SPACs: The Downfall of the IPO

What do Lazard, Shaquille O'Neal and Chamath Palihapitiya have in common? Investment banking! Sort of, at least. In a time of grave uncertainty, another phenomenon has been compounding on our markets. Last year, Special Purpose Acquisition Companies (SPACs) had their strongest year to date, hedging the gap between SPACs and rivalling IPOs- the traditional avenue for companies to go public. With ever-increasing returns, stronger leadership, combined with the influx of retail investors and dry powder, SPACs are becoming the more attractive option for companies looking to go public with mitigating barriers in sight. Soon enough, SPACs will become the norm, and reverse the traditional IPO, rendering them obsolete.

SPACs are a method for private companies to go public and raise money, like an IPO. The main difference between a SPAC and an IPO is that a SPAC first raises money with an IPO, then uses the funds it’s raised to merge with a private company. In practice, SPACs can technically be considered a pool or fund of money. For enthusiasts or non-enthusiasts, they are non-operational, publicly listed companies. The purpose of these pools, funds or non-operational, publicly listed companies is to go out and merge with a suitable, private company. When the merger between the SPAC and private company occurs (also known as the de-SPAC), the private company becomes public as a result of the merger; with the SPAC. In the time between the SPAC launching and the de-SPAC occurring, the generally very experienced SPAC management team, also known as sponsors, work on day-to-day operations in pursuit of a merger which like an IPO, provides an exit and entry opportunity for investors and other stakeholders. To summarize an investment in a SPAC, a SPAC through an IPO is the launch of a blank cheque company in which investors can buy shares- then own a piece in the future to be merged with a company that becomes publicly traded, because of the SPAC. Inherently, investors trade and invest in the SPAC sponsor’s ability to find and merge with a suitable target company.

Now if the successful outcome of the SPAC is a merger, why can a SPAC compete against an IPO? At the end of the day, both a SPAC and IPO allow companies to access public markets. A SPAC does it through an IPO, then a merger, whereas an IPO allows private companies to go directly public. Over the past few years, nuances and differences between the SPAC and IPO have highlighted a few key components, which have been magnified as a result of the COVID-19 pandemic. Further accelerating the wider acceptance and takeover of the SPAC as the soon and becoming, the preferred way for companies to go public. The first important component is in regards to timelines. The de-SPAC or merger process, compared to an IPO can be 4x shorter. This is largely as a result of the straightforward process and filing requirements for the merger. Additionally, for the SPAC, as it’s just a blank cheque company with no operational history, there are fewer things to consider which can allow the SPAC process to be both quicker and cheaper. For the private company, this shorter timeline for going public can be much more desirable as it minimizes effects on the day-to-day operations of the business, can be cost-effective and is simply less gruelling. Further, and arguably the most important component of a SPAC is certainty. After a SPAC is launched, the search process is dedicated to seeking a suitable company with which the SPAC can merge with. When an appropriate company is found, the sponsor will enter negotiations to set purchase price, conditions and valuation terms. These terms and negotiations give early investors of these private companies much more certainty in regards to the valuation of their investment, allowing their exit to be steady, certain and green. Compared to an IPO, a SPAC for a founder, or early investor of a company provides a lot more security compared to an IPO, which holds massive appeal. Through negotiations, influence and decision making is also extended to investors who get a vote. While sponsors are responsible for searching and negotiating, shareholders of the SPAC ultimately hold the final say.

Through a vote, SPAC shareholders vote on the merger proposal and are given the chance to redeem their shares if the vote follows through. To close the merger, SPACs must be approved by regulatory bodies, like any other public company going through a merger. When finalized and approved, the acquired company becomes public, trading under the ticker of the SPAC.

The process of a SPAC has showcased major benefits over an IPO due to the merger process and differentiated deal-making phase- which has and continues to provide greater value to stakeholders and owners.

Over the past few years changed regulatory requirements have made SPACs more common and attractive. With recent trends suggesting investors also preferring the SPAC over a traditional IPO. Though the first SPAC launched in 2003, it wasn't until 2008’s regulatory changes, that there was a boom in popularity. Before 2008, the ideas of SPACs seemed odd and eerie, abated with poor returns and frequent ties to fraudulent schemes. In 2008 the New York Stock Exchange made changes. Finally, allowing SPACs to be listed on a major exchange- meeting updated conditions to serve governance and regulatory requirements. Specifically, in May of 2008, the SEC approved proposed rule changes under s. 102.06, of the NYSE Listed Company Manual. Under the new rules, SPACs required an aggregate value of $250m and were able to forgo the requirement of having prior operating histories. In ways, allowing SPACs to appeal to more investors and allowing the investment vehicle to take its shape, more closely resembling what we see today. Other approved rule changes included requirements for proceeds to be held in trust, shareholder approval for acquisitions, and clarity in regards to timelines. These pivotal rule changes brought an increased element of legitimacy and clarity to SPACs, which before were traded loosely on OTC markets. The crucial amendments in rules for SPACs reflected their increasing presence and importance to the SEC, the NYSE and investors alike. Now, over a decade removed from major regulatory amendments, SPACs have become popular and better perceived on markets for the value they can add in the public listing process.

Particularly, SPACs and their outlined process add a few key benefits over an IPO to different stakeholders. The process for companies to go public can be long, strenuous and expensive. SPACs however are significantly quicker than IPOs. The SPAC merger (de spac) can be executed within 3-4 months, whereas preparation for IPOs alone can take upwards of 36 months, often proving to be expensive and exhaustive through the process. With the long timeframe behind IPOs, there is also too much uncertainty and risk for the private company- wanting to go public. In a SPAC, private companies negotiate the terms and underlying value of their business, whereas, for an IPO, a company's purchase price and valuation is outlined or set by bankers which would have a ballpark range- contingent on market sentiment and response on IPO day. This added benefit of certainty, pertaining to valuation is inherently better for employees and shareholders, as well as early investors seeking an exit from their investment in private companies. For stakeholders and owners, having control and influence for valuation terms is an incredible incentive to use a SPAC over an IPO. For stakeholders and owners, the incentives don’t end here. SPACs also have more flexibility in regards to liquidity. Unlike IPOs, SPACs don’t have the same lock-up period. Generally, IPOs follow a 6-month lock-up. For SPACs, who can and can’t sell shares is open to negotiation between the SPAC and respective target. For investors, this flexibility is enormous and hasn’t exactly been replicated or provided by IPOs. Overall numbers and deal values with SPACs can also be more favourable, as SPACs have the potential to provide both faster and greater access to capital via PIPEs (Private Investment in Public Equity). PIPEs are private investments in public entities which SPACs have turned to recently. For companies, or SPACs that want to raise money quickly in a cost-efficient manner, PIPE transactions have been the go to- sometimes helping seal the deal for SPAC mergers. Notability, Venture Capitalist, SPAC sponsor and founder of Social Capital, Chamath Palihapitiya has funded 8 SPAC deals as a member of the PIPE. The PIPE allows funds to be raised but also allows both notable and influential investors such as Chamath, to hop on board. Ultimately, today’s version of a SPAC, which can raise money through multiple means and points, provide liquidity and security for stakeholders and incentivize the deal-making process, opens the possibilities for SPACs going forward.

For the acquisition company, a SPAC can also serve as a next step and opportunity for strategic partnerships to form, which can prove to be valuable over the course of time. Generally, sponsors pursue SPAC investments on the basis of their insight, value, experience and track record in specific sectors as sponsors tend to be successful and accomplished in their professional careers or respective areas of expertise. Understanding what a SPAC investment (pre-merger) really is, it is a bet on the management team of a SPAC moreover, their ability to find a target and close a deal. SPAC investors essentially bet on the relevant industry knowledge, experience and negotiating expertise of SPAC sponsors and management teams to source deals. Steve Fletcher, CEO of Explorer Acquisitions, an advisor and backer of SPACs, states: “With the recent proliferation of SPACs, we believe that investors will increasingly focus on SPACs that have deeply experienced and talented operating executives. These executives can truly help companies after the SPAC business combination.” More recently, sponsors have played a bigger role in their acquisition companies by becoming involved in the day-to-day business of the companies, such as by serving on the BoD. Looking at Chamath Palihapitiya again, he served as the Chairman of Virgin Galactic after taking the company public in 2019 through a SPAC deal, “I remain as dedicated as ever to Virgin Galactic’s team, mission and prospects,”. In 2019 alone, 76% of SPACs were sponsored by industry executives with proven histories, prior M&A experience and exits for public companies. Further, expertise and experience are growing in the SPAC market. As of 2019, 75% of industry exec-sponsored SPACs had a sector focus with the sponsor teams today, being backed by accomplished professionals with track records of successful value creation and proprietary deal sourcing networks.

On the flip side, a SPAC is also beneficial for the sponsor. With private companies seeking optimal partners who fit well, sponsors are also further driven by their own incentives. Sponsors generally receive 20% of founder shares (promote) in addition to warrants, after paying minimal amounts for the said promote. This minimal risk and the high upside for SPACs have lured many banking and industry execs to try their hand at SPAC sponsorship, establishing some as SPAC giants. Prominent SPAC sponsors include former banker Michael Klein, former Facebook exec Chamath Palihapitiya and notable hedge fund manager, Bill Ackman. These SPAC sponsors have developed followings and admiration for and behind their investment strategies, insight and performance. Further leading to greater recognition among retail investors for SPACs as a potential investment.

Recently, public perception of SPACs has been favourable, specifically because of access. Access to information, sponsors and opportunity. Social media, the democratization of investing, and access to markets have allowed retail investors to enter and better understand investment vehicles and opportunities that exist- which they wouldn’t have been able to in the past. Social media has been vital for both SPAC management teams as well as retail investors with platforms such as Twitter and Linkedin being among the most important social media channels for investor relation strategies. One person who’s amassed quite the following and who's SPAC deals have fared fairly well over the past year is Chamath. In less than a year, Chamath’s following on Twitter has increased 4-fold!

Unlike SPACs, with IPOs historically, retail investors watch from the outside and miss out on preferred IPO pricing- for which institutional and accredited investors benefit and capitalize on greatly. Now, SPACs allow anyone to getinvolved, at perhaps more attractive entry points, while also offering additional investment opportunities in late-stage private companies. With added warrants and the opportunities for shares to be purchased at preferred pricing (now accessible to retail investors), the allure to SPACs is substantiated by the generated risk and reward which is fair game for anyone. In addition to the investment access, SPACs and sponsors provide a certain level of transparency and interaction between management teams and investors. Typically, for IPOs, bankers conduct roadshows for institutional investors- something inaccessible to retail investors.

With the rise of social media and access to information, market movers and sponsors, SPACs have gained the support of retail investors- now providing new opportunities for the coming years for both the SPAC and retail investors. Though SPAC returns and investment horizons are not always aligned, the access to knowledge and encouragement to invest in public markets warrants a new era of opportunity. One in which retail investors can invest in and access new opportunities, which wouldn’t have been possible or as seamless a few years ago. With the volume of retail investors putting their trust and funds into SPACs, along with the accessibility, transparency and access to SPACs and information- soon enough, the IPO will no longer be relevant, needed or preferred. The SPAC spectacle on the markets today is the beginning of the downfall of the IPO.