Analysis breaks down private and public market dynamics that make IPO alternative appealing to stakeholders
While the inherent benefits of special purpose acquisition companies (SPACs) have always been clear to sponsors, conditions borne out of recent developments in the private and public markets have underscored their appeal to multiple stakeholders.
In a recent analyst note, Pitchbook outline laid out different factors and trends that have made SPACs the current vehicle of choice for private companies to make their debut in the public markets.
“The sustained volatility and the distinct price declines earlier in 2020 made IPOs and direct listings impractical options for the majority of private companies, which is where SPACs have found an opportunity,” Pitchbook said in its note.
Aside from the fact that direct listings prohibit private companies from raising new capital as they transition into the public markets, selling shares through both direct listings and IPOs involve an auction process that can be difficult to complete in a volatile market.
“Since a SPAC is essentially just a large box of money, the listing of a SPAC necessitates a much lower level of diligence than a similarly sized IPO of an operating entity,” the note said.
The relative scarcity of IPO listings in recent years has left investors chomping at the bit for any opportunity to put their capital behind the next great growth story, which has led to the elevated demand for SPACs so far this year. For their part, the current demand for SPACs has allowed both serial sponsors and new entrants to upsize the amounts they raise in their IPOs.
“Sponsors are also potentially assuming that the market dynamics driven by the pandemic will create a host of targets at attractive valuations,” the note said. “This frenzy in new SPAC listings could hinder performance for these vehicles as competition heightens, which could inflate some valuations.”
For investors, Pitchbook said, a SPAC is akin to a growth equity fund with a single portfolio company, only with a truncated time horizon; aside from the potential returns from a successful combination, they stand to get an added kicker in the form of warrants. SPACs typically have redemption rights built in for investors, allowing them to get their money back if an announced acquisition’s target or price is not to their satisfaction.
“After buying into the SPAC IPO, the investment is essentially committed capital, similar to an allocation to a PE fund that is waiting to be called but resides within the institutional investor’s public equity strategy,” the note said.
The target companies of SPACs, meanwhile, stand to relieve themselves of the traditionally burdensome cost and process of becoming a publicly traded business. According to Pitchbook, the reduced time commitment is the primary appeal of SPACs for companies eyeing a path to the public markets. Rather than trying to woo a host of investors through a road show, they’ll have to deal with just the SPAC, smoothening the deal pricing process.
“A company can transition from identification to completion in around four to six months as opposed to the year or more it takes for an IPO,” Pitchbook said.
A SPAC acquisition also provides for more creative deal structuring, letting the principals of private companies raise more capital by selling a larger proportion of equity from the SPAC itself or a PIPE (private investment in public equity) deal, according to the note.