Thought Leadership  •  September 29, 2020

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SPAC vs. IPO: Market Update

SPAC Transactions

The numbers alone speak volumes. As of mid-September 2020, 95 SPACs (special purpose acquisition companies) with a valuation of approximately $35 billion had priced year to date, shattering “all previous records,” said Craig Clay, President of Global Capital Markets for Donnelley Financial Solutions. In contrast, he said, for the full year of 2019, 59 SPACs had priced, and even this represented a sizeable increase over 46 in 2018 and 34 in 2017.

Clay joined J. P. Morgan’s Managing Director John Rickert and Executive Directors Brittany Collier and Matthew Fong, as well as Davina Kaile, Partner at Pillsbury Winthrop Shaw Pittman, at the “SPAC Market Update” webinar on September 16, 2020, hosted by J. P. Morgan. The webinar panelists explained the fundamentals of SPACs and suggested why these alternatives to traditional IPOs were gaining so much momentum.

What is a SPAC?

The panelists agreed that one of the most important things to understand about SPACs is that they provide a different kind of opportunity for investors that want to be involved in bringing a company public. SPACs have gained in credibility because highly-regarded institutional investors (think Wellington, TIAA-Cref, and T. Rowe Price) have begun to invest in them. Bulge-bracket banks have even started to commit capital in advance of a deal closing through forward purchase agreements.

While IPOs continue to be the traditional route for going public, SPACs “are increasingly part of the menu for capital raising for high-quality companies,” said Collier. She attributed part of the increase in the number of successful SPACs to their growing legitimacy as the quality of companies going public via SPAC has improved.

“For many,” said Rickert, “the SPAC market is the better way to reach the public market.”

Here are additional takeaways from the webinar:

  • SPACs offer several advantages over traditional IPOs. Pillsbury’s Kaile described a SPAC as “a shell company formed to raise capital in an IPO,” in which proceeds from the IPO are used to fund the acquisition of an unspecified business target. “With a SPAC, the IPO process tends to be more streamlined because it’s a shell company with no operating history and no historical financial statements,” she said.

    The sponsors who form a SPAC generally boast a strong reputation for acquiring and operating businesses, explained Kaile. That reputational luster is what makes SPACs appealing and not simply—as one nickname implies—a blank-check IPO.

    Kaile explained that because the target is not initially identified, there are fewer disclosure and financial statement requirements. That said, SPACs must have charters and must consummate a business combination within 18-24 months of their creation (extensions are possible but 36 months is the outer limit, according to regulators). Investors are asked to vote “for” or “against” a given deal, and can recoup their initial investment regardless of whether or not they support the deal. A SPAC is dissolved if a business combination is not consummated.

  • Top-tier institutions are increasingly investing in SPACs, bolstering their overall respectability. In the early days SPAC investors tended to be hedge funds, or more event-driven investors. That changed when the SPAC market took off, becoming far more robust than earlier anticipated, explained Collier. She continued: “2019 was really an inflection point, where a lot of shareholders you would want at the top of your shareholder base decided SPACs were something to pay attention to.” Today, she explained, most of the capital raised by SPACs comes from bulge-bracket banks. 
  • The pricing structure for SPACs is evolving. Historically, SPAC sponsors received 20-25 percent of the capital raised for a deal in exchange for the time and capital they had committed (and in recognition that their capital could be lost if no business combination was consummated within the allotted timeframe).

    “If you are an owner of a business that is going to be sold to a SPAC, for every $100 million there is $25 million of what we call dilution,” said Collier. “That’s a lot of friction cost.”

    She noted that “SPAC economics” are now being revisited, with some investors negotiating 20 percent or even 10 percent payouts for sponsors. This period of negotiation highlights what Collier called “the beauty of the SPAC system: its flexibility.”

  • SPACs are increasingly free-ranging in their targets. In the early days, explained Kaile, SPACs committed to locating targets within a specific industry. This is no longer necessarily the case.

    When SPACs specify an industry, that limits the number of available deals, said Rickert. He noted that this can be problematic because a SPAC might look at 120-130 different ideas before finding the right model. “It’s not like these things are falling out of the trees,” he said. “It takes quite a while to find the right ideas.” 

    Rickert observed that while some SPAC sponsors focus on a particular industry, they are also looking to fulfill a number of other criteria. These criteria include finding companies with easy-to-decipher business models, consistent financial track records, strong cashflow, great management teams, and an appropriate size (typically, within the $700-$800 million range).

  • Forward purchase agreements are occurring more frequently. Kaile noted that sometimes founders and affiliates enter into forward purchase commitments, agreeing to provide additional financing once a business combination takes place. Often, she added, this additional financing agreement takes the form of a PIPE, or private investment in public equity.

    Forward-purchase agreements help mitigate one of the downsides of SPACs: that all the capital raised can be redeemed and therefore evaporate. Today, said Collier, in around 20% of instances, SPACs are coming to market with PIPEs or other forms of committed capital. “The entrance of PIPEs -- and the frequency we’re seeing PIPES-- have been a gamechanger,” she underscored.

  • Targets need to be ready in terms of governance.  “It’s very important to do your legwork so you hit the ground running on Day 1 as a public company. In this day and age, you don’t have time to play catch-up,” said Kaile. Preparedness entails having in place legal, compliance, and investor relations functions; solidifying corporate governance practices in a code of ethics; and establishing training programs for employees.

    Fong noted that when it comes to SPAC targets, sponsors are increasingly looking at earlier stage companies. For newer companies, demonstrating an ability to meet reporting requirements and having an overall risk management structure in place are extremely important.

  • Companies poised for success model the business on a quarterly basis and educate investors.  In a traditional IPO, industry analysts act as mouthpiece for a company, while in a SPAC, the company puts its own predictions in the proxy. Making predictions for investors “puts a lot of pressure on an organization to get those predictions right,” said Collier.

    To that end, Collier recommended placing “considerable emphasis on modelling the business out on a quarterly basis and understanding what the margin of error is such that you’re prepared as a management team.” 

    What’s more, she highlighted the importance of building credibility with investors within the first three or four quarters of operating as a publicly-traded entity.

  • SPACs are expected to continue to grow in popularity. Clay noted that the SPAC 2020 market shows signs of added strength in the remaining months of 2020. For instance, as of mid-September, in addition to the 95 SPACs that had already been priced, another 43 SPACs were on file with the SEC, pending pricing.

    “SPACs continue their march,” concluded Clay. “We look forward to many great things to come. Onward and upward.”