By Mark Watson, founder, Aquila Capital Partners
SPACs, or Special Purpose Acquisition Companies, are an important factor to consider when taking a company public. Any business leader should be attuned to this method, which has seen an increase in popularity in recent years, as it gives your organization another avenue to raise more capital. But with the pros come the cons and that’s why it is critical to understand what SPACs are and how to understand their value in the marketplace.
Many people are evaluating the SPAC market and having second thoughts about whether or not their company is ready to go public. This is completely understandable. The market has grown and changed exponentially in the past year. So many launched at the end of 2020, in the midst of uncertain economic times, but the momentum eventually leveled out in the spring of this year. But this doesn’t mean SPACs are going anywhere. They are still a perfectly viable option to take your company public—as long as leaders correctly assess the health of their company and if they are ready to take this next step.
There are many benefits to your company going public. It helps you raise funds with a lower cost of capital, gives you currency as a company, more opportunities for mergers and acquisitions, and the prestige you need to attract top talent. There’s a lot of appeal in SPACs, but equally as much to consider when deciding on this route.
The Pros and Cons of SPACs
SPACs once existed in relative obscurity. In 2019, there were fewer than 60 SPACs. Now, we are in a SPAC-saturated field. There are 400+ SPACs currently looking for targets, with about 200 more in the pipeline. Where and when those targets will emerge is the more pressing question.
Hundreds of SPACs are chasing private companies that may or may not be going public. So it’s a seller’s market, meaning that if you have a company that you’ve been thinking about taking public, but you haven’t wanted to go through the headache of an IPO, this might be a path for you.
Many companies chose to go public via SPAC in lieu of late-stage fundraising. For some people, this has its advantages over a regular underwritten IPO. SPACs have a much faster execution, with SPACs merging into their target companies in 3-6 months on average, versus IPOs, which traditionally take 12-18 months. IPOs require exhaustive regulatory filings, are underwritten by investment banks, and companies have to go find a group of public equity investors to take interest in their company.
This process is considerably time-consuming. This is one of the many reasons SPACs became so appealing—less time spent means fewer fees. In the first quarter of 2021, they made up roughly 28% of US deals. Just because the pace slowed this spring doesn’t mean they are disappearing. They just need to be appropriately utilized.
While saving money is certainly important, the real advantage of SPACs is that they provide more certainty. The reason why one chooses an IPO via SPAC isn’t so much about saving money, but about getting the deal done. Another big advantage of SPACs is that they are not dependent on or sensitive to the market conditions like IPOs, and give some space to negotiate. SPAC mergers also don’t need to generate the same level of interest or fanfare for investors. Right now, there is a fair amount of investor appetite for IPOs as long as they are seasoned companies as opposed to start-ups with a pitch budget.
Like any good thing that everyone jumps into quickly (meaning too much of a good thing is too much of a good thing) many SPACs won’t find deals because there aren’t that many companies that are seasoned and capable of operating as public companies. Compounding this challenge, it’s very difficult for institutional investors, of any size, to invest in companies with a market cap of less than $2 billion, and for sure companies with a market cap of less than $1 billion.
While some companies are going public for hundreds of millions of dollars, this is the exception, not the rule. There is no institutional research that can cover all of these smaller companies. You are left with no liquidity and very little investor interest. Simply put, if your market cap is less than $1 billion, and you couple this with an already selective market, imagine the difficulties companies can face when trying to go public if they’re small or not seasoned operators.
What to Consider Before Taking the SPAC Route
Before deciding if a SPAC is right for your company, think twice about whether your company is seasoned and ready to be a publicly-traded company. Whether a company becomes public via traditional IPO or SPAC, the end result is the same—they’re trading as a public company, which means they need to have a clear line of sight about their financial performance, as public equity investors tend to be fairly (if not severely) punitive when a company’s financial results different materially from investors’ expectations. We saw recently in the second quarter financial report results of two companies in particular—Root Insurance and Metromile.
Both Root and Metromile were early-stage companies that grew up with some venture investment and then went to the stock market. In February of this year, Metromile became a public company via SPAC merger. They initially met some success with a market cap of $1.3 billion and were expected to garner almost $300 million at closing. But in the past few weeks, they stood at about $4.75 per share with a market cap of roughly $610 million, a significant decrease from this spring. Root went public via SPAC in the late fall of last year and raised $750 million on day one of being publicly traded.
While this appears to be impressive, their earnings report and share value dropped significantly at the end of February, from $27 per share to approximately $6 per share. So what’s happening here? Two companies in the same field went public using two different routes. One met investor expectations initially, with a subsequent drop-off (Metromile) and one did not (Root). Regardless of how you go public, you need a great company with a great product. You must believe in what you are doing and have a path to a minimum of $1 billion in valuation, especially in an unpredictable market.
Lemonade went public via the traditional IPO route. They are getting hammered for the same reason—their financial results differed materially from investor expectations of their financial performance. It wasn’t necessarily about the share prices dropping or losing money—to some degree, investors expected this. But they ended up having worse results than their investors expected, and they continue hemorrhaging cash. While these companies did not give their investors exact guidance, they did give a general impression of how they thought things would go and in the end, it was a disappointment.
SPACs aren’t out of vogue, but there are other companies whose finances are more in line with investor expectations. If you have a seasoned business where there is more predictability of financial performance, taking your public company is a great idea. And at the end of the day, no matter which route you chose, investors are looking through the same lens when vetting companies.
There is no difference in expectations, whether you take the IPO or SPAC route. Sometimes the SPAC promoters suggest to operators that going public via SPAC is more forgiving, but the recent change of market value in many companies suggests that this might not be the case anymore. This is more reflective of and reliant upon public markets in general.
If you’re thinking about taking your company public, this should be top of mind. If you think you have an amazing company and can go all in, the possibility should excite you. If you don’t think your company is ready, take a step back and reassess your options. Remember, the private equity markets are still flush with cash as well. It can be done and done well but only if your business is truly ready to go public.