What is a SPAC IPO? Here's Everything You Need to Know.
By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting
If you follow the financial media, you probably heard the term SPAC lately.
Probably in the context of Chamath Palihapitiya's Social Capital Hedosophia Holdings or the electric vehicle company Nikola.
But what is SPAC? What is the difference between SPAC and traditional methods to go public, like IPO or direct listing?
In this post, we'll see why companies go public in the first place.
When companies go public, why should they choose a traditional IPO over a direct listing?
Why should they use SPAC? Who should use it?
What going public means to the company?
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 complexities to the company's business.
Many private companies hire investor relations ('IR') professionals above a certain number of investors.
The IR responsibilities are to bridge between the company and its investors.
Naturally, investors pressure the management team for information about business decisions and progress on different fronts.
The IR department balances between investors' information requests to the amount and type of information the company is willing to share.
Usually, the IR professionals share financial and legal information proactively with investors to keep them informed of the business progress. Good IR professionals share certain information with investors under the assumption that some may leak to the media.
While it is much work for a high-profile private company to keep its information confidential, it is even harder for a public company.
On the one hand, a public company regularly needs to share its financial, legal, and business information required by regulation. However, on the other hand, it still needs to keep the most sensitive information private.
Besides the IR activity, a public company has to deal with many legal requirements and regulations from the Securities and Exchange Commission ('SEC), the stock exchange, and other United States regulators like the FTC.
Also, there are limitations of what public company executives or board members 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.
It also requires to embrace many changes when not all these changes are comfortable for the company.
Why should a company go public?
If going public adds so much complexity to the business, 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: startup founders sell shares of the company to external investors who believe its valuation and share price will appreciate over time. Founders bring very little, if any, money from their pockets compared to options 1 & 2.
Once traded in Wall Street, the company joins an elite club of public companies.
A public company status helps with PR and brand recognition. It enables the company to boosts sales and raises additional funds in the future.
If the company bootstrapped, it could use the IPO to raise money from selling its common shares on the public market to fund the operations and pay back the founders' investments.
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 mentioned above for bootstrapped and debt-backed businesses are applicable in this case.
What are the different mechanisms for going public?
1 - IPO
The most popular method of going public is an Initial Public Offering ('IPO'), in which a company sells shares to institutional and retail investors.
When going public through a traditional IPO, the company hires investment banks to lead the process.
Then it files an S-1 with the SEC and goes on a roadshow with potential investors where they can ask questions about the prospectus.
The goal of the roadshow is to drive demand for the company's shares when it goes public.
There are many examples for companies that went public through traditional IPOs such as Facebook (FB), Google (GOOG), and Microsoft (MSFT), among many others, as this is the most common method of a public offering.
In the IPO process, 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.
2 - Direct Listing
While it's lagging behind IPO in popularity, Direct Listing became a valid alternative lately as Spotify (SPOT) and Slack (WORK) chose that way for the public market debut.
Unlike in an IPO, 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.
3 - SPAC
Although it's a more complex alternative, going public through a Special Purpose Acquisition Company (SPAC) is becoming increasingly popular.
SPACs are shell companies with no existing business operations.
In the past, they were called 'blank check companies' since their owners receive a blank check from shareholders to acquire a business.
The SPAC sponsor who initiated the SPAC takes it public in a traditional IPO, where it raises money that will be used later on to acquire a business and merge it into the SPAC. If needed, the trading liquidity in the public markets provides an easy exit scenario for investors.
If the SPAC sponsor closes the deal, the SPAC will cease to exist, and the new business will be traded as a standalone company under its ticker.
SPAC sponsors have a two-year time frame to locate an acquisition target, convince the SPAC shareholders to support the acquisition, and complete the business combination.
If sponsors fail to meet the time frame, they must return their funds to investors.
Since SPAC sponsors have limited time to find the right target and close the deal, they are usually experienced, investors. Either hedge fund managers, private equity managers, or ex-silicon valley VCs.
The time frame also drive sponsors to look for quality businesses that will be easier to sell to the shareholders to approve the deal.
Since SPACs are already traded, they cover all the regulatory burden, which frees the potential acquisition target and saves them from unnecessary noise.
For business owners, to be 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 (NYSE: SPCE), Nikola (Nasdaq: NKLA), and DraftKings (Nasdaq: DKNG).
Additional Read: Above the Crowd: Going Public Circa 2020; Door #3: The SPAC
More Additional Read: Harvard Law School: Special Purpose Acquisition Companies: An Introduction
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 from 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 the 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, provisions of IPO do not apply to these companies), and institutional investors' interest.
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 assess and evaluate the business accurately. 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 go through a full-blown IPO or afford the changes it requires in 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 are 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.
