Recent years have seen a dramatic increase in new ventures and startups seeking to introduce new solutions and disrupt industries across the board.
With a larger number of startups looking to grow capital or achieve liquidity, the IPO process available to such companies has also been subject to significant change, offering more—and faster, more efficient—avenues to take a company public.
What are SPACs and how do they operate?
Enter SPACs, or Special Purpose Acquisition Companies. These have become a leading solution for startups in going public. And while SPACs aren’t that new of a concept or alternative to a traditional IPO—in fact, they have been around since the 1980s as blank-check corporations—they have seen a wider adoption and acceptance in the last few years in the U.S.
According to the Harvard Business Review, in 2020, SPACs accounted for over 50% of new publicly listed companies in the United States. In 2019, there were a total of 59 SPACs formed—a number that spiked to 247 in 2020 and 295 in 2021.
SPACs are publicly traded entities with a two-year life span that are created with the sole purpose of merging with a private startup or business in order to go public. These mergers are known as “combinations” and are facilitated by funding from investors. They are currently seen as a lower-risk method to going public than the traditional IPO process.
SPACs go into initial public offerings with a specific thesis that details the goal of the entity to merge with a target in a specific sector or geographic area, or a target that aligns with the sponsor’s background and area of expertise.
Who are the leading case examples?
Many recent IPOs have undergone the SPAC route—namely, the notorious WeWork whose traditional IPO attempt came under intense scrutiny in 2019. Other companies that have gone public by merging with SPACs include Virgin Galactic, DraftKings, Opendoor and Nikola Motor Co.
The list of advantages that SPACs offer doesn’t end with lower risks, though. Compared to the traditional IPO process, SPACs have unlocked higher valuations, faster turnaround times and offer less uncertainty for the investors and startups alike.
What criticisms have arisen regarding the use of SPACs?
While there is a lot of enthusiasm around SPACs, there is also some skeptcisim.
For one, SPACs always run the risk of not completing the combination, given the tighter timeline than a traditional IPO. Despite the overall favorability they have achieved throughout the years, SPACs are not immune to failure. Target companies also run the risk of facing the rejection of the SPAC investors and shareholders. And while the SPAC process still requires transparency and due diligence like a traditional IPO process does, it certainly is less rigorous and exhaustive than the latter.
What effects have come from celebrity involvement in SPACs?
Another cause for concern has been the increasing involvement of celebrities—such as Ciara, Serena Williams and Alex Rodriguez.
Celebrities leading SPACs can be interpreted in many ways. For one thing, the investment can be regarded as a new way for public figures to flaunt their social status and affluence. Celebrity involvement can also attract investor attention to the blank-check corporation solely based on the celebrity endorser’s celebrity persona rather than their acumen in making an educated choice for the target.
What might the future hold for SPACs?
No doubt that SPACs are here to stay given their popularity, but the future of successful SPACs will have little to do with celebrity. The surest chances of success for SPACs will come from the expertise, knowledge and strategy that sponsors bring into the corporation (and its thesis) from the moment it begins to form.
Resources such as connected advisors and teams with appropriate in-depth expertise in the sector and geography detailed in the thesis will be important. Profound knowledge of the players in the space will also be essential in decreasing the risk for targets and increasing the successful exit rate for future combinations.
When it comes to sponsors’ success story, it’s important to note the team that backs the SPAC in addition to the sponsor—namely the team of bankers and underwriters who complement the sponsor’s industry-specific expertise with a deep understanding of the market and the economic climate.
As of today, the IPO/SPAC market is not as optimal as it was during its boom in 2020 and 2021. Sponsors will need to listen extra carefully to their bankers, board and underwriters to ensure a smooth process.
How might incentives come into play?
The importance of finding targets with high revenue potential is more important than ever. The lock-up period that a sponsor commits to plays a direct role in ensuring that the target company is high-quality—in fact, longer lock-up periods that prevent sponsors from selling their shares can create additional incentives for sponsors to diligently seek and acquire quality targets. This helps prevent the adoption of the mindset that, no matter how low the stock price plummets, the board and the sponsors will receive a return on their investment.
What about the matter of disclosures?
While SPACs are not new concepts, they do enjoy more flexibility as a process in comparison to the traditional IPO route. To this end, following existing regulations—which are increasing in quantity with time as SPACs gain popularity—set by the CFA Institute and the SEC has become as important as ever. Sponsors must make it a goal to build a “model SPAC” from the moment it’s starting to form. These efforts are geared toward preparing for any complaints about the lack of protection against conflicts of interest and fraud, which are cause for significant concern at the moment.
All of the above can be addressed with the right incentives in place, ensuring the creation of SPACs that follow increased regulation, seeking high-potential and revenue-generating targets and disclosing necessary information to avoid inflation and exaggerations.
Originally published in Forbes