SPACs vs. Traditional IPOs

By Benzinga on CFO.com

The rise of SPACs was one of the big stories for investors in 2020. Based on the record number of SPACs filed and money raised in early 2021, the trend looks primed to continue.

Bank of America analyst Michael Carrier shares the positives and negatives of the SPAC market for both investors and private companies to consider.

SPACs or special purpose acquisition companies, have been around since the 1990s. Also referred to as “blank check” companies, SPACs are now a popular vehicle for private companies to hit the public markets.

In 2020, 248 SPACs came to market. This was an increase of more than four times compared with the prior year. Carrier says the rise stems from investors seeking alternative sources of yield, private companies pursuing alternative routes to market, and retail investors having a bigger appetite for private assets.

The units that SPACs offer also are particularly attractive to arbitragers, Carrier said.

Units include a common share and in most cases a portion of a warrant. SPAC warrants are options to buy a share later, for $11.50 in most cases.

The timeline of a SPAC consists of several phases, according to Carrier. SPACs do marketing, raise capital and find a target during the premerger announcement phase.

The SPAC makes a deal announcement in the next phase. After the deal is announced, a redemption and vote phase takes place where shareholders can exchange their shares for net asset value, typically $10 plus interest, if they don’t like the deal or shares are trading below that level.

Private companies are flocking to SPAC deals for a few big reasons.

One is that a typical SPAC comes with a 2% underwriter fee and 3.5% fee at completion compared with 7% for a traditional IPO.

The timeline of a SPAC is usually three to four months versus up to a year with a traditional IPO.

Another big positive is that private companies are able to present forward-looking guidance for revenue and profitability five to 10 years out. In a traditional IPO, companies can share their past financials and talk about a total addressable market size but cannot get into detailed financial projections.

Investors have benefited from SPACs as well, with the common one being the ability to redeem shares back at the IPO price.

SPACs also come with a time limit to get a deal done, which gives investors a shortened horizon for a possible upside.

Another big reason investors could be flocking to SPACs is that they provide a way to invest in private companies that could see high growth in the near future.

Investors place a lot of faith in the sponsors of a SPAC to find a good target, Carrier said. The risk with investing in a SPAC before a deal announcement is that a good deal may not be reached.

A sponsor’s stakes in the SPAC and warrants are both factors that could lead to diluting the company’s value in the future, Carrier cautions. The “promote” on a typical SPAC deal is 25% of the IPO proceeds.

There is also the risk of investing in early-stage startups and pre-revenue companies. Once a vote to merge has happened, investors are no longer able to redeem shares at net asset value and could see their shares go to $0.