Did you know that market analysts have already declared that 2021 is the year of SPACs? Today, many private companies are bypassing the traditional IPO and going public through SPAC. Recently, the flexible workspace provider, WeWork, has announced to go public via a merger with SPAC called BowX Acquisition. The company took this decision after a failed attempt at IPO in 2019. Since then, the company’s valuation has plunged from $47 billion to $9 billion! And why did this happen? Why are companies choosing SPAC over IPO?
Let’s dive in further and answer all your doubts regarding Wall Street’s latest trend.
What is a SPAC?
Investors set up a shell corporation, popularly known as a SPAC or special-purpose acquisition company, with the sole purpose to raise capital through an IPO, and acquire one or more companies and operating businesses. SPACs are often referred to as “blank-check companies”, shifting fortunes on Wall Street. In simple words, a SPAC doesn’t have any commercial operations as it neither makes a product nor sells one. They don’t even have stated targets for acquisition. The Security and Exchange Commission (SEC) states that SPACs do not have any assets other than cash and limited investments, including the proceedings from IPO. The investors in the field typically include the likes of private equity funds to the general public.
Conventionally, SPACs have two years to complete the acquisition or they have to return the funds to the investors. Did you know that in the year 2020, SPAC IPOs in the United States raised almost twice as much as they raised in the previous 10 years combined and had already surpassed 2019 levels by March 2021?
How Does a Typical SPAC Timeline Look Like?
SPAC Formation and Funding
Generally, a SPAC is formed by a group of sponsors, investors, private equity firms, or venture capitalists with nominal capital – typically translating into approximately 20% in the SPAC. These are also known as ‘founder shares’. The remaining 80% is held by public shareholders via ‘units’ offered in an IPO.
While going through the traditional IPO process, investors don’t publicly identify the companies they are looking for an acquisition to avoid the perplexing process with the SEC. The investment of this IPO is typically based on the sector, geography, technology, and even the sponsor’s background and experience.
Acquisition Search and Finalization
Usually, SPACs have a period of two years to search for a private company to merge with or acquire. Later, the merger should be able to make the company public as in the process, the company will become a part of the publicly traded SPAC. Once the company has been identified for acquisition, the investors announce it and the shareholders should approve the deal. However, in some cases, the SPAC has to raise additional money for the complete acquisition of the company.
KiwiTech recently hosted a curated panel focused on SPACs as an exit strategy for tech companies. During the panel discussion, Christine Y. Zhao, CFO, Edoc Acquisition Corp, added the delusion impact to a typical deal structure relating to, “Whether the target company chose the right SPAC to merge with, there’s synergy between the SPAC’s management team’s expertise and network area vs the target company’s operating sectors, as well as a pragmatic perspective on the sizes of them both.”
The SPAC merger closes and the company becomes public only when the shareholders approve of the merger and all the regulatory matters have been cleared. And if the SPAC merger isn’t completed in the given time of 2 years, the SPAC liquidates and the IPO proceeds are returned to the public shareholders.
How do SPACs Work?
Generally, SPACs raise money to acquire the company through an IPO. The fun fact? The IPO investors usually don’t have any idea about the company they will be investing in. The IPO price for a SPAC stock is mostly $10 per share. The capital raised in an IPO is then placed in an interest-bearing trust account. The interest earned from this account can be later used as working capital for SPACs. The SPACs have two years to complete a deal or face liquidation if not completed in the given time frame.
Why are SPACs Suddenly Sprouting Up in the Market?
SPACs have been around for decades, but have recently become popular and attracting the big names of investors and businesses. Talking about the growth of SPACs in recent years, Anita Gupta, Co-founder of KiwiTech, asserted, “2020 has been an important year for SPACs with over $80 billion raised from around 240 deals, outperforming traditional IPOs that raised about $70 billion.”
SPACs were often considered as the last hope for small companies that often face troubles in raising money from the open market. But the complex market volatility in the unprecedented pandemic times made many companies postpone their initial public offering, fearing it could negatively affect their stock’s debut. And that is why many companies choose SPAC over traditional IPOs as it allows them to go public with fewer hassles and generate capital from the open market. In fact, the average SPAC IPO was $336 million in the year 2020, as compared to $230 million in 2019.
What are the Advantages of a SPAC?
Apart from being a viable alternative to traditional IPOs, SPACs do bring in various benefits for the investment community:
Hassle-Free Public Listing
SPACs offer a much better approach for companies to go public over traditional IPOs that encounter some market and pricing risks.
Good Source of Capital
Through the open market, SPACs provide equity capital for the growth of the company and interests that can be utilized as working capital. With permanent capital, they allow the management to focus more on long-term value creation as well.
Uncomplicated Time Frames
Through SPACs, it’s possible to mitigate the procedures involved in traditional IPOs as a private company can easily merge into a shell company, i.e. already a publicly traded company. Even the registration and paperwork required for SPAC IPO can be completed in a matter of a few weeks.
Poor SPAC Performance
Despite the rise during the global pandemic in 2020, SPACs have been seeing the earth in recent months. Here’s a record of their performance through April 1.
- For a typical mid-size SPAC of around $300 million, the percentage fee and flat fee costs around 3%-5%, which is very high considering the overall investment.
- In recent weeks, 14 out of 15 SPACs traded below the $10 IPO price.
- According to a Goldman Sachs Report, SPACs post-merger underperform the broader market by 24%.
- SPACs have filed plans to raise $8.4 billion through US IPOs, with a major decline of 36% from the last few weeks and this is their lowest tally since January.
SPACs are taking the town by storm and the future is full of anticipations around their existence. While these public shells seem to be recreating the rising sun on the horizon of the stock market, there are risks and challenges associated with them as well. If you would like your business to take the traditional route of finding investment, making a pitch at a Demo Day can be fruitful.
As more and more renowned investors and hedge fund managers continue to invade the SPAC space, do you think this new vogue is here to stay? Or, is it just a bubble that is about to burst? Let us know in the comments section.
KiwiTech has helped hundreds of entrepreneurs connect with investors through its various events involving SPACs, VCs, and family offices. If you are actively raising capital, click here to check out all our upcoming events!