Breaking Down The Key Elements of an IPO Through SPAC
By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting
When going public, most companies will choose either IPO or direct listings.
However, lately, fuelled by the high-profile SPAC IPOs (e.g., Nikola and DraftKings), the term has created confusion around the topic of going public.
In this post, we’ll cover why companies go public, what is an IPO and direct listing, and who uses SPAC IPO.
If you follow the financial media, you probably heard the term SPAC lately, alongside direct listing and IPO. But what do they mean, and what is the difference between them?
To explain the different alternatives to go public, we need to go one step back and understand which companies want to go public and why. While there is a certain prestige for being a public company, it adds many additional layers and activities to the business that it hasn’t had before.
What going public means to the company?
Many private companies hire investor relations professionals above a certain number of investors. The IR responsibilities are to mitigate between the company and its investors to ease the pressure for information from the company’s executives and board and to share business decisions in different stages with investors proactively. Another roll of the IR department is to control the financial/legal information that the company shares with investors under the assumption that some of it may leak to the media.
While it is a lot of work for a high-profile private company to keep its information confidential, it is even harder for a public company that needs to share many of its financial, legal, and business intelligence as required by regulation but still keeps the most sensitive information private.
This is only one of the additional activities, a public company has to deal with, but it also has many legal requirements to meet. Executives of public companies have limitations about what they can say publicly about the company, when and to whom. A public company is required to be more transparent than it might want to be; however, legal requirements aimed to protect public market investors need companies to reveal every significant piece of information while in private companies. That’s not always the case.
Transforming from a privately-held company to a publicly-traded company requires a fundamental shift in business and financial approach, as well as a willingness to embrace many changes when not all these changes are comfortable for the company.
Why should a company go public?
To understand companies’ incentives to go public, we need to know how private companies fund their business. There are generally three ways that a business can fund its operations:
Bootstrapping: founders fund all expenses out of their pockets. Founders maintain most of the shares but need to put in the cash from their resources.
Debt: taking bank loans or private loans to finance the business operation. Founders maintain most of the shares but need to meet certain thresholds to repay the loan. Founders bring less money from their pockets than option 1.
Venture capital funds: founders sell shares of the company to external investors who believe that the value of the company’s shares will appreciate over time. Founders bring very little, if any, money from their pockets compared to options 1 & 2.
If the company is bootstrapped, going public can help it raise funds from the capital markets to finance business activities while joining an elite club of publicly-traded companies that could help the business in PR and brand recognition that will assist the company in generating revenue and raising additional funds in the future.
If the company is debt-backed, it might need the money to repay loans or that the loan agreement had a deadline for going public to ensure the company will have enough cash to repay the loan. As mentioned above, other aspects of public companies for bootstrapped business are applicable in this case.
If the company is venture-backed, going public is an opportunity for current investors to liquidate their holdings (exit) and allow the company to restructure its cap table. Other aspects of going public that were mentioned above for bootstrapped and debt-backed businesses are applicable in this case too.
What are the different mechanisms for going public?
The most popular method of going public is an Initial Public Offering (‘IPO’) in which a company sells shares to institutional and retail investors. Examples for going public through IPO include Facebook (FB), Google (GOOG), and Microsoft (MSFT), among many others, as this is the most common method of a public offering. In IPOs, investment banks serve as underwriters in which they provide some insurance for the stock price and guarantee a sale of the quantity of the required shares.
Another popular method, even though less than IPO, is the direct public offering, also known as a direct listing. In a direct listing, the company does not use an investment banker to underwrite the transaction and sell stocks from its pool of shares or its investors’ pool of shares directly to the public. Recent examples of direct listings include Spotify (SPOT) and Slack (WORK) and rumors that Airbnb will use this method when going public.
However, one more method is gaining popularity, although it’s a more sophisticated alternative - the Special Purpose Acquisition Company (SPAC). SPACs have no existing business operations or even stated targets for acquisition and are formed to raise money through an initial public offering to buy another company. SPACs have two years to complete an acquisition, or they must return their funds to investors.
Accuracy is essential, so according to Investopedia: selling to a SPAC can be an attractive option for the owners of a smaller company, which are often private equity funds. First, selling to a SPAC can add up to 20% to the sale price compared to a typical private equity deal. Being acquired by a SPAC can also offer business owners what is essentially a faster IPO process under the guidance of an experienced partner, with less worry about the swings in broader market sentiment.
Recent cases of IPO through SPACs include Virgin Galactic, Nikola, and DraftKings.
Additional Read: SPAC-tacular by MailChimp
In Which Cases, A Company Should Go Public Through SPAC?
SPAC lifetime includes two main phases: the first phase is the SPAC IPO, where the acquisitions company goes public and receives a blank check form investors to look for businesses to acquire or merge into the SPAC. In the second phase, the SPAC management brings different potential deals to stockholders vote. If the SPAC’s stockholders approve a deal, the target company is acquired to merged into the SPAC and become a publicly-traded company.
This process had many different benefits for the company that goes public and for investors. The company benefits from a quick process, few regulatory requirements (since it’s not in an IPO, requirements of IPO do not apply to these companies), and interest from institutional investors. In
John James, CEO of Fusion Acquisitions Corp (FUSE.U), explains that using a SPAC structure to go public is ideal for high-growth mid-market companies with a value between $1B and $5B. In the SPAC process, a company controls its narrative to the market, when it’s able to tell its story to potential investors in a way that traditional IPO does not allow due to SEC regulations. That enables the company to send the right message and investors to accurately assess and evaluate the business. Moreover, it gives fundamental investors an early-access to high-growth companies in the public market.
In the overall universe of businesses that consider going public, some are too small and will not be able to go through a full-blown IPO or afford the changes it requires int the company. Other companies are large companies that can manage an IPO or direct listing process according to their needs. However, the companies in the middle that is not small enough to remain private but not big enough to IPO independently can find the SPAC structure useful. For VC-backed companies, a SPAC deal could be a natural transaction into public markets.
