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The PE Industry: SPACS Review

2020 has been a record year for Special Purpose Acquisition Companies (SPAC). What started as a niche strategy for small investment firms is now an atypical pathway to public markets. Despite the uncertainties posed by the COVID-19 pandemic, certain high-profile SPACs have shown companies and investors that a traditional IPO is not the only way to go public; there are other simpler ways, too.

After a staggering increase in the volume of these blank-check vehicles and as the reputation of the concerned investment professionals promoted the space, the SPAC strategy has become 2020’s hottest financial topic.

This SPACs review provides an overview of the surge in IPO activity from SPACs. It will provide some exciting insights into those who might be considering SPACs as a means to transform the mechanism of going public. But before that, let’s take a look into what SPAC is.

What is SPAC?

Simply put, SPACs are blank-check companies, the founders of which seek to raise a few hundred million dollars via an IPO. With the raised funds, they aim to acquire another. According to Benjamin Kwasnick, the founder of SPAC Research, going public through a SPAC helps private companies realize a few advantages as opposed to using a traditional IPO. Not only is there more certainty around the equity capital raised and the company’s valuation, but private companies can also go public on a faster timeline. Among the most popular examples of companies that went public via SPAC include Nikola Motor Co., Virgin Galactic, and DraftKings. As improved governance practices made SPACs more shareholder-friendly, their reputation has improved over the past decades. A simple example is the fact that shareholders can now vote in favor or against a deal and yet request cashback.

What Caused SPACs to Take over the PE Industry?

When VCs were evaluating possible public market exits for their portfolio companies this time last year, the latest and most desirable choice for them was direct listings. Then suddenly, the COVID-19 pandemic came from nowhere, paralyzing the markets with severe uncertainty. At the beginning of 2020, sharp price declines and high volatility made direct listings and IPOs unviable for most private companies. The resultant gap provided a tremendous opportunity to SPAC.

The traditional IPO process is quite risky, which is why the venture community has been dissatisfied with the process. They have experienced immense scrutiny primarily because of the way they're priced. Plus, the process is both extensive and expensive. With direct listings, private companies don’t have the option to raise new capital while going public. Given the economic ambiguities presented by the pandemic, this turned out to be a problem for most startups. In addition, shares in IPOs and direct listings are sold through auctions, which might prove chaotic in a highly volatile market like this.

SPAC, on the other hand, is nothing more than a large box of money. Unlike a comparable IPO of an operating organization, SPAC requires a considerably lower degree of diligence since there aren't any financial statements to assess. From a sponsor's perspective, raising a SPAC is similar to raising a closedend fund, in which the timeline through the fundraising process can be shorter and more accommodating. Because SPACs typically trade close to the NAV, the easy process of raising a SPAC IPO has allowed listings to proceed. Plus, when a fresh operating company goes public and investors engage in evaluation and share trading, the reverse merger represents a true test for SPACs.

For the creators of the SPAC, that is, the sponsors, incentives are often clear. They acquire a special class of shares that are equivalent to 20% of the shares in the SPAC for ‘promote’, which is a nominal cash consideration. They also enjoy other benefits of leading the SPAC, including the chance to have a say in the acquired business’ strategy by securing a position on the board and the choice to set a PIPE deal simultaneously with the acquisition. It’s this decision-making potential that motivates former executives and operators to dominate SPACs and use their capabilities to find attractive targets and lead them to success. For identifying the deal, sponsors do get considerable economic interest in the business. Yet, there are certain indications of a SPAC structure becoming more of a company-friendly vehicle with value-creation potential than a fee grab on subpar deals. The future of SPACs has further been legitimized by a shift in the makeup of SPAC sponsors toward reputable and institutional market participants.

Besides, a simple explanation of the dramatic surge in demand for SPACs in 2020 is the rarity of traditional IPOs. In the hopes of backing the next popular growth story, IPO investors hurriedly participated in these deferred listings. With high demand, many SPACs are able to upsize the funds raised in their IPOs. It presented a massive opportunity for both new SPAC entrants and serial SPAC sponsors to raise capital while strategy stays in good favor. Hence, from a sponsor's perspective, raising a SPAC is just another way to raise funds with a different LP base.

Sponsors have now assumed that the pandemic-driven market dynamics will set up new sets of targets at attractive valuations. This could mean that the SPAC explosion may not have stemmed from an indepth analysis of investment theses but simply from opportunism. As competition increases, this agitation in new SPAC adversely impacts the performance of these vehicles, causing some valuations to inflate. Now that the iron is hot, it seems feasible to accumulate assets, but only time will tell whether or not it's a genuinely rational strategy. Things should be clearer in a couple of years or so.

Final Word

This is what the Special Purpose Acquisition Companies (SPACs) situation was all about in 2020. We hope you found our SPACs review insightful. If you’re an investor weighing the SPAC opportunity to go public, this guide can help you make an informed decision.

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