The SPAC Highway to Riches

Wooden blocks spelling SPAC surrounded by money.

Don’t think that SPAC is just another four-letter word. For increasing numbers of startups and entrepreneurs, it just may be the abracadabra that unlocks wealth in fast motion.

Ask the entrepreneurs behind Solid Power — a solid-state battery developer with backing from BMW and Ford — which has announced it is going public via a SPAC to the tune of an implied valuation of $1.2 billion.

Then there is Dave, a Mark Cuban-backed neo bank with the distinguishing feature that it will eliminate overdraft fees — and now it too is going public via a SPAC that values it at $4 billion.

In 2020, some 200 SPACs went public, garnering around $64 billion in total funding, according to Renaissance Capital and that total is about the same as the money raised in the year’s Initial Public Offerings (IPOs).

Do we have your attention now?

The other part of the story is that SPACs are not for every startup, and not every SPAC will bring in billions of dollars of funding. Will they work for you? Read on to discover what kinds of businesses are best suited for SPACs and what potholes hide in the SPAC highway to riches.

Defining a SPAC

Start by understanding what a SPAC is. It’s an empty vessel by design. The initials tell why. They are shorthand for “special purpose acquisition company,” and a SPAC is a publicly held company that is formed to raise money for the purposes of acquiring other companies before they go public. That makes a SPAC an alternative to an IPO and also to seeking to be acquired by a larger company. All three are valid routes for a startup to pursue — and experts advise eyeballing all three in plotting a startup’s next moves — but, right now, it is SPACs that have grabbed center stage.

SPACs have a history, not necessarily one their proponents like to remember. Before there were SPACs there were so-called “blank check companies” that raised money in public markets to buy other companies. But blank check companies lacked transparency and investor protections, and the Securities and Exchange Commission (SEC) eventually issued Rule 419, which in effect imposed more investor protections.

That led to the very first SPACs in 1991, said Robert Brown, CEO of ClearThink Capital and a SPAC pioneer.

With SPACs, he said, there are significant transparency requirements as well as investor protections. Nonetheless, for many years, the biggest money players stayed away from SPACs, mainly because of the blank check company heritage.

However, according to Brown, that’s changed. “It took 27 years for institutional investors to get involved in SPACs. Now they are.” Hedge funds, in particular, are active players.

The entry of these large wallets is what, in the last half dozen years, has moved SPACs into a starring role in the entrepreneurial arena.

Why Invest in a SPAC?

“You invest in the team,” said Brown. Look at most SPACs and the founders have credentials showing they developed such and such million-dollar success when employed at Apple, or maybe it is Google or Amazon, or name any mega-business that has nurtured ideas that bloomed into billions.

For SPAC target companies, it’s the team that matters too. Word of advice to executives in target companies: when considering a SPAC buy out carefully study the backgrounds of the main players. Can this team help guide your company to the next level?

As for ownership, deals unsurprisingly vary, but a rule of thumb is that the SPAC managers (aka sponsors) typically own 20% of the SPAC’s equity. They may have put in a few percentage points in cash; the rest is in return for their labors.

The Clock Ticks for a SPAC

With a SPAC, keep your eyes on the calendar.

There are variations, but a SPAC typically has two years to put the money it raised into an acquisition. If a SPAC cannot do a deal in the specified timeframe, the money goes back to the shareholders.

Nobody wants that, not the SPAC founders, not the investors, not the SPAC targets. But with so much SPAC money in the hunt for good acquisitions, the chance that more SPACs will whiff in their dealmaking rises.

That ticking clock should never be forgotten by SPAC targets. The SPAC may be under extreme time pressures, and that can work in favor of the targets who can and often do insist on sweetened offerings when the last clicks of a SPAC’s life are sounding. A month 23 deal will almost always be better for the target than a month 1 deal would have been.

The SPAC Targets

Not every company is a potential SPAC target. Brown says that any business with “a good growth story” could be pursued by a SPAC. But some industries lack the aggressive growth potential that SPAC managers and their investors want. A case in point, said Brown, is real estate where many companies are structured to deliver safe and steady but not spectacular returns.

SPACs want homeruns, not singles. Be realistic about the upside of your startup when scheming to attract SPAC interest.

To IPO or Not

Isn’t a tried and true initial public offering (IPO) the smarter way to enter public markets? Not really, Brown says. He argues that the IPO rulebook, in essence, dates back to the 1930s when Washington D.C. regulators sought to bring significant investor protections along with transparency to Wall Street in order to try to prevent a recurrence of the 1929 stock market crash.

An upshot: “The IPO process can stretch for years,” said Ryan Reiffert, a San Antonio attorney who has been involved in several SPAC deals.

That also means that expenses multiply with an IPO, said Brown.

Another issue: Going public requires “a more mature company,” said Ryan Falvey, managing partner at Financial Venture Studio in San Francisco. A SPAC target has to be a viable business, but it will not always have the depth and breadth of a company filing an IPO.

Going public typically requires a documented track record, one that is fully audited and vetted, along with a fleshed-out staff. A SPAC may be much more flexible with its acquisition targets if the growth potential is there.

Rating the SPAC Offer

Although not commonly acknowledged, a SPAC deal sometimes can in fact be costlier to the owners of a target company than an IPO. How? Merchant banker Peter Goldstein, CEO of the Exchange Listing Company, said that often company owners who go through an IPO retain more equity in the company than they would if they were acquired by a SPAC. That’s a cost that often is overlooked — but it can be a very high price to be paid by the equity owners.

SPACs and IPOs fundamentally are for companies at different life stages. Many early-stage companies definitely will and should look at both options. But in many cases, say the experts, one route will be a far more comfortable fit than the other.

And for some companies choosing to remain private — perhaps in hopes of an acquisition offer from a bigger company — might be the best route of all.

There is no one “right” choice.

The SPAC Slowdown

Have you missed your chance at a SPAC deal? Stifle that pessimism.

Yes, experts say they have seen a recent slowing of SPAC formation. “There’s been a decline,” said Walt Spevak, who leads the CFO practice at Burkland Associates, a full-service fractional CFO and accounting provider.

Catherine Turgeon, a partner in the law firm of Barnes & Thornburg in New York, says something similar: “Deals were happening like gangbusters. There’s more caution in the market today.”

A reason is believed to be an April statement from the Security and Exchange Commission that has forced SPACs to review how they treat the warrants they issue, typically to investors and the warrants convey a right to buy additional shares at a set price. Specifically, the SEC seems to have stated that warrants need be treated as liabilities for the SPAC and, without getting in the tall accounting weeds, this had triggered a slowdown of SPAC activity as players figured out what it all meant.

More broadly, Turgeon said, “the SEC is scrutinizing SPAC deals more closely.”

And investors and targets alike had hit “pause” as the situation clarified.

There also had been a growing sense among some observers that too much investment money was chasing too few solid SPAC targets. “The SPAC market had been quite frothy,” Goldstein said. “Some balancing is happening now.”

But now clarity seems to be emerging, and experts say the SPAC market is recovering.

That means early-stage entrepreneurial companies will continue to need to weigh the options: SPAC, IPO, or staying private.

The decision will rarely be easy. But smile at this reality: More money, in more vehicles, are chasing solid early-stage companies, and that makes for an entrepreneur’s thrill ride. “There now are more options for capital,” says Falvey, “and that means more companies are being created.” Buckle up and enjoy!

Robert McGarvey

Robert McGarvey, a veteran journalist who has long covered startups and small businesses, created and hosts the CU2.0 Podcast for credit union and fintech executives which is at 120 episodes and counting.

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