Earlier this week we wrote a bit about SPACs, the “hot” financial vehicle of the moment. Over the past few months several people have asked us some variant of “A streamlined path to IPO sounds great, what is the drawback?”
There are several answers to this. There are a lot of questions about how long SPACs will be in favor with the markets. This looks a lot like a Bull market phenomenon, and the regulators may (or may not) eventually start asking questions. But setting aside those, we think there are two primary thinks to keep in mind when transacting with SPACs.
First, public market investors may end up participating in companies they do not fully understand. This is the nature of ‘blank check” vehicles, there are going to be a lot of unknowns. But many of those can be assuaged by the participation feature built into SPACs, which lets IPO investors decide whether or not they want to participate in the SPAC’s ultimate acquisition. In our previous post we linked to a Matt Levine article that outlines how this works out in practice, and it is not simple.
A second, related concern is what happens to the company that is acquired by the SPAC. Here the picture gets very complicated. In the moment, getting acquired by a SPAC seems like a really good option. There are dozens of SPACs out there right now, all with a clock ticking, they are highly motivated to do deals. As a result, valuation multiples are rising, in some cases to levels reminiscent of the heydays of 1999. Every company needs to consider this path, they owe that fiduciary duty to their shareholders.
That being said, at some point, the company will have to contend with the valuation. Many, many companies we have spoken to have a hard time seeing past the valuation, and tend to not think much past that. All of this is very familiar to us. We wrote a book about IPOs, and we started with the statement that IPOs are the wedding, being a public company is the marriage. The same holds for SPACS. Right now, we are in the heady wedding planning and honeymoon stages of this relationship. And like the couple that blows their budget on the wedding reception with dancing unicorns, five chocolate fountains, the Hummer Limo and fireworks, some thought needs to be spared for the future.
A key problem we identified our book (excerpted here) is that the SPAC acquisition, just like the IPO, is a transition from one group of well-known investors to a group of near strangers in the form of public market investors. This creates a conflict as the outgoing shareholders tend to push for a higher valuation. This leaves the company with the risk of very quickly disappointing this new group of strangers. First impressions matter, and a company that misses its first two earnings estimates as a public company has a nearly impossible time of winning back investor confidence.
Admittedly, a SPAC is different. For one thing, the SPAC sponsors stick around. And smart companies can take the time to vet and get to know their new board, a subset of the new investors. This is not perfect, as the SPAC sponsors have that strong incentive to do a deal, but at least it relieves some early board pressure on the executive team.
We spend a lot of time working with companies to cope with this and prepare for being a public company. The abbreviated path to going public that is a SPAC greatly shortens the company’s time to prepare for being public. Set aside all the accounting and other process changes this require (which can generally be solved with time and money), companies also have to learn the new language that is public company investor relations. This is a very different dialect of finance than private companies use to speak to venture investors. There is of course much more focus on near-term, quarterly developments. In the past, companies had to learn how to translate their glossy slides showing a bright but distant future, into a much more prosaic set of accounts focused on cash flow and quarterly results.
So we have found it very interesting the way that many of the SPAC deals that have closed recently have included long term projections going out four or five years. Public market investors have historically been averse to thinking more than eight quarters in the future, but they now seem to be willing to extend their time horizons. As we said, this feels like a Bull Market phenomenon.
We do not want to paint with too broad a brush. Many of the SPACs, and the companies they acquire, will turn out to be great companies and great stocks. Some, will not, adding a new acronym to the Street, does not change the risks.
However, for companies and management teams that are taking the SPAC path, they need to spend some serious time thinking about how they will operate and communicate with public markets long after the glow of the SPAC has faded.