When I’m surfing, as I paddle out into the ocean, I’m constantly scanning the horizon, looking for that great set to roll in. I don’t want to be content with just a mediocre wave that doesn’t get my juices flowing (but I will take anything since the Gulf of Mexico does not smile upon us often). I’m always looking for the big one — one I can ride down the beach and get the thrill that brings me into the waters.
Of course, I don’t want to get swamped by a monster that will leave me bruised and bloody (but I tend to do this especially during storm surf sessions). And I don’t want to sit in the water all day waiting for the perfect wave, so I do have to catch a wave after my best evaluation.
I take the same approach when it comes to venture capital investing. I’m constantly watching the horizon to see what’s brewing in the market. Where are the startups? What exciting ventures are coming up the pipeline? How are other investors working the field? How are startups and venture capitalists making that merger to meet both their dreams?
The latest wave that has caught my attention is the SPAC. Over the past two years, a number of the most promising startups have gained the capital and financial and management expertise they need through a SPAC merger rather than the traditional IPO.
It’s definitely a wave that has me intrigued. Will it replace the traditional IPO? Is it the right solution for every startup? Is it an attractive vehicle for investors?
What Investors and Startups Should Know about SPACs
Special purpose acquisition companies (SPACs) allow their sponsors to raise buckets of money from investors with the aim of searching for a place to invest that money once it’s in the bank. Therefore, SPACS are also known as blank-check companies or blind pools. Investors are putting their faith in the SPAC organizer (“the sponsor”) to find a rock star investment that will generate a great return.
The blank-check IPOs appeared in the 1980s as a vehicle to snag money from penny-stock investors. But they quickly became a scheme for fraudsters who pocketed the bulk of the money and closed shop without ever finding an investment. This caught the attention of regulators and led to the passage of the Penny Stock Reform Act of 1990 and the SEC adoption of Rule 419 in 1992 that put strict limits on the use of blank-check investment programs. These moves, in effect, drove out the fraudsters and virtually ended blank-check IPOs.
David Nussbaum, chairman of GKN Securities, recognized the need for some startups that were not ready for an IPO but that still needed a vehicle for funding. He relaunched the idea of the blank-check company while meeting the rules set forth by the SEC. These rules require the majority of the funds to be in escrow until an investment opportunity is found. This means organizers cannot access the money for their own gain. The company has a limited time (18-24 months) to find that investment. Investors must have the opportunity to pull out if they don’t approve of the proposed investment. Nussbaum endowed the companies with the SPAC name.
In their initial public offerings (IPOs), SPACs generally offer units, each comprised of one share of common stock and a warrant to purchase common stock. The SPAC’s sponsors typically own 20 percent of the SPAC’s outstanding common stock upon completion of the IPO, comprised of the founder shares they acquired for nominal consideration when they formed the SPAC. An amount equal to 100 percent of the gross proceeds of the IPO raised from public investors is placed into a trust account administered by a third-party trustee. The IPO proceeds may not be released from the trust account until the closing of the business combination or the redemption of public shares if the SPAC is un-able to complete a business combination within a specified timeframe, as discussed below. In order for the SPAC to be able to pay expenses associated with the IPO—the most significant component of which is the underwriting discounts and commissions—the SPAC’s sponsors typically purchase warrants from the SPAC, for a purchase price equal to their fair market value, in a private placement that closes concurrently with the closing of the IPO.Courtesy of McDermott, Will, and Emery
I will write more about SPACs in the future as we watch this play out in the energy transition. There are a few other interesting details about SPACs. A SPAC sponsor may seek more financing “back-end” closer to the time that the blank-check company finds a company to invest. In these cases, since the SPAC is a public entity, sponsors may get a loan and/or raise money from a new investor in the form known as a PIPE (private investment in public equity). In a PIPE transaction, the SPAC identifies an investor or group of investors to provide additional capital to the SPAC in exchange for a private placement of the SPAC’s public securities at a price typically equal to the IPO price.
SPACs in the News Today
SPACs have not played a prominent role in the venture capital/startup/investment world over the intervening decades, but they have boomed over the past two years and drawn attention with some big-time acquisitions.
2019 witnessed 59 SPAC IPOs that netted $13.6 billion in investments. But the numbers have exploded in 2020. As of mid-September, 82 SPAC IPOs have raised more than $31 billion, both records for a single year.
It’s not just the numbers that have caught my attention (though I love numbers, and these numbers are eye-popping).
It’s the deals that have gone down or been announced and the names and values behind the companies:
Virgin Galactic Holding Inc.
British billionaire Richard Branson’s space travel company merged with Social Capital Hedosophia in October 2019, probably the most famous name to enter the SPAC arena at that time. The merger put the value of the company at $1.5 billion. The stock has continued to rise about 35 percent in 2020, though pandemic financial hits to Branson’s other businesses have led him to consider another SPAC deal this fourth quarter.
Online gambling site DraftKings and online gaming site SBTech merged with Diamond Eagle Acquisition Corporation in April. They created a company valued at $3.3 billion and operating under the DraftKings name. Diamond Eagle brought a pedigree to the deal as it is the fifth SPAC that Hollywood executives Harry Sloan and Jeff Sagansky have founded. Their IPO had raised $400 million in May 2019. The merged company’s stock shot up 80 percent in three months after the deal closed.
In fairness to readers ( to show that SPACs are not all wine and roses), I’ve included this stock for the shock value of what happened after the merger. Nikola, a startup making electric pickup trucks and hydrogen-fueled commercial trucks, merged with VectorIQ Acquisition Corporation in June of this year. The merged company lost half its value in the ensuing month. But the initial SPAC investors still were looking at more than a 200 percent return on their investment.
I want to highlight two more recent deals that affect the transportation industry and show how youthful founders are cashing in quickly on SPAC trades. Hyliion Inc. is another truck electrification business located in Texas. I met the founder during his days on the Rice Alliance circuit. It was founded by Carnegie Mellon mechanical engineering grad Trevor Healy. The company is developing hybrid and electric propulsion systems that can be built into heavy truck manufacturers’ existing models. This will improve fuel efficiency and reduce emissions. Hyliion just completed a deal with Tortoise Acquisition Corp. that would put the company’s value at $7 billion.
Tortoise was founded by Ted Cubbage, a former oil and gas executive and former investment banking sector chief at Banc of America Securities. Since announcing the merger in June, Tortoise shares quadrupled. The Hyliion deal also signals how quickly a SPAC arrangement can come together. Tortoise launched its interest in Hyliion in March and completed its due diligence by June. Then it scheduled a stockholder vote on the deal for October 5. This gets Hyliion in the money much faster than if it had pursued the traditional IPO.
One of the latest deals announced in August and due to be completed in the fourth quarter is Luminar. This lidar company was working underground for about five years before bursting onto the scene in April 2017. Now Luminar, whose founder Austin Russell is a mere 25 years old, plans to go public through a SPAC merger with Gores Metropoulos Inc., with a post-deal value of $3.4 billion. Gores Metropoulos is the first SPAC effort from The Gores Group, a global investment firm founded by Alec Gores in the late 1980s.
Luminar seems to be taking the smart approach in a field that’s rushing to get autonomous vehicles on the road. In May, Luminar announced a deal with Volvo to begin installing its lidar and a perception stack in its vehicles’ roofs beginning in 2022. Russell says providing companies with the systems now to improve their driver assistance systems will give the company the economy of scale to grow as they look to build out an autonomous vehicle system over the coming decade.
Pros and Cons of SPACs, for Startups and for Investors
These would seem to be pretty exciting times for SPACs, for both startups and investors. But there might be some caveats.
A report released this summer from Renaissance Capital shows that of 223 SPAC IPOs launched between 2015 and July 2020, only 89 found a merger partner and took the company public. Only 26 of those showed a positive return after the merger. Those 89 companies have delivered an average loss of 18.8 percent. They have also had a median loss of 36.1 percent as of July 24. Contrarily, the average after-market return on traditional IPOs since 2015 is 27.2 percent.
Investors certainly are taking a gamble in placing their faith in the sponsor to find a great investment. However, it’s initially a pretty safe gamble because the money is placed in escrow. It’s also returned to investors if the sponsor fails to find a merger target during the designated time period.
Investors also benefit from their patience when they invest. Besides shares, they also typically receive warrants that allow them to buy additional shares at a cost near their initial investment — if the merged company’s shares rise above a certain threshold.
SPACs vs. IPOs
Startups can gain quicker access to needed capital by finding a SPAC investment, rather than going the traditional IPO route. They also negotiate a fixed price with the investor, rather than relying on the whims of market traders and the timing of the IPO with market conditions. They do risk leaving some money on the table as founders, though. Investors could gain a greater share of increased market interest.
Still, I don’t see SPACs replacing traditional IPOs anytime soon, though SPAC will continue to make inroads. And a SPAC won’t be the best route for every startup. Pitchbook notes, “It will likely work best for capital-intensive businesses and those with a complicated or long-term story.”
If you’ve been thinking about SPACs and how they’re going to impact your industry, let me know your thoughts. I’m still keeping my eye on the SPAC wave and imagine I’ll be shifting some investments into that field.