Why SPACs are (Sometimes) Better than IPOs
February 04, 2021
SPACs offer retail investors the ability to invest early in a company’s life cycle. In the case of Snowflake, a company that went public via a traditional IPO, retail investors did not have this opportunity. By the time Snowflake debuted on the public markets, the share price had soared over 200% from its indicated opening price.
Many pundits and analysts have claimed that the IPO process is broken due to examples like Snowflake and AirBnb. Wall Street institutions and a select group of their top clients can buy shares at discounted prices before they hit the open market.
SPACs allow investors the ability to buy equity in companies going public before the initial price surge. This allows retail investors to participate in some of the same opportunities that have traditionally gone to institutional investors and preferred brokerage clients.
Why would a company want to go public via a SPAC? One of the main reasons is that SPACs provide companies with fast cash and the ability to bypass the regulatory hurdles of a traditional IPO. SPACs allow companies to get to the public markets a lot quicker. Many of the SPACs we are currently seeing are still pre-revenue or have very little revenue and are mostly unprofitable. SPACs are ideal for companies that want to get to the public markets as quickly as possible and not have to deal with a long, drawn-out traditional IPO process.
This also happens to be one of the main risks as these are mostly newer, unprofitable companies with not a lot of revenue. The SPAC method of going public may entice companies in need of fast cash because their financial situation is not fit for a traditional IPO.
SPACs had a bad reputation in the past because the industry was not as regulated and therefore open to more fraud. In the 1990’s, SPACs would take small companies that were destined to fail public for a large fee. The SEC, however, has cracked down on it, and the regulation on SPACs has undoubtedly ramped up. Many more companies are now exploring alternative methods to going public and SPACs have been a key beneficiary.
Source: Bank of America
The SPAC route gained notable popularity among companies in the 2nd half of 2020 and has continued its torrid pace into 2021. We are currently on pace to see over $200B in US SPAC capital raised in 2021, representing well over 100% growth year-over-year.
What are SPACs?
SPACs are special purpose acquisition companies, sometimes called blank check companies, formed to raise capital to acquire an existing company and bring them public. They are traditionally formed by investors with expertise in a certain industry, who are looking to pursue deals in that industry. The SPAC management team can be a value add for the target company over traditional IPOs as they can partner with an experienced leadership team for guidance.
After a SPAC raises money for its potential acquisition, the funds are placed in an interest-bearing trust account. The SPAC company then enters a timeline where they look to make a deal. Once that deal is complete and approved, the SPAC combines with the business they are merging with and starts trading publicly under a new ticker. If the SPAC fails to acquire a business by the closing date, and the shareholders do not grant an extension, the shares are redeemed for a portion of the cash in the trust account and returned to the shareholders.
In the IPO, a SPAC typically offers units to investors for $10.00 per unit. These IPOs usually take place at a net asset value of $10.00, although there are some exceptions.
The bottom line for investors is that SPACs are an increasingly popular method for companies to reach the public markets. SPACs do not come without risks, but they represent an area of the market that growth investors can no longer ignore. In some cases, there are notable opportunities for investors to buy equity in promising young companies.
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