Selling to a SPAC. A primer for CFOs.
Guest Contributor, Matt Kemp
Prior to 2020, the term SPAC was a seldom-used, rarely mentioned financial instrument that even the most seasoned professional investors had never run into. However, last year this unique financing vehicle exploded onto the scene and has become a mainstay of CNBC daytime debriefs and Nasdaq social media announcements. Let’s explore the SPAC and learn why a CFO of a privately-held company should understand its purpose.
What is a SPAC?
A special purpose acquisition company (SPAC) is a “blank check” company formed for the purpose of effecting a merger, share exchange, asset acquisition, or other business combination transaction with an unidentified target. The financing vehicle is initiated and operated by a sponsor team, which assembles an investment bank, attorneys, and a Board of Directors to raise capital in the public markets by pitching institutional investors.
2020 was the “Year of the SPAC”
It was a record year for SPACs, according to SPAC Insider, with 248 transactions that went public totaling over $83 billion in SPAC gross proceeds. That is over 6x higher than the $13.6 billion in gross proceeds raised in 2019 according to SPACInsider1. In 2020, SPAC IPOs in the United States raised almost twice as much as they raised in the previous 10 years combined.
Who are the people creating SPAC’s and why would I invest in one?
Typically, SPAC’s are formed by sponsors whose experience and reputation will contribute to a successful business combination. These sponsors have disproportionately been seasoned entrepreneurs with one or more exits in the public markets, but they can also include a “celebrity” sponsor2 whose name attracts attention and will ensure the sponsor can achieve the capital target it files to raise with the SEC. SPAC’s are often sponsored by a leader in a particular field, such as healthcare, gaming, or space technology, with the sole purpose of completing a merger transaction in that pre-defined industry. While not every SPAC specializes in an industry, the majority announce a focus area, and the premise of targeting a distinct category is that the owners of the private company will be more attracted to a buy-out by a leadership team that can add value to them during and after the business combination. The make-up of SPAC sponsor teams and Boards are usually peppered with extremely well-known experts, advisors3, and moguls of the announced industry.
The Race to De-SPAC
The most peculiar part of a SPAC is the time limitation on the capital deployment. A SPAC has at most 24 months to complete a business combination, and occasionally this term is negotiated to be shorter. The funds raised by a SPAC are held in a trust account and returned to the investors if they do not complete a transaction, and with IPO sizes averaging over $300 million in 2020, the opportunity cost of failure to the sponsors in time and money is substantial. The risk to investors pre-transaction is very low, which makes this investment vehicle a favorite for hedge funds. If the money is not used to complete a business combination it is returned to investors at money market rates of return. However, if an acquisition is made, which is colloquially knows as a “de-SPAC” then the institutional money now owns both stock and warrants in the target. Of course, once the newly public company is trading, there is traditional market and fundamental risk to the investors.
Benefits of SPAC’s for an employee owned or private equity backed company
When a SPAC completes a purchase of a private company, that target immediately becomes publicly traded with its own ticker symbol. This process is nicknamed a “de-SPAC” and it gets the same fanfare of a traditional IPO. The founders can ring the bell on Wall Street, get interviewed by CNBC, and send swag to all their employees.
There are significant benefits for founders and PE firms to sell their shares to a SPAC to go public versus taking the traditional route.
1) Time and Effort
The process to IPO can take years. The SEC oversees and regulates the equity markets, and the company must open up its operations and finances to the general public for the first time. Founders are subjected to a level of scrutiny that is very unfamiliar to them. There are weeks or months of meetings with potential investors via road shows and “testing the waters” presentations to gauge the level of interest. Once committed, the company may end up divulging information that has long been kept from view, without a guarantee of actually monetizing that effort.
By agreeing to a merger with a SPAC, the private company avoids this work. The SPAC team has done most of the heavy lifting already. They have hired the investment bank, flown around the country to pitch investors, created 100’s of pages of documents, paid for attorneys, purchased insurance, presented their S-1 to the SEC and received approval by the government and investment community. The sponsor team completes all of this effort without cash payment. They receive founder’s shares in the SPAC, and that risk only pays off for the team if they complete a purchase and their new partner company continues its success. The incentives between sponsors and founders are completely aligned.
2) Higher Returns
For entrepreneurs and private equity firms alike, the SPAC offers a higher guaranteed return than the traditional IPO process. Take the most recent glamor IPO as an example, AirBnB. The company went public on December 10, 2020 at a price of $68 per share4. However, the initial trade on the Nasdaq was at $146 per share. Did the employees who sold at the IPO benefit from this upside? They did not. The founders sold their shares for $68, valuing their company at approximately $40 Billion. Yet, after the first day of trading, the market capitalization was over $86 Billion. This additional $45+ Billion of value was not captured by the owners of AirBnB, it was delivered to the institutional investors who bought the shares at $68 and flipped the stock on the first day for a 112% return in 24 hours. When choosing to IPO with a SPAC, the founders and their investors capture the full enterprise value for themselves. The valuation of the company is agreed to between the owners and the sponsor team, and the entire proceeds of the SPAC vehicle are passed over. Additional capital in the form of a Private Investment in Public Equity (PIPE) is commonly raised by the SPAC team at the time of the de-SPAC to complete the purchase, which further benefits the sellers.
3) Protection from Macroeconomic Factors
The timing of an exit for an entrepreneur or PE firm can be tricky. Obviously in the last decade, this issue has been moot, as we have been enjoying the greatest bull market in history. However, for those of us old enough to remember a time prior to 2010, there were major bear markets in the early part of this century, with the 2001 bust of the Internet boom, and the period from 2007-2010 during the “Great Recession.” It was difficult, if not impossible, to raise money in the public markets for most companies in these downturns, regardless of the fundamentals of their business operations. With a SPAC IPO, the companies are protected from macroeconomic forces. If and when the stock market finally comes down to earth, there will still be billions of dollars of SPAC funds sitting in cash needing to be deployed. This protection from external factors should provide a unique safety net, which alleviates concerns about “election uncertainty” or black swans.
In the near term, there will be never before seen competition to purchase private companies who have completed Series C and Series D financings. Venture capital start-ups who have graduated to these milestones will be looking to exit their investments. With a shot clock ticking down, SPAC sponsors must put their capital to work. Founders and managing directors will be courted by these SPAC’s and the leverage will be heavily on the side of the sellers. If your company has ever considered a public market sale, the next 18 months may be the best time in history to cash in. If your company has taken equity investment already, speak to your existing venture capital or private equity firm about the SPAC opportunity. Historically, these investor groups have shied away from SPAC’s, but this attitude is changing as SPAC’s become more mainstream. If you have bootstrapped your company and don’t have professional investors, contact an investment bank. As with a traditional IPO, the investment bankers earn fees on closed transactions, and engaging one for advice on a potential de-SPAC to go public and monetize your equity can be done without incurring a lot of upfront costs. For more information on SPAC’s that have been announced or successfully launched in your industry, we recommend SPACinsider.com and SPACresearch.com as additional sources of information. Both are behind a paywall, but the cost is nominal if you are serious about considering an exit via a SPAC for your company.