SPAC v Direct Listing for Faster, Cheaper IPO
The investment world is always shifting and evolving with the needs of its producers and investors. But one of the more recent and interesting changes I’ve seen in the market has been the rise of SPACs: special-purpose acquisition companies that can take the place of a traditional IPO roadshow and fundraising season.
While IPOs remain a popular option for a majority of companies, and direct listing fundraising remains the go-to option for large companies with plenty of capital already, SPACs offer alternative fundraising options for smaller companies and might be changing the market overall. to get an idea of the alternative startup funding available to founders, check out my startup funding blog
Today, I’ll break down why companies might consider using a SPAC to acquire capital faster and more cheaply than through direct listing or through an initial public offering.
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Before I can compare SPACs to direct listings, let me explain how companies have gained capital historically – in most cases, that’s been through IPOs or initial public offerings.
An initial public offering occurs when a company creates new shares – these are also usually underwritten by someone called an intermediary. In a nutshell, the intermediary (also sometimes called the underwriter) works with the company by:
- helping to decide the initial offer price for shares
- assisting with certain regulatory requirements
- buying the shares
- and so on and so forth
In my experience, underwriters are most helpful to ensure that shares get where they need to go through a distribution network
In most cases, a successful IPO requires both the company and the underwriter, alongside several bankers or other financial investors, to go on a “roadshow”. During this time, they’ll meet with potential future investors and people who might be interested in the shares due to crop up with the IPO. This produces interest and a successful roadshow often results in more capital raised by the IPO.
Of course, IPOs come with some downsides even though they’re arguably the signature method of raising capital as a company expands and enters the stock market. For instance, underwriters usually only provide their services for a fee of between 3% and 7% per share.
Furthermore, IPO roadshows can take quite a long time, meaning new companies must often wait several months up to a year in order to receive capital from the IPO effort. For newer companies that are really strapped for cash and that need an injection of capital soon in order to remain operational, let alone grow, this can be a death sentence.
Thus, IPOs or underwritten public listings, as they are in practice, are sometimes ignored in favor of fundraising through direct listings of company shares.
Direct listing is another method of raising capital if a company doesn’t have the resources to pay an underwriter or the time to spare for a long IPO season. Furthermore, direct listing allows company owners to avoid diluting any existing shares since no new shares will be created in the process.
Direct listing can also be known as direct placement or direct public offering (DPO as opposed to IPO). With this capital-raising model, existing investors – which can include company founders, employees, and promoters – sell their shares directly to the public in order to acquire the necessary capital for growth.
Let me clear that this comes with its own issues and potential risks. For instance, there’s no guarantee that available shares will be sold, and there isn’t always a defense for large shareholders against volatility in their shares’ prices, both before and after the direct listing process.
Still, this type of fundraising has been used successfully in the past. Spotify, now one of the most successful music streaming services, originally pioneered modern direct listing processes in 2018. Slack, a well-known messaging platform that has recently skyrocketed in value with the COVID-19 pandemic, also utilized direct listing for fundraising purposes.
This is all because the US Securities and Exchange Commission recently allowed the New York Stock Exchange to let companies list shares directly while also issuing new shares at the same time. For now, Nasdaq doesn’t allow direct listing but is currently working on the process to allow it.
Generally speaking, bigger companies (even bigger than Spotify and Slack) prefer direct listing or IPO fundraising efforts compared to any other option. They can utilize direct listing successfully in particular since they usually have enough capital that they can make a profit by selling certain shares. This is not always true, however.
Now I can finally get to SPACs, or special purpose acquisition companies. In my opinion, SPACs represent the most complex and the most distinct type of fundraising for new companies, and SPACs also come with similarly distinct advantages as well.
A special purpose acquisition company is essentially a company formed without any commercial operations – instead, it’s formed entirely through investor funding with the intention of acquiring an existing company. SPACs, in a nutshell, are the ones who make the IPO to a company in exchange for shares.
Due to their nature, SPACs can also be known as “blank check companies”.
While SPACs have been around for decades, they’ve only recently become more popular such that newer companies are taking note of this method and considering it for their own fundraising needs.
A SPAC works just like any other company except they don’t produce any value of their own. Instead, SPACs are created by fundraisers who get together and pool their income in order to buy another company outright. Once a purchase is made, the SPAC may take over operations of the company or leave the company largely alone depending on business objectives.
SPAC investors can vary dramatically. Some SPACs come from well-known private equity funds, while others are created through public funds. However, SPACs are also limited in other ways. They usually only have two years to make an acquisition or they have to return their funds to their investors.
Because of this time limit, SPACs are generally formed by well-known investors and sponsors with expertise in certain business sectors or industries. This allows them to more accurately and consistently locate and purchase companies worth the cost without wasting investors’ money.
The money raised within a SPAC is usually placed in an interest-bearing trust account to prevent the funds from being misused.
From a company’s point of view, a SPAC might approach them and make an IPO or equivalent offer, proposing a certain amount of cash for a certain amount of stocks or a percentage of the shares in a company. In many cases (almost all of them), this is a majority of the shares so that the SPAC in question has at least some control over the operations of the acquisition.
Since SPACs essentially work in the reverse order compared to a traditional IPO, these companies are becoming more and more popular. There are multiple reasons for this shift.
in my opinion, SPACs can be attractive fundraising opportunities for young companies in particular, especially since smaller companies are usually private equity funds.
For instance, a young company could turn quite a profit by accepting an offer made by a SPAC. I’ve seen some deals result in total sales prices of up to 20% higher compared to a regular share or private equity deal.
Furthermore, many young companies find the speed (how long it takes to get funding) offered by SPACs to be attractive, especially compared to regular IPO roadshows. In some cases, acquisition by a SPAC can result in extremely fast funding. Usually, business negotiations are concluded after a matter of days or weeks rather than months or up to a year.
Even better, since most successful SPACs are run by experienced business investors, young companies can benefit from that investment expertise and not have to worry too much about swinging investment amounts or shifting negotiations. Broader market sentiment matters less – the SPAC investors commit to the purchase, sometimes allowing companies to remain truer to their original mission statement or purpose than if they were purchased by a larger board of investors.
But SPACs can also be a good strategic vehicle for investors as well. Remember, investors can usually get their money back if the SPAC in question doesn’t like the acquisition target that ends up getting purchased or if the two-year time limit ticks by. Furthermore, promoters usually keep hefty fees for any equity that does get raised. Some SPACs have this as high as 20%.
This isn’t to say that SPACs are always the best option or that they don’t come with any downsides. In fact, SPACs do have a number of drawbacks that may cause some younger companies to hesitate to approach them for fundraising.
For instance, SPAC acquisition sometimes causes company owners to lose control over their company in a way they might be able to prevent with a traditional IPO process. This mistake is harder to make with a traditional IPO (though it still happens).
Furthermore, SPACs are only as successful as the investors that guide them. I’ve seen some SPACs fail due to bad decisions, acquire poor companies, or give bad advice to the companies they purchase and accidentally wasting most of the money of their constituent investors. Indeed, A SPAC that doesn’t know what it’s doing could end up leading to a new company’s downfall if managed appropriately.
In this day and age, with the stock market soaring regardless of the COVID-19-related troubles that many people are experiencing, many blank check companies and their associated investors are maneuvering as though it’s a free for all hunting season. They’re scouring the financial waters for fresh companies to acquire and uplift, and the advantages of SPACs have caused something of a renaissance for this fundraising process.
As SPACs become more popular, I think more and more companies will look to them as their first source of fundraising revenue rather than traditional IPOs.
SPACs have recently come into the spotlight due to recent big acquisitions, such as the special purpose acquisition involving Virgin Galactic: one of the most famous companies owned by Richard Branson. In a nutshell, a SPAC called Social Capital Hedosophia Holdings purchased a 49% stake in Virgin Galactic in 2019, and all for $800 million. The SPAC then listed the company later in the same year for great profits, making waves throughout the market.
More recently, Bill Ackman – the founder of Pershing Square Capital Management – recently sponsored a SPAC called Pershing Square Tontine Holdings. This is the largest SPAC ever created on record and has thus raised $4 billion for its IPO for one or more target companies by July 22, 2020. With all that cash, Ackman and his SPAC are well-positioned to make some big moves in the market.
So, will the market be changed forever? It’s tough to say whether the current boost in SPAC popularity will last for a long time or make old-school IPO roadshows relatively obsolete, especially with the glut of big data now available to investors.
SPACs are more popular now, in large part, due to the typical expenses you incur by doing things the old-fashioned way. Indeed, many initial public offerings leave money on the proverbial table since they take so long and companies are often undervalued. Since SPAC purchases can be more directly dictated by what investors see in a company, the chances of undervaluing (or overvaluing) a given company are much lower.
Still, it’s unlikely that SPACs will ever fully replace IPOs. Most investors know that there isn’t a one-size-fits-all solution for investment. Furthermore, many larger companies will likely still rely on direct listing fundraising efforts since they don’t need much support from big investors or Wall Street banks.
But in my opinion, it’s safe to say that SPACs represents a new era in investing, and they’ll provide new opportunities for young companies that would otherwise find themselves on the financial ropes due to the time and money requirements needed for a successful IPO.
About the Author
Jonathan Hung is one of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.
Jonathan and his team target investments in US companies that have global market potential with a focus on long-term growth expansion to East Asian markets.
Jonathan developed his investing prowess as a Managing Member for his family office fund, J Heart Ventures, which made investments in start-up companies such as Gyft, ChowNow, Miso Robotics, Clover Health, Bitmain, to name a few startups he funded.
Jonathan has various degrees from the University of Southern California, London School of Economics, Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.