SPACs vs IPOs: The Good & The Bad
You may have heard the term SPAC (Special Purpose Acquisition Companies) in the media lately. SPACs essentially serve as a temporary pool to identify a merger target and facilitate access to public markets. SPACs have been around for years, but in the past were often seen as a last resort for private companies, with no other options to go public. With the rising popularity, that is no longer the case. In 2020, there were 247 SPACs completed compared to only 2 in 2010.
Many private companies thinking of going public want to know if merging with a SPAC would be preferable to an IPO. The short answer is, it depends. Some private companies may find certain advantages in a SPAC merger—such as speed and a guaranteed price, while also finding many challenges. One of the most significant challenges is finding the best-fit SPAC sponsor among a sea of so many.
So How Do SPACs and Investors Work Together?
When going public through a SPAC, the SPAC’s founder will serve as its sponsor and work with advisors to handle the groundwork for an IPO. SPAC sponsors may also raise debt or private equity investment funding in addition to their original capital to fund the transaction. Raising the additional funds fuels the combined company's growth and ensures a completed transaction even if some SPAC investors redeem their shares. Unlike most IPOs, where your price depends on market conditions at the time of listing, you can negotiate the pricing with the SPAC before the transaction closes.
One of the most significant advantages of a SPAC is straightforward: time. Working with the SPAC and completing a merger to go public over an IPO typically shortens the timeline by 6-12 months. The compressed timeline is because SPACs are easy to understand. Most businesses can complete their paperwork with the SEC within three months with very little back and forth. Once the IPO is complete, the SPAC can begin evaluating and approaching potential merger targets. When the SPAC finds an ideal partner and shareholders approve an agreement, the transaction closes, and the target company survives as the publicly listed company.
Many of the benefits SPACS provide include:
Investment opportunities similar to private equity
Access to high-quality sponsors without a management fee
Capital protection in the form of redemption rights
Additional upside through warrants
Bounded investment horizon — SPACs generally have 18-24 months to complete an acquisition
So you may be saying - This all sounds too good to be true. What is the downside?
There are some risks of going public with a SPAC merger vs. an IPO. One of the main risks that we have seen is shareholder dilution. SPAC sponsors usually own a 20 percent stake in the SPAC through founder shares, as well as warrants to purchase most of the shares. The SPAC sponsors also typically will benefit from an earnout component, allowing them to receive more shares when the stock price achieves a specified target over a certain period of time, which typically leads to further dilution.
A few of the other cons we have seen associated with SPACs include:
Capital shortfall from potential redemption: Initial SPAC investors may redeem their shares. If redemptions exceed expectations, cash availability becomes uncertain and forces SPACs to raise PIPE financing to fill the resulting shortfall.
Compressed timeline for public company readiness: Although the SPAC sponsor may offer help during the merger process, the target company usually takes the brunt of preparing for required financials in the SEC filings and establishing public company functions, such as investor relations and internal controls, under a much shorter deadline than in an IPO.
Financial diligence performed at narrower scope: The SPAC process does not require the rigorous due diligence of a traditional IPO, which could lead to potential restatements, incorrectly valued businesses, or even lawsuits.
Lack of underwriting and comfort letter: In a traditional IPO, the underwriter ensures all regulatory requirements are met, but because a SPAC is already public, the target company doesn’t have an underwriter.
Going public by merging with a SPAC rather than launching an IPO is worth considering for many private companies. All the SPACs pursuing targets at this time may make M&A seem even more enticing. But there are pros and cons to each option. One way to decide which is better is to survey the current SPAC landscape and see if your company would be comfortable exploring the possibilities. If you are comfortable, the next step is to find a proper SPAC suitor that matches your specific criteria, and KCG is always here to help you.