Why SPACs Are the New IPO
The traditional route to going public is too slow for companies that want to cash in on hype
Special purpose acquisition companies (or SPACs) have raised record amounts in the last few years. Some 28 SPACs have had IPOs this year, raising $8.9 billion, according to SPACData.com. At the current rate, that’s on pace to reach $16.5 billion by the end of the year, beating last year’s $13.6 billion and massively ahead of the 2011–2015 average of $1.7 billion.
SPACs have a simple model: raise funds from the public markets, then find a company to merge with. When they announce the merger, shareholders can either accept stock in the new company or redeem their shares at the original price of the offering. So, to the SPAC issuer and the company they merge with, the SPAC is a deconstructed IPO with a very short roadshow (in theory, you just negotiate with one investor — or with a few SPACs as you try to attract the highest bidder). To the SPAC investor, it’s a subpar money market fund with a Kinder Surprise Egg-style option attached: invest, and for the cost of tying up your capital for a while, you have the option to get… something.
Nikola, DraftKings, and Virgin Galactic all went public through SPACs.
There’s been a recent blizzard of SPAC deals:
- Earlier this month, a rare-earth miner announced plans to go public via SPAC, with an expected market value of $1.5 billion.
- Pershing Square founder Bill Ackman’s SPAC planned to raise $3 billion, a record. Then it raised its target last week to $4 billion with a novel pricing mechanic. There’s a fixed pool of warrants to be distributed to all shareholders who accept the deal, so as more shareholders reject the deal, more equity goes to the ones who accept it. This sounds more like a game theory thought experiment than a useful feature, but we’ll see.
- Nikola, DraftKings, and Virgin Galactic all went public through SPACs.
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Where did all these SPACs come from? What does all this mean?
Compared to an IPO, the SPAC is much less risky for the company: You sign a deal with one person (the SPAC sponsor) for a fixed amount of money (what’s in the SPAC pool ) at a negotiated price, and then you sign and announce the deal and it probably gets done. With an IPO, you announce the deal before negotiating the size or price, and you don’t know if anyone will go for it until after you’ve announced it and started marketing it. Things could go wrong in embarrassing public fashion.
The SPAC structure is less risky for the company than an IPO, which means that it’s riskier for the SPAC (than just buying shares in a regular IPO would be), which means that the SPAC should be compensated by getting an even bigger discount than regular IPO investors.
Some also theorize that the SPAC boom is accelerating due to Covid-19 because IPO roadshows are hard to do and don’t work as well remotely. So there is a shift toward one-on-one deals rather than one-to-many capital raises. While this explains 2020, the increased popularity of SPACs is just a continuation of a decade-long trend.
In the ’90s, you could start a company, prep it for IPO, take it public, and white-knuckle your way through the lockup, all before the bubble popped.
That’s why the most compelling explanation for the SPAC boom is not that the IPO process is costly (it’s expensive but cheaper than a SPAC), but that it takes a long time. And that’s especially challenging for companies that want to ride a hype wave. In the ’90s, you could start a company, prep it for IPO, take it public, and white-knuckle your way through the lockup, all before the bubble popped. The dot-com bubble had incredible turnaround: DrKoop.com was founded in July of 1997 and filed its S-1 in March of 1999. Pets.com launched in November of 1998 and went public in February 2000. Hotjobs, a comparative laggard, was founded in February 1997 and didn’t manage to produce a prospectus until June 1999.
Today, there are higher standards, and there’s a longer process. The market is not structured to quickly turn well-hyped businesses into public companies.
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SPACs change this. If Nikola had planned a normal IPO, it would probably schedule it for some time after it had a working product rather than renderings of prototypes. It wouldn’t make sense to hire a big-name CFO this early, though there’s a long list of senior finance executives with EV experience to choose from.
The SPAC is the Vegas wedding chapel of liquidity events; it seems like an urgently good idea at the time, but it doesn’t always turn out that way.
The standards for SPACs are lower, so any time there’s a well-hyped trend or the possibility of one, a SPAC is the right vehicle for a quick IPO. Nikola is not a coincidence. MP Materials, for example, is a trade-war play; they’re the only U.S. producer of rare earth, and China has used rare-earth embargoes as a policy tool in the past. So now is a great time to offer the market a pure-play on domestic rare earth.
This pattern means that SPACs tend to be very adversely selected. The companies that go public via SPAC are not usually the ones that planned an IPO for a long time but the ones that suddenly had an opportunity and really wanted to take it. The SPAC is the Vegas wedding chapel of liquidity events; it seems like an urgently good idea at the time, but it doesn’t always turn out that way.
But in another sense, SPACs are a return to normal. The IPO process isn’t broken because it’s too expensive but because it takes so long. And SPACs are a faster alternative.
Finance tends to find ways to work around restrictions. Take risk tolerance: In the 1920s, bucket shops offered their customers absurd amounts of leverage, letting them make investments with borrowed capital — up to 100:1 in some cases, so you could lose all of your money in one bad afternoon. During the Depression, the Federal Reserve instituted margin restrictions, requiring investors to put up a set amount of collateral before borrowing. But investors found a way to take risks by speculating in small-cap stocks, uranium miners, and assorted fly-by-night operations. And by the ’70s, retail trading in futures started getting big, and anyone with excessive risk tolerance could lever up as much as they wanted. (The pseudonymous “Dash Riprock” from Liar’s Poker and actual Jeff Skilling both lost money trading futures while they were in school in the ’70s. There is nothing new under the sun.)
Regulators have flexibility in determining the form of risk tolerance. But they ultimately can’t change its existence that much. Some market participants crave volatility, and they’ll find it one way or another.
Similarly, regulators can make the IPO process slow. But some companies have a preference for speed, and some traders have very specific and urgent needs that can’t be satisfied in time by the usual way of going public. We are, as always in finance, somehow back to square one.
A version of this was published on The Diff.