significant upside: Sponsors typically receive 20% of the SPAC shares post-IPO (the “promote”), which can lead to many millions of dollars in gains even if the target company shares drop after the merger.
- Opportunity to invest in late-stage companies: The SPAC merger allows sponsors to invest in later-stage private companies where extraordinary gains have been made over the last years. This is one of the reasons why SPACs have been of such interest to hedge funds that historically have focused on public market investing.
Examples of SPACs
One of the early and successful SPAC IPOs of this modern era was for human spaceflight company Virgin Galactic Holdings. The company went public in 2019 in partnership with Chamath Palihapitiya’s original Social Capital Hedosophia SPAC.
DraftKings has been an enormous success and is a highly popular SPAC due to its widespread consumer usage. The company went public in April 2020 and has consistently traded above $50, which means over a 400% return for its investors.
Other successful SPAC IPOs include:
- Nikola: Electric semi-truck company
- Gemini Therapeutics: Precision medicine company
- AppHarvest: Agricultural Tech Company
Private aviation company Wheels Up, an Alumni Ventures portfolio company, also recently announced a SPAC-based IPO.
Some VC firms are even starting their own SPACs. For example, Thayer Ventures, a travel-focused VC based in the Bay Area, created a subsidiary brand to focus on longer-term investments with disruptive, competitive advantages. This may be a trend on the rise as it can be a cheaper, faster route to raising a venture fund, while still allowing the venture partners to invest in long-term, disruptive moonshots.
While there are many examples of positive SPAC IPOs, not all are successful. For example, in April 2020 — due to market complications from the COVID-19 pandemic — TGI Fridays terminated their SPAC merger with Allegro Merger. In certain circumstances, however, failed traditional IPOs can potentially find success through a SPAC. An example being commercial real estate company WeWork merging with BowX Acquisition after continuously struggling to raise capital due to previous doubts regarding the company’s business model.
Are They Here to Stay?
While SPACs have a slew of benefits and continue to become increasingly popular, are they positioned to overshadow typical IPOs?
The potential for weak returns presents one potential barrier to future SPACs. The long-term operating performance of innovative private tech companies often does not match expectations, leading to downward pressure on the stock price. Moreover, the dilution hole created by the exercise of the warrants can create an artificial ceiling on the price of the stock unless the SPAC is executing its business model well. And sponsors have every incentive to sell their 20% ownership when and how they can, as they have a very low-cost basis. Given that the SPAC structure hasn’t changed despite these “holes,” suggests the poor performance trend could continue, and the bubble might burst.
Finally, because new SPACs continue to be launched by the week with the need to close a transaction or risk expiry, it seems that either the quality of assets could fall or the acquisition prices could continue to rise. Both could potentially result in negative returns of the asset class.
That said, individual SPAC returns can greatly vary. Similar to traditional IPO methods, some companies will prosper, while others will fizzle. Howard Lutnick, Chairman and CEO of Cantor Fitzgerald, believes SPACs will fill a void between private equity and the IPO market. He stipulates that public investors who have largely been shut out of the private markets will give SPACs a competitive funding edge.
Can I Invest in a SPAC?
Unlike a traditional IPO, you do not need to be an accredited investor to invest in a SPAC, as a SPAC IPO costs less. According to Sylvia Jablonski the CIO of Defiance ETFs, “everyday investors are often left out of an IPO since share allocations are generally reserved for high-net-worth and high earning investors.” However, the typical price for a SPAC common stock is only $10 a share.
Through an online brokerage account, you can learn more about current SPAC offerings or invest directly.
Want to learn more?
View all our available funds and secure data rooms, or schedule an intro call.
New to AV?
Sign up and access exclusive venture content.
Contact [email protected] for additional information. To see additional risk factors and investment considerations, visit av-funds.com/disclosures.