Will SPACs Save the Public Markets?
Bill Gurley, the Silicon Valley venture capitalist most closely associated with Benchmark Capital, recently published a piece about how the traditional IPO process is broken, that the direct listing alternative is better but not perfect, and that SPACs will solve the problems that both IPOs and direct listings have.
He makes a lot of cogent points, especially about traditional IPOs:
IPOs leave a lot of money on the table by underpricing the initial share price. The spread between initial price and closing price is profit for the banks and their clients. Thus, the cost of capital for going public via a traditional IPO is very high.
Direct listings eliminate much of the bad incentives inherent in a traditional IPO. However, you cannot simultaneously sell shares directly to the public and raise capital.
Gurley further argues that SPACs solve all of these problems:
SPACs have a much lower cost of capital versus a standard IPO. Even before negotiating terms, the SPAC is a cheaper way to go public (because of systematic underpricing). When you are able to improve the terms it becomes a clear no-brainer.
SPACs have access to primary capital which is an advantage versus today’s version of a Direct Listing.
With a SPAC the company has much, much more control. The company negotiates the company value/price directly with the single Sponsor (as well as many other aspects of the transaction). If you like being in control, this is a good way to go. As I mention above, watch out for the PIPE as this has the potential to recreate the oligopoly power of the large institutional investors (and will likely lead to price reduction).
SPACs are a much faster way to become a public company. The SPAC door is much faster than an IPO or a Direct Listing, which will both take 6-7 months from beginning to end. With a SPAC you could be public in two-months [sic] from when you start the process (assuming you have your house in order). This time window may or may not matter to you.
Let’s grant the salience and correctness of Gurley’s points.
However, I’m not convinced, yet, that SPACs will solve all of the problems that he observes.
Following is my attempt to flesh out this line of thinking.
Most SPACs, even today, are traditional “blank check” companies, formed for the explicit purpose of searching for a suitable acquisition target. In other words, most SPACs are shell companies whose sole reason for existing as a publicly traded entity is to find a company interested in effecting a reverse merger.
Most of these targeted companies are small cap companies which no one has heard of. Think companies formed for energy exploration, media and entertainment, real estate development, restaurant chains, etc. While these companies may or may not be good businesses, they are often thinly capitalized, closely held by insiders, and have little to no institutional support.
You can see Early Bird Capital’s list of SPACs here. If you look at these, you will note that many of them have acquired companies, and then have had their stock essentially stall on the markets. I wrote a post about one of these companies, Opes Acquisition Corp, here.
What does this mean for tech companies that want to use SPACs as an alternative for IPOs? Nothing, if, and it’s a big “if”, Bill Ackman’s tontine and other institutional-class SPAC sponsors prove successful.
However. If demand does not arise for Ackman’s (and others’) offerings over time, SPACs will continue to attract marginal companies, and all their attendant stink.
Institutional investors, who have to buy offerings in order for there to be a market in them (whether IPO or direct listing or secondary offerings or SPACs) tend to be risk-averse, and, further, often are prohibited from buying stocks that trade under $10/share. Again, if you review the list of SPACs on Early Bird Capital’s web site, you will note that many of these SPACs’ shares trade at sub-institutional levels.
So on the question of whether SPACs will revolutionize access to public markets: I remain agnostic. Bill Gurley makes excellent points in his post I link to above, but good arguments don’t by themselves create change.