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Companies typically pursue an initial public offering to raise capital, provide shareholder liquidity, create brand awareness and obtain resources to further expand their business. Increasingly, companies across all sectors are considering mergers with special purpose acquisition companies (also known as SPACs), rather than a traditional IPO, to achieve these goals. This trend will likely continue as a growing number of major private equity (PE) firms, venture funds and operators form more SPACs.
SPACs are “blank check” companies created solely to raise capital through an IPO in order to merge with private companies. By merging with a SPAC sponsor, firms can access liquidity via the public market. For example in August, driverless car startup Luminar Technologies announced it would go public via a $3.4 billion merger with the SPAC, Gores Metropoulos Inc.
SPACs were first created in the 1990s, but they didn’t gain popularity with blue-chip investors until recently. In 2019, the number of SPACs as a share of IPOs rose to 30% from 4% in 2013, according to PwC’s analysis of Dealogic data. The surge comes as more blue-chip private equity firms, banks and high-profile entrepreneurs form SPACs, which in turn, has further attracted owners of private companies interested in going public. For instance, the latest wave of SPACs involve Pershing Square Capital Management, Goldman Sachs and TPG Capital, among other major investment groups.
Despite uncertainties amid a US economic recession, SPACs have become a viable liquidity option. By going public under a SPAC, private companies benefit in the following ways:
Small and mid-sized companies may want to continue to fund development, invest in brand awareness or make acquisitions to continue growing, but they may not be ideal candidates for traditional IPOs. By merging with a SPAC sponsor, existing companies can retain a stake in their business and gain access to liquidity that otherwise would not be available to them.
The pool of capital available from SPACs has widened significantly. SPACs reached their previous height in 2007, raising $12 billion. So far in 2020, there is an estimated $34 billion raised by SPACs looking for targets. As these investment vehicles continue to evolve and mature, companies will likely have more SPACs to consider.
With US stocks more volatile, finding the right window to debut on Wall Street can be tricky and costly. If a company is too conservative and prices its offering too low, the company risks “leaving money at the table.” Also, the price of the stock may suffer simply because the market was down the day the company goes public.
With SPAC mergers, there’s less uncertainty. Unlike traditional IPOs, target companies can negotiate the price of their stock with the SPAC sponsor as part of their merger agreement. In other words, targets can lock in a price; therefore, helping shield its value from market uncertainty.
Besides negotiating valuation, SPACs also present target companies the flexibility to negotiate other terms of the deal that work in their favor. This could include structuring the transaction to bring in additional dollars through a private investment in public equity (PIPE), as well as add additional debt or equity. Further, a target’s board of directors is subject to negotiation.
For target companies considering a SPAC, having the right expertise will be key to negotiate the most optimal deal.
In recent years, one of the bigger developments to have emerged are the management teams and sponsors involved in SPACs. Major private equity groups and experienced management teams are behind a new generation of these investment vehicles, which in turn could spawn higher standards when it comes to fundraising, returns on investments and therefore further build investors’ confidence.
SPACs behave much like PE firms in that a group of investors raise funds to strategically buy companies – the main difference being that the SPAC executes a public versus private offering.
However, not all SPACs are the same. Choosing the right SPAC sponsor will be key because unlike a traditional merger deal where the buyer and seller seek out business synergies, a company looking to merge with a SPAC needs to agree with the sponsor’s long-term business goals. For example, a startup focused on electric vehicles should seek out SPAC sponsors backed by investors focused on that space and who will understand that area. This is especially important because a key goal of a SPAC transaction is to ensure the target has adequate capital to be successful following the merger. Since investors in a SPAC have the right to redeem or pull out of their investment at closing, it’s critical that the target and sponsor agree on the long-term prospects of the business.