Most private companies that want to become publicly traded utilize the initial public offering (IPO) route. However, another type of arrangement a special purpose acquisition company (SPAC) has gained popularity in the last few years. Let me break down the good, the bad, and the differences between these two forms of raising capital and going public.
In most cases going public allows founders, large early investors, and the company to raise money from public investors. In essence, adding shareholders to their investor base is the goal as staying private too long can actually be detrimental in some cases. Typically two main objectives are met: raise additional money to spur the company’s next growth phase, and second to allow early investors to cash in some of their invested capital. There are lock-up periods, in which after going IPO, rules prohibit sales of shares by early investors usually for 90 days. This prevents “pump and dump” situations. IPO’s are lengthy and expensive for companies as you hire multiple investment banks to underwrite, or examine, your business and try to assign an IPO price range to your shares. Companies then meet with large investors in a series of roadshows presenting their company’s prospects and drawing interest to the IPO. The good thing about this process is the Securities and Exchange Commission (SEC) requires companies to produce many documents about their business that a prospective investor can look over to do their due diligence. Investment banks then gather data on the demand of investors and set a price for the IPO and list the company on a stock exchange.
A SPAC is a much different process as the “sponsor” of the SPAC has an IPO with no commercial operations. The sponsor raises money for the purpose of buying an existing company, hence why they are referred to as “blank check companies”. Typically the shares start trading at $10/share. The SPAC doesn’t list any companies they are pursuing and generally have two years to buy a company or face liquidation and return investors’ money. When a SPAC buys a company the SPAC’s stock merges into the new company and undergoes a symbol change. For companies looking to speed up the process of going public the SPAC route is much quicker. Also, when the overall stock market is going through volatility the IPO process can be more difficult to accomplish. Like any market, with supply and demand “shocks”, the stock market might not be ready for additional shares flooding the exchanges.
The bad side of SPACs from a prospective investor’s point of view is there are fewer disclosures and information on a company relative to the IPO process. Secondly, for existing investors, there is no lockup period typically compared to the IPO process. Therefore you can argue the existing investors, and the sponsor’s fees on the deal, get a better deal than the public investor. Adding fuel to the fire is the existing investors are granted warrants, which are contracts that give the investor the right to buy the stock at a certain price. Let’s say the warrant allows existing investors to buy more shares at $11/share. If the stock is trading at $20/share or more the existing investor right off the bat has the upper hand relative to new investors. This could cause selling pressure on the stock after the SPAC merger goes through. With the recent flood of deals lately my concern is this oversupply of stock could actually hurt the overall market in the near term as the amount of new SPAC shares could outweigh what the market can handle.