WeWork was the most anticipated IPO of 2019 until investors opened the books and tore the company’s numbers to pieces. The cryptocurrency company Ripple had big plans to go public last year until it ran into legal trouble with US regulators.
Then the pandemic locked the world down and the number of IPOs crashed 23% in the first half of 2020. People started thinking there had to be an alternative to the traditional IPO. Turns out there is, and it’s been around for a long time.
In 1992 a lawyer from New York created something called a SPAC, a special purpose acquisition company that provided up-and-coming businesses a shortcut to an IPO in return for a discount on its shares. After a rocky start plagued by accusations of shady behavior, the SPAC faded from the investment scene and spent decades in the wilderness until emerging again recently, because SPACs are back and in a big way, accounting for more than half of all the money raised by IPOs in America last year.
So what is a SPAC?
A couple years ago executives at Virgin Galactic were probably asking the same question. The space flight company had burned through more than $1 billion and needed a lifeline. They got one from the Saudi government but that fell through in the aftermath of Jamal Kashoggi’s murder in the Saudi consulate in Turkey. Virgin Galactic was back to square one until someone mentioned a SPAC.
A SPAC is a listed company with no products but lots of cash that is formed for the sole purpose of acquiring another company. Because it has already done the heavy lifting of arranging the investors and appeasing the regulators, it can offer an unlisted company a fast-track to an IPO without having to face the gauntlet of uncertainty you see in traditional IPOs.
Running short of cash and time, a SPAC was just what Virgin Galactic needed. The company was introduced to the famed venture capitalist Chamath Palihapitiya who had recently raised $600 million for a SPAC that was in the market for a disruptive tech business. The space flight company received their listing and funding, while the investors in the SPAC got a dynamic tech company at a discount.
The Virgin Galactic deal in late 2019 proved to be a tremor that triggered a tsunami. From the 59 SPAC IPOs worth $13.6 billion in that year, the number would explode to 248 valued at $83 billion in 2020.
SPACs are on an even bigger tear this year with 330 SPAC IPOs worth a total of $104.9 billion already completed by the end of May.
We just saw how Virgin Galactic was rescued by a SPAC led by Chamath Palihapitiya. Virgin Galactic received expedited access to funding and a public listing in months instead of the years it takes for a conventional IPO. But nothing in life is free.
Since the SPAC has already done the work of arranging the investors and obtaining a public listing, in return they expect to buy shares at a discount to what the company would get in a regular IPO. The all-important sponsor of a SPAC like Chamath Palihapitiya may also seek a substantial share of the company’s equity, up to 20% in some cases.
And finally there are the warrants, which allow existing investors to buy more stock at a discounted price down the road. The convenience of a SPAC comes at a price, though for an increasing number of companies it’s clearly a price they’re willing to pay.
A SPAC provides investors with a discounted price on promising companies, and unlike some SPACs from the 1990s their money is held safely in escrow during the 18 to 24-month window that a SPAC is assigned to find an acquisition. If there’s no acquisition, the money is returned.
But there are risks. When Glenn Kelman suffered through the IPO roadshow for Redfin, it was because investors were taking their time to conduct rigorous due diligence. The expedited time frame of SPAC IPOs increases the risk that investors don’t uncover errors and omissions in the target’s books.
SPACs are also designed to find younger companies that may not be fully ready for an IPO, which means investors could be dealing with inexperienced management. However, a recent story in the Wall St. Journal suggests the targets of SPACs are beginning to address this concern by hiring CFOs a lot sooner than they normally would. The hiring of CFOs at early- and mid-stage startups jumped 95% in the last year.
Pivot to Asia?
While the US remains a frenzy of activity for SPACs there are signs that the dust is starting to settle. With over 300 SPACs hunting for a limited number of acquisitions, some investors are now looking to Asia.
Only four companies in Asia were successfully acquired by SPACs last year but interest is rising as the region’s flourishing tech scene produces a growing number of unicorns. India alone has seen a dozen startups reach a $1 billion valuation so far this year, exceeding the total for all of 2020.
Regulators are noticing too. Japan recently joined Singapore and Hong Kong in exploring the listing of SPACs on their exchanges.