SPAC that, I got you a floor: A fortune cookie with a unicorn inside it (Part 2 of 5)
A brief definition of what a SPAC is, from the perspective of - a sponsor, a founder and a retail investor.
In the first part of this post, we started to peel the layers of complexity around a Special Purpose Acquisition Company (SPAC) and tried to understand why it makes sense for a certain special kinds of founders, with some very typical business models, to look at SPACs as a vehicle to go public.
In this section, I will try to briefly define what a SPAC is, from the perspective of - a sponsor, a founder and a retail investor. I think it is very important to understand it in this sense, because it then helps us to see their motivations and the risks and returns they are looking to expose themselves to, using this vehicle. Next, I provide some stylized facts around the proliferation of SPACs in 2020, which strengthens the case for investors and startup founders to understand them.
A fortune cookie with a unicorn in it
A SPAC or a blank check company is basically a corporate shell company (ignore the negative connotations) that is sponsored by a well-known investor. A SPAC is almost always a publicly listed entity, with a single purpose – to find a private company and merge with it. When a SPAC merges with a target company, the shares of the two companies become one and therefore, the merger immediately makes the target company public. As a result, the private company goes public without an IPO
There are multiple ways to see a SPAC.
From the point of view of the person who sponsors a SPAC, it is like running a Private Equity/Late stage Venture Capital fund that raises capital from the public – with one twist. Unlike the usual PE/VC fund that will invest in a number of companies to diversify its risk, the sponsor of a SPAC will invest in only one company and bind itself to it.
Looked at from the vantage point of the private firm that merges with the SPAC, it is an investment scheme with an inbuilt minimum price guarantee. In a usual IPO process, the company never knows until the day of its listing what price its shares will eventually trade at once it goes public. With a SPAC, the company negotiates a fixed price at which shares of the two companies will merge with the SPAC sponsor. At the outset, it removes any uncertainty around IPO pricing – a trait which is highly valued in a volatile equity market.
Finally, from the perspective of the retail investor who puts their money in the SPAC, it is an opportunity to sit at the table with the experts. SPACs over the past few years have been sponsored by investors who have had an excellent track record of timing the markets, or former corporate executives with an impressive resume (Alan Mullaly, the former CEO of Ford Motors is one example, Reid Hoffman of LinkedIn another). It allows them an opportunity to invest in the IPO of a highly attractive prospect in advance, with an option to back out of the company if they do not like the merger.
That 2020 SPAC spirit
In a recent post, Crunchbase called 2020 “The Year of the SPAC” in the start-up funding universe. As trends go, nothing could better encapsulate the spirit.
SPACs have been around since 1990s, with the cumulative amount raised by SPACs raised by such structures over the nearly three decades being $132 billion. However, this is the big deal; $77 billion, or more than half of that money was raised just in this year. And we are still a quarter away from the finish, with SPACs being sponsored by people as diverse as tech wonderkids (Chamath Palihapitiya) to politicians (Paul Ryan) to celebrities (Shaquille O Neal).
What is also notable is that the average SPAC pot - the money they raise from public investors- is also getting bigger. The average SPAC size in 2020 is ~2.6x the average money raised through such vehicles since 2003.
Some of the notable SPAC transactions over the past 3 years include:
Rare earth miner MP Materials going public through a SPAC sponsored by Fortress Investment Management, in a deal valued over $500 million
Virgin Galactic, British tycoon Richard Branson’s space tourism company went public last year by selling a 49% stake to a blank check company Hedosophia Capital sponsored by Palihapitiya
Hybrid Electric truck manufacturer Nikola Corp went public in June this year through a SPAC transaction that infused (directly and indirectly) over $700 million in the company at a valuation of $3.3 billion
Sports betting giant Draftkings listed via a SPAC sponsored by Diamond Eagle in a $2.7 billion valuation deal.
Multi-plan Holdings limited, a healthcare services provider, merged with a SPAC sponsored by Citi group stalwart and Winston Churchill fan Michael Klein
Lest these numbers, which are large compared to our daily experience with money, mislead you, it is important to understand that the size of a SPAC fund, even the cumulative size of all of them, is significantly small compared to the pools of cash raised by PE/VC firms. In fact, all of $63 billion raised by SPACs in their record year in 2020 will neatly fit within the size of about two or three late stage growth superfunds. On the other hand, SPACs should not be written simply as another aberration born in the COVID age. Some of them have been backed and advocated by highly respected figures in the investing community from across the board. The notable ones are:
Celebrity Hedge Fund manager Bill Ackman recently raised a $4 billion SPAC to take public a “mature unicorn”. It is still one of the biggest SPACs in the market looking for a target.
Investment Banker Michael Klein’s Churchill Capital sponsored SPACs have on board former Ford CEO Alan Mullaly, Apple’s design chief Jony Ive, ex-CBS CEO and Chairman Joe Ianiello, John Thornton, Chairman of Barrick Gold and Oak Hill Capital’s former CEO and Founder Glenn August to provide strategic advice to the target companies
Tech VC Social Capital sponsored Hedosophia Capital which has raised over $ 1 billion in three fund vehicles (for both direct and SPAC deals)
Fintech VC Ribbit Capital’s $600 million SPAC exclusively for fintech startups
Per Crunchbase, LinkedIn founder Reid Hoffman and former Speaker of US House of Representatives Paul Ryan would also endorse SPACs in near future.
While it is too early to comment on the future of SPACs and the investment appetite for them, it appears that they could fast emerge as a niche product for going public. This is especially true for startups that want investors to buy into their growth story from Day 1 or those that want to insure themselves against the risk of a perception gap in their valuation.
This was a rather short post! And I wanted it to be so - we need to define and internalize what a SPAC is before we jump into how the process of creating one works. In the next one, I will try and break down the entire SPAC process into a series of steps, so that you can see how incentives and risks are structured at different steps of the exercise.
