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Five things to know about SPACs, the exit trend of the year

October 29, 2020
By: Jason Rittenberg

More special purpose acquisition companies (SPACs) have been formed in 2020 than in the last several years combined. These entities have helped some high-profile unicorns go public recently, including DraftKings and Nikola Corp. PitchBook recently suggested, backed by several transactions involving electric vehicle companies, that SPACs may be well-suited to taking companies with relatively high product costs public. Here are five things for tech-based economic development practitioners to know about SPACs.

1. SPACs provide an alternative path to going public

The primary purpose of a SPAC is to take a private company public through a merger, rather than through an initial public offering (IPO). A SPAC, commonly called a “blank-check” company, is essentially a publicly-listed fund established for the explicit purpose of acquiring a private company: through this acquisition, the private company becomes listed in the public market.

2. Exiting through a SPAC is likely easier than via IPO…

Broadly speaking, the primary advantage to startups of exiting through a SPAC instead of an IPO is the ease of working with one partner instead of shopping the transaction to a range of potential investors. In addition to the time savings, a SPAC transaction also entails less public disclosure from the startup.

3. … but SPAC transactions cost more

The tradeoff is that a typical SPAC transaction likely costs the exiting company three to four times more than an IPO would cost. A SPAC will pass along its underwriting fees (typically 5.5 percent of the SPAC’s raise) and also acquire about 20 percent of the target company’s stock. This can be compared against a typical IPO underwriting fee of up to 7 percent.

4. SPACs may value startups more like a venture capitalist than a public investor

For companies with a longer time horizon before substantial profitability, a key appeal of exiting via SPAC may be the opportunity to be valued based on future potential more than current reality. There are two primary reasons for the difference. First, companies face restrictions on the information that can be shared while shopping a potential IPO, and information relevant to financial forecasts is notoriously limited; however, the company can use forecasts during a potential SPAC transaction. Second, the target audience for a potential IPO is broad and diverse, while the target audience for a SPAC is just the SPAC manager (who must then convince their shareholders, an audience that willingly signed up for precisely this type of transaction).

The need to use an alternative exit process to achieve a valuation based on potential may be less relevant now — about 80 percent of companies going public in 2018 lost money during the year before their listing — than in the past. However, many of the high profile venture capital-backed IPOs in recent years have been software and services companies. Conversely, major SPAC acquisitions in the last 18 months have included hardtech companies, specifically in commercial space and electric vehicle manufacturing. If this trend continues, SPACs could provide a viable fundraising and exit strategy for tech companies that still require substantial capital to realize their vision.

5. Are SPACs here to stay?

While the current burst of SPAC activity is new, the structure has been around for decades. The vehicle fell out of favor in part because of questionable decisions and poor performance. While some observers claim SPACs are now guided by new rules and better teams, performance and decision-making issues are already under scrutiny. As with any financial vehicle, investor interest can only be expected to continue if the funds can demonstrate reasonable returns.

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