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CB Insights: SPACs and the Future of IPOs

Core Content

CB Insights provides an overview of Special Purpose Acquisition Companies (SPACs), an alternative to the traditional Initial Public Offering (IPO), and examines their rise in popularity, benefits, and risks. The report highlights how SPACs have become a significant trend in the public markets, particularly in 2021, and discusses the implications for the future of IPOs.

Main Points

What is a SPAC?

• A Special Purpose Acquisition Company (SPAC) is a shell company that goes public and later merges with a private company to take it public.
• SPACs are also known as "blank check" companies because they do not have an operational business when they go public.
• The SPAC process involves three stages: formation and IPO, target identification and acquisition, and merger (de-SPAC).

Why SPACs are Booming Now

• Private companies are staying private longer, often due to access to venture capital.
• The Covid-19 pandemic has created uncertainty in traditional IPO markets, making SPACs a more attractive option.
• SPACs offer greater speed and certainty compared to traditional IPOs, which can take 24-36 months.
• The IPO market has seen increased activity, with SPACs contributing significantly to the total amount raised.

Why Private Companies Choose SPACs

• Certainty: SPACs allow companies to negotiate a fixed purchase price, avoiding the uncertainty of traditional IPO pricing.
• Speed: The SPAC merger process can take as little as 3-4 months, making it ideal for companies seeking quick access to capital.
• Strategic partnership: SPACs with experienced sponsors offer companies guidance and resources post-merger.

Why SPACs are Popular Among Investors

• Retail investors can participate in SPACs, though they face higher risks and limited rewards.
• Institutional investors benefit from limited risk and warrant opportunities, allowing them to profit from SPACs without deep due diligence.
• Sponsors can make significant profits due to founders shares and PIPE investments, even if the target company underperforms.

Challenges and Concerns

• Sponsor risk: Sponsors have incentives to prioritize speed over due diligence, which can lead to poor target company choices.
• Target company quality: Many SPAC-acquired companies have weaker financials and higher failure rates than traditional IPOs.
• Market performance: SPACs have underperformed compared to the S&P 500, with a median post-merger return of -65.3% over 12 months.
• Retail investor risk: Retail investors often buy common shares at higher prices, missing the initial "pop" and facing share dilution and limited upside.
• Supply and demand concerns: The number of SPACs may exceed the number of viable target companies, potentially leading to a market crash.

Future of the Traditional IPO

• The traditional IPO is not in jeopardy, as many companies are still choosing it over SPACs.
• The SEC's regulatory scrutiny in 2021 has led to a decline in SPAC activity.
• As market volatility subsides, the cost advantage of SPACs may diminish, leading to a return to traditional IPOs.

Key Information

• SPAC proceeds in 2021 have already exceeded those of 2020, with over $95B raised.
• United Wholesale Mortgage holds the record for the largest SPAC merger at $16B.
• Bill Ackman raised $4B for his SPAC, the largest to date, but has criticized the structure for its incentive misalignment.
• Chamath Palihapitiya has launched 6 SPACs since 2019 and filed for 7 more, showcasing the popularity of the model.
• Institutional investors dominate SPAC ownership, with the top 75 investment managers holding ~70% of SPAC securities as of late 2020.
• Retail investors often face limited upside and high risk, with a median post-merger return of -14.5% after 3 months.
• SPAC failures are common, with 58% of SPAC-acquired companies failing between 2003 and 2013.
• SEC regulations have introduced new accounting rules, leading to a decline in SPAC activity in Q2 2021.

Summary

SPACs are reshaping the landscape of public market offerings, offering a faster and more certain path to going public. While they are popular among sponsors, institutional investors, and some private companies, they come with significant risks, especially for retail investors. The SEC's scrutiny and market volatility have led to a slowdown in SPAC activity, but the trend remains influential. As the market stabilizes, the traditional IPO may regain favor, but SPACs continue to play a role in the public market ecosystem.