Meet SPAC, IPO’s little sibling…

​Everyone knows the story of the two siblings, where one is the perfect example of success, the “try hard” varsity athlete, straight A’s, Harvard bound, the “talk” of the town.

While the other goes about their business where success is in essence behind the scenes, success is understated but appreciable.

This is what I think of when asked about the difference between an IPO and a SPAC.

But let’s not get ahead for ourselves. IPOs or Initial Public Offerings have traditionally been the moment when private companies get entrance into the grand dance called Wall Street. It allows companies to access capital through share ownership rather than debt.

More than that, it’s been that moment when a private company has “made it” and by making it they have run the gauntlet of hurdles both financial and operational. More than a host of people must accept their “application” to go public, which culminates in an investment bank, think Morgan Stanley or Goldman Sachs, that underwrites and raises the capital for the company and brings it public.

Going public through a SPAC or special purpose acquisition company is quite different. Similar in intent, to raise capital for a private company but very different in approach and not so entirely “public”. In fact the capital raised tends to be from hedge funds, private equity funds plus the public investors.

Without yet getting into all the nuances, the best description I have heard of the difference between an IPO and a SPAC was by Don Butler of Thomvest Ventures stating “an IPO is basically a company looking for money, while a SPAC is money looking for a company” thus my earlier sibling analogy.

In fact, the SPAC is a shell company sponsored by an expert management team whose initial purpose is to raise capital into the shell company and identify, target and acquire an existing private company.

Most describe a SPAC as a blank check company. Better yet these sponsors put up $10 million to fund this acquisition process along with their expertise, strategic relationships, and money raising ability.

This blank check company goes public after working with the SEC. Common shares and warrants are issued and traded, typically at $10 as shareholders “stake” the management team. The team has a two year deadline to get a merger done. Interestingly, if the SPAC is unsuccessful the shareholders get their money back plus interest while the $10 million is lost. On the other side, if successful the sponsors get 20% of the company as a success fee or “promote”.

Candidly, at first, this seems similar to the reverse mergers of years gone by, but much like Uber is not anything like the taxi service of old. SPACs are an innovation that allow for a potentially better way to access capital than a traditional IPO. In fact, the SPAC process is cheaper, quicker and easier for the target company to access capital.

I recently talked to a CEO of a SPAC target and he admitted that working with industry experts made it easier to negotiate the terms of the merger and most importantly, his company was profitable and had no pressure to take a deal that wasn’t to their liking. Money looking for a company!

The final steps involve agreeing to an IBC or initial business combination and then the investors vote to approve the transaction. Post-merger or de-SPAC is where the company finally becomes a regular publicly traded company. The option to not approve the transaction or redeem shares on disapproval is a key part of the process which hopefully ensures an alignment between management team and investors and avoids what we call “misaligned incentives”. You can see this with the 20% promote which can incentivize the sponsors to do “any” deal rather than a “good” deal.

Other positive attributes around the SPAC process is that future forecasts and forward looking projections are utilized and presented, not so in the IPO process and given the merger’s fixed valuation there is a limit to price volatility that we don’t see in the IPO and post IPO trading.

This doesn’t mean that these SPAC investments will perform any better than any other publicly traded, though the evidence shows a growth and demand for this type of capital raise and will undoubtedly compete with traditional IPOs, DraftKings, Nikola and WeWorks to name a few.

Or it might be just another fad caused by the immense amount of liquidity sloshing around in the post pandemic system, think FED!.

But at least we get a chance to invest in the little sibling from time to time.